Australian homes and businesses are vulnerable to financial stability risks as rising inflation and interest rates continue to pressure the global economy.
Key points:
- Australia’s financial system is well-placed to deal with global economic shocks
- The share of households falling behind on their mortgage payments has picked up a little
- Despite rising rates, the vast majority of households are servicing their debts
A growing share of Australian households have also been seeking financial counselling as interest rates have risen, with a small but rising share of borrowers on the cusp of financial stress, or already in its early stages.
The latest Financial Stability Review released on Friday by the Reserve Bank says the share of owner-occupiers with variable-rate mortgages whose essential expenses and mortgage costs exceeded their income in July 2023 is estimated to be around 5 per cent, up from around 1 per cent in April 2022.
It says these households are likely to have little capacity to cut back on spending, and 30 per cent of them are at risk of depleting their buffers within six months – and so are at higher risk of falling into arrears on their housing loan.
It says the National Debt Helpline has also seen demand for its services increase by around one-quarter from the low level experienced during the COVID-19 pandemic.
However, it says only a “very small share of borrowers” are in negative equity (where the value of a loan exceeds the value of a property), and banks are not too concerned at this stage.
“While budget pressures have led to an uptick in arrears and personal insolvencies, the vast majority of households continue to service their debts,” it says.
“Lenders in the Bank’s liaison program have reported that borrowers have been more resilient than expected in their ability to service their debt, given the sharp rise in interest rates.”
Some households struggling, but the banking system is fine
The review of Australia’s financial system is updated every six months.
In Friday’s release, it says if inflation and interest rates remain high for an extended period, it could lead to a significant deterioration in credit quality that “could lead to lenders cutting back on the provision of credit”.
It warns that “disorderly declines in asset prices” could disrupt the functioning of the financial system.
While stressing that Australia’s banks are well-positioned to absorb any shock, the review says financial institutions could become more cautious about lending given the stresses on households struggling to meet higher mortgage repayments.
“In an adverse scenario where growth slows and unemployment rises more than expected, loan losses for banks would increase,” the review says.
However, it says high provisioning and capital levels “leaves banks well-placed to manage the increase in arrears limiting the impact on credit provision in the economy”.
“Systemic risks are limited due to Australian banks’ low exposure and conservative lending practices,” it says.
When it comes to Australian households, the review says households are well-placed to adapt to challenging economic conditions, but warns that “some are vulnerable to further shocks”.
“While almost all borrowers have been able to make adjustments that have allowed them to continue servicing their debts and cover essential spending, the share falling behind on their mortgage payments has begun to pick up from a low level,” it says.
It says in a hypothetical situation where interest rates were to rise from 4.1 per cent to 4.6 per cent, the share of owner-occupiers with variable-rate mortgages whose essential expenses and mortgage costs exceeded their income would rise from 5 per cent to 7 per cent.
“Of these borrowers, about 30 per cent are at risk of depleting their buffers within six months (equivalent to 2 per cent of all variable-rate owner-occupier borrowers),” it says.
It says those households would need to draw down on available savings buffers or find other margins of adjustment, such as additional work, to meet their essential expenses and scheduled mortgage payments.
But the review says “the vast majority of households” are continuing to service their debts, even though variable rate borrowers, who account for three-quarters of all loans, have seen repayments increase between 30 per cent and 50 per cent since May 22 when interest rates started rising from 0.1 per cent.
The RBA also doesn’t appear to be alarmed about a feared “mortgage cliff” when fixed interest rate borrowers rollover over a higher variable interest rates world.
“They (fixed rate borrowers) do not appear to be at more risk than similar borrowers and in fact have benefits from having fixed their interest rates at a very low level for an extended period”.
Global risks to the financial system
The review singles out China as a major global risk where stress in the country’s ailing property sector and other imbalances could spread to the rest of the Chinese economy and “reverberate globally”.
Other potential flashpoints include banking systems in the United States and Switzerland where global financial risks remain “elevated” despite intervention by governments to provide support and in the case of Credit Suisse, a forced takeover by rival UBS.
“Higher than anticipated loan losses resulting from rising unemployment could lead to a tightening in lending standards, amplifying the downturn,” the review warns.
Other risks to financial stability include “the increasing intensity of cyber attacks” on financial institutions, rising geopolitical tensions stemming from the war in Ukraine and effects on climate change on the global economy.
Global sharemarkets have been volatile in recent days on fears that interest rates in the United States will stay higher for longer given resilient inflation.
The Reserve Bank left interest rates steady at 4.1 per cent earlier this week, but some economists think fears about inflation and rebounding real estate prices could prompt a November rate hike on Melbourne Cup Day.