One-quarter of homeowners could be spending 30% of their income on loans by late-2023, RBA says

Reserve Bank warns households with high debt relative to income are ‘particularly vulnerable to shocks’

The Reserve Bank of Australia says more than a quarter of mortgage holders will be spending at least 30% of their income to repay debt if the central bank’s key interest rate peaks at the level expected by investors in mid-2023.

The RBA’s semi-annual financial stability review, released on Friday, found Australian households, firms and banks were “entering this more challenging environment in a strong financial position”, as interest rates rose and global economic headwinds strengthened. Strains, though, were unevenly felt and would likely intensify.

“A small number of borrowers have both high debt relative to their income and low saving and equity buffers,” the review states. “These households are particularly vulnerable to shocks.”

The RBA report comes amid a global growth slowdown as central banks hike interest rates to curb inflation. Energy shortages, particularly in the wake of Russia’s invasion of Ukraine, were also contributing to price pressures for households and businesses in many nations.

“A deteriorating geopolitical environment has the potential to lead to widespread disruptions to global trade and capital flows,” the bank said. “It could also magnify the risk of cyber-attacks on key institutions and infrastructure.”

These economic concerns were echoed on Friday by the federal treasurer, Jim Chalmers, who said “the picture is dynamic, it’s increasingly dangerous, and it sets the scene for new problems which can emerge without much warning”.

“No responsible government could ignore [these challenges]”, Chalmers said, adding the government hadn’t “changed our position” on the stage-three tax cuts due to come into force in mid-2024 that would lop revenues by $243bn over a decade.

The RBA said more than a third of mortgage holders had built up at least a two-year buffer in loan repayments, shielding them somewhat from rate rises. Since May, the bank has lifted its cash rate 250 basis points, including Tuesday’s record sixth consecutive monthly increase.

The bank modelled the effect of further increases including to 3.6% – as markets now predict. Assuming incomes grow in line with current forecasts, the percentage of borrowers spending more than 30% of their income to repay loans would rise to about one in four by the end of 2023. At the current 2.6% level, the share is a bit higher than one in five.

The RBA also says if the cash rate were to rise to 3.6% (roughly where markets are betting) the share of borrowers facing a minimum debt-servicing ratio to income of 30%+ would increase to about a 1/4 of borrowers by the end of 2023. Lower income households would be hardest hit.

— Peter Hannam (@p_hannam) October 7, 2022

“Borrowers with projected debt-servicing ratios above 30 are much more likely to be in the lower half of the income distribution for variable-rate borrowers than other borrowers,” the RBA said. “[A]round one-third are estimated to have low prepayment buffers – equivalent to less than three months’ of minimum payments.”

Economic strains were not just being felt by those with mortgages, the bank said, noting renters tended to have less spare income and thinner savings buffers, “making them more vulnerable to increases in rents and the cost of living more broadly”.

Information from the RBA’s liaison crews also suggested demand for a range of social and community services – including low-cost housing and food services – had lately risen. “Increases in indicators of financial stress are likely in the period ahead,” it said.

For now, at least, business bankruptcies were generally subdued – with the construction industry one notable exception. Commercial banks were also yet to report an uptick in provisions to account for delinquent loans.

The RBA also notes that while some households and businesses are doing it tough (esp. in construction), the overall health of the bank balance sheets - with falling bad debt provisions - remains good (and therefore a plus for financial stability).

— Peter Hannam (@p_hannam) October 7, 2022

While the domestic outlook remained relatively benign, the same was not true for some major economies. How China was faring, for instance, would influence Australia’s fortunes particularly if demand for commodities in the world’s second-biggest economy weakened.

Despite government efforts, China’s property sector “remains under considerable stress”, the RBA said. “This threatens to expose longstanding vulnerabilities affecting local governments, the shadow banking sector and small banks.”

While market volatility and even cyber-attacks pose near-term threats to financial stability, global heating also could not be ignored.

“[C]limate change and extreme weather events have the potential to affect economies and societies on a global scale, and thereby present a systemic challenge for private institutions and policymakers,” the report states. “Both physical and transition risks could result in large losses for financial institutions that are yet to put in place adequate risk controls and resilience strategies.


Peter Hannam

The GuardianTramp

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