APRA Wants to Prop up Banks and Property Market
Like many Australian investors, you probably overestimate the size of the Australian stock market.
In truth, by both domestic and global standards, the ASX is relatively small.
Its total value, at $1.7 trillion, is less than Australia’s $2.1 trillion superannuation kitty. In fact, it’s smaller than the value of outstanding mortgages across the nation.
What’s more, it’s absolutely tiny compared to the massive $29 trillion New York Stock Exchange. Or even the $6.6 trillion Shanghai Stock Exchange. Globally, the ASX ranks 16th by market cap, just below the Stockholm Stock Exchange.
What sets the ASX apart from the rest of the world, however, is the dominance of the banking sector.
Collectively, the Big Four banks are worth $380 billion. That’s one fifth — 22% to be exact — of the total value of the ASX.
Throw in the smaller banks — Suncorp, Macquarie Group, AMP Bank and the like — and the total market cap of Aussie banks jumps to $500 billion, or 29% of the ASX market cap.
Given the Aussie banking sector is a key part of the economy, it’s easy to understand why so many people are captivated by the Royal Commission into banking.
But, like them or loathe them, bankers and financial advisers are people too. Dangle massive bonuses in front of them and their duty and responsibility to do good by customers changes.
As businesses, banks prioritise themselves first, shareholders second, and the rest of us distant last.
Unfortunately, the biggest problem is that the people who are meant to keep the banks in check are failing us badly…
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Expanding the banks one brick at a time
As details of the Royal Commission emerge, we’ve discovered that the Australian Prudential Regulation Authority (APRA), the regulator of the financial services industry, is nothing but a toothless tiger.
APRA is meant to oversee and regulate banks. It’s meant to ensure bankers don’t become too overzealous in their ability to lend money.
But consider that APRA may be nothing more than an authority keeping the banking industry solvent.
A key part of expanding the Aussie banking sector involves the issuance of home loans.
In 2014, APRA was concerned about the rate of home loan expansion. So it imposed caps on lending.
Around this time, APRA claimed it was the Reserve Bank of Australia’s fault that the spate of new loans was getting out of hand, with low interest rates encouraging more investors into the housing market.
APRA warned that if the banks wouldn’t regulate themselves, they would do it for them. So it did.
The investor loan crackdown saw APRA impose a 10% limit on the creation of new investor loans.
The only problem was that the Big Four banks in Australia already kept their investor loan growth at 10% a year. Take a look:
Big Four banks: Investor loan growth 2015
Source: Business Insider
In fact, it was the smaller community-run banks that were growing their investor book over and above the 10% cap.
In March 2017, APRