RBA warns on loan risks

INTEREST-ONLY housing loans, and loans for 100 per cent of the property's valuation, could be scrapped in future after the Reserve Bank's annual conference heard that they inflate property booms and busts.

Three papers from key economic institutions found requiring borrowers to finance part of the purchase themselves would help to moderate future housing booms - and reduce the scale of the subsequent bust.

Senior officials of the Reserve Bank, the International Monetary Fund and the Bank of International Settlements separately reported that setting maximum loan-to-valuation ratios could help reduce the damage housing cycles cause to the economy.

The Reserve Bank paper, co-authored by the head of its financial stability department, Luci Ellis, also found similar benefits from requiring borrowers to pay down the capital of the loan over time, rather than taking out interest-only loans.

Most Australian home loans already meet both criteria. But many housing investors take out interest-only loans for 100 per cent of the property's valuation, as do investors in commercial property.

Housing booms and busts, in the United States, Spain and Ireland, were the main cause of the global financial crisis. While Australia escaped relatively unscathed, the Reserve has used this year's conference to work out how the booms and busts could be better regulated in future.

Australia's banks are free to lend as they see fit. But the Australian Prudential Regulation Authority makes them set aside extra capital to cover loans for more than 80 per cent of a property's valuation. There are no bars to interest-only loans.

In a survey of housing policy options, senior IMF researcher Giovanni Dell'Ariccia found the most promising were setting limits on loan-to-value ratios, and borrowers' debt-to-income ratios.

"Containing leverage will reduce the risks associated with declines in house prices", he said. "This will likely result in fewer defaults when the bust comes ... (and) reduce the risk that a large sector of the real economy ends up with severe debt overhang."

The Reserve's paper, by Ms Ellis, Mariano Kulish and Stephanie Wallace, concludes that the terms of loan contracts "matter a great deal for financial stability... Loans that build in some amortisation of principal over time are less destabilising.

"Short-term loans that must be rolled over are particularly dangerous. This helps explain why commercial property lending ... has been so problematic for financial stability."

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We're moving away from big banks

AUSTRALIAN borrowers are dumping their banks to get a better interest rate. A record 35 per cent of all housing loans written in 2011-12 saw borrowers refinance existing mortgages with a new lender, rather than buy or build new property.

Bureau of Statistics figures show all the growth in new lending to owner-occupiers in the past year was in refinancing. Every week, the banks and other lenders refinance $1 billion of existing loans at better interest rates, as borrowers freed from exit fees vote with their feet.

In the year to June, lending to refinance loans swelled by $7.3 billion or 17 per cent from a year ago, and by 30 per cent from two years ago. By contrast, lending to buy existing real estate fell by almost $1 billion, while lending for new construction rose just $24 million.

Australian Prudential Regulation Authority (APRA) data shows the big four banks have been the losers. This year their market share shrank slightly as growth in their stock of home lending was far outpaced by the smaller Australian banks and wholesale lenders.

But the big four remain dominant. At June 30 they held 86 per cent of all the banks' housing loans, up from 75 per cent four years earlier, before they were allowed to swallow their two biggest rivals.

But in the first half of 2012, the smaller banks won 24 per cent of the growth in the stock of home loans. And the banks collectively saw new lending shrink, with all the growth going to non-bank lenders.

The data suggests Treasurer Wayne Swan's campaign to get unhappy borrowers to vote with their feet has been enough to make the big banks take notice.

A spokesman for Mr Swan said the figures show the government's reforms have stirred competition in banking, to the benefit of mortgage holders.

"People are taking advantage of our ban on mortgage exit fees," he said. "This has put more power in the hands of Australian families: they can walk down the street to another lender if their current bank isn't looking after them."

Victoria, New South Wales and Western Australia have been the main battlegrounds. In Victoria and WA, 37 per cent of home loans in 2011-12 were for refinancing, and in NSW and South Australia, 36 per cent.

The bureau figures report the new loans written each month, and they show all the growth this year has gone to non-bank wholesale lenders. In trend terms, between December and June, monthly lending by banks shrank by $224 million or 2 per cent, but wholesale lenders lifted lending by $69 million or 27 per cent.

Excluding refinancing, seasonally adjusted new lending rose 2 per cent in June, suggesting the Reserve Bank's interest rate cuts have injected life into the market, as intended. The growth went mostly to finance new construction, rather than existing real estate.

The APRA figures show that even though new lending fell in 2011-12, the stock of money we owe the banks in housing loans grew by $83 billion or 8 per cent. Smaller banks gained $10 billion of that, with Macquarie Bank more than doubling its lending to $3.8 billion, and the Bendigo and Adelaide Bank's lending up by $3.4 billion or 16.5 per cent.

