Rates and housing risk: beware outsourcing policy to regulators

The Reserve Bank of Australia would dearly love to be like Dr Doolittle’s amazing pushmi-pullyu, able to face both directions at once. Cutting interest rates to encourage economic activity (and a lower dollar), but at the same time raising rates to dampen the superheated Sydney housing market. But unlike the mythical vicuna, the RBA board just cannot have it both ways.

So after being dragged to its second rate cut this year, the RBA looks like it will throw up its hands and hospital pass the housing problem to someone else – the Australian Prudential Regulation Authority.

Since late last year, the RBA and APRA have been brainstorming what could be done about the rise in investment mortgage lending, which along with foreign investors, appear to the main culprits in runaway house price increases. In December last year, the two regulators announced they had written to banks reminding them they should be “prudent” about their lending practices.

In fairly benign language APRA warned bank CEOs that if banks did not pay heed they “may institute further supervisory action” and threatened such action “could include increases in the level of capital” that individual banks are required to hold.

In its Dear CEO letter, APRA also drew a line in the sand pointing out that growth in lending to property investors “materially above a threshold of 10%” will be an important risk indicator in considering the need for further action.

That particular letter must have sat in the “do after the holidays” pile because the latest figures show a 10.4% increase in lending for property investment for the year to the end of March. Only the Commonwealth Bank stayed within the regulator’s guideline - just.

Market jitters

When APRA head Wayne Byres brought this profligacy to everyone’s attention and warned of further action, the markets got spooked and bank shares were sold off by nervous investors.

But why would banks take APRA’s warnings that seriously? In an ongoing stoush resulting from APRA’s cave-in to the banks on the so-called Committed Liquidity Facility (CLF), it is reported that some of the big banks are not cooperating on the relatively simple matter of reporting which mortgages make up their Residential Mortgage Backed Securities (RMBS). Given the amount of low-risk profits banks make from investor lending (due to the magic of negative gearing) it is highly likely they would turn a deaf ear to APRA on this one.

The three little pigs (also known as the Council of Financial Regulators) may puff and blow all they like but the banks will continue to lend to property investors until the rules are changed and it becomes unprofitable. But that is another discussion.

Regulating the economy

Should APRA have any role at all in implementing economic policy?

In 2012, the RBA and APRA issued a document attempting to clarify the roles of the respective regulators – not an easy task. In obtuse regulatory speak, APRA’s role was described as:

…to promote financial system stability in Australia while balancing its objectives of financial safety and efficiency, competition, contestability and competitive neutrality.

In addition to being the supervisor of individual banks, credit unions, insurance companies and the largest superannuation firms, APRA is also what is known as the macro-prudential, systemic regulator.

APRA’s remit is to take actions to reduce so-called “systemic risk”, specifically in the case of clearing and settlement facilities, and more generally and opaquely by “limiting the systemic risks associated with breaches of financial promises”.

Does lending to property investors pose a systemic risk?

Depending on one’s position, borrowing to purchase investment properties may be a good thing (if one is benefiting from negative gearing), or bad (if one is frozen out of the housing market). However, this is an economic, tax and social issue rather than a banking one.

The question is whether this is a risk sufficient to cause a major bank to fail and bring other banks down with it.

In reality, negative gearing is as close to a risk-free profit as banks can get - after all taxpayers pick up the tab. Banks are more likely to fold as a result of other systemic risks, such as lending to iron ore producers.

The role of APRA in this issue is disquieting. Where did the 10% growth “limit” come from? [It turns out it was agreed with ASIC and RBA]. Why not 5% or 15%, what is the economic purpose of this very specific limit?

And why would shareholders not be informed of which banks are being targeted by APRA, as Byres has intimated? It is not APRA’s role to control continuous disclosure requirements, that is up to ASIC.

If the government wishes to dampen down the housing market, using banking regulators to do the hard work for it just won’t work. Banks are too far removed from the problem to be able to force meaningful change.

But more than that, banking (and other) regulators should not be used as agents of short-term government policy, they should be independent agencies warning when policies start to go wrong.

Pat McConnell does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.