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Banks' recovery rate since GFC of awesome interest

IN THE year to September 2007, just before the global financial crisis, Australia's big four banks made after-tax profits of $16.6 billion. People thought that was huge. Ian Macfarlane, former governor of the Reserve Bank, used to wonder how Australia's banks made such big profits.

In the year to September 2011, the big four made after-tax profits of $24 billion. Many, perhaps most, Australian businesses are doing worse than in 2007. Yet the banks now make profits almost 50 per cent bigger than at the peak of the boom. How much is enough?

ANZ's Australian CEO, Philip Chronican, says it decided to raise interest rates on home mortgages and small business loans by 0.06 percentage points because its margins in retail and business lending had been squeezed in recent months. I don't doubt him, but since when have banks seen these margins as fixed?

Not in the Howard/Costello era, when from 1997 to 2007 they moved in lock step with the Reserve Bank, passing on each rise and fall in the bank's cash rate, no more, no less. That had nothing to do with funding costs or margins. They were just too frightened of Peter Costello to step out of line.

Not since the GFC came. It broke their business model, so they had to raise their margins. The government guarantee and a history of sensible lending allowed them to sail through the GFC with profits only slightly lower. But once out of danger, they kept raising margins; and now their profits have soared.

Yesterday's moves were modest: on a typical mortgage, $13 a month from ANZ, $20 from Westpac. Mortgage holders are the lucky ones. You can go to the bank and demand a discount, or walk out and take one of the many cheaper loans available on the web (websites such as Canstar or InfoChoice can point you to them).

Small businesses are the captive customers. The Reserve tells us that in January, the big banks' average rates were 6.59 per cent on mortgages, 6.70 per cent on big business loans, but 8.25 per cent on small business loans. Small business can't just walk over the street and be sure of finding another loan. And it's their profits the banks are taking.

One question: will the banks pledge to reduce their interest rates in future whenever funding costs fall?

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Good news for bad reason: rates tipped to fall

THE Reserve Bank will cut interest rates four times over the next year or so, as Australia slumps into a marked slowdown, with unemployment rising and consumers saving instead of spending, Westpac has forecast.

Breaking ranks with other economists who forecast rate rises and a boom year ahead, Westpac's chief economist, Bill Evans, said growth would remain stuck in second gear in 2011 and 2012 - forcing the Reserve to take back its last four rate rises.

''Interest rates are too high in Australia, given the state of the non-mining sectors of the domestic economy,'' Mr Evans said. ''A downward adjustment is required to avert a damaging round of contraction.''

His forecast comes as ratings agency Standard and Poor's warned there is now ''at least'' a 50 per cent chance that it will downgrade $14 trillion of US government debt unless Republicans and Democrats agree on a $4 trillion deficit reduction package.

If the stalemate over the deficit is not resolved by August 2, the US will run out of money and default on debt repayments. Analysts say this would trigger a second global financial crisis.

US President Barack Obama wants to cut $US4 trillion from forecast deficits over the next 10 years by cutting spending and closing off more than 150 tax loopholes. Republicans are insisting that the loopholes remain.

Mr Evans predicts that global growth will be below average in 2012, with Europe possibly in recession. Slow global growth will slash Australia's export prices and send the Australian dollar back below the US dollar.

He forecast that the Reserve would take time to concede that it had overdone the monetary tightening. But Westpac expects the first rate cut in December, to be followed by cuts every three months or so in 2012. If it is right, that would cut $250 a month off the cost of servicing a typical $300,000 mortgage, saving home buyers $3000 a year.

But what would be welcome relief for home buyers would also see widespread job losses, particularly in retailing, wholesale trade, manufacturing, non-mining construction and finance.

Westpac predicts unemployment will rise from 4.9 per cent now to 5.7 per cent within a year. That implies 100,000 more people unemployed.

''The Reserve Bank has made it clear that it welcomes softer activity in the household/housing sector to create [spare] capacity for the mining boom,'' Mr Evans said.

''We assert that it will see it is over-achieving, given that consumer spending and housing investment represent 60 per cent of economic activity, while mining investment is around 4 per cent.''

He said concerns over the carbon tax have contributed to a slide in consumer confidence, now at its lowest level since the global financial crisis.

Mr Evans said a similar slump before the GST came in lasted until some months after it had taken effect. ''With the carbon price not due to be introduced until July next year, it is likely to remain a drag on confidence for some time yet,'' he said.

The sharpest fall is in households' perception of their own financial situation. Mr Evans said households' forecasts of where they will be in 12 months' time is ''at extremely weak levels, only recorded on three previous occasions - during the recessions of the early 1980s and early 1990s, and in mid-2008''.

His grim forecast sent the Australian dollar plunging half a cent in half an hour on financial markets yesterday. Futures markets are predicting one or two rate cuts in coming months, but a Bloomberg survey found most market economists still predicting a rate rise by November.

David Jones chief Paul Zahra this week blamed the carbon tax debate for causing the worst conditions for retailers in 20 years.

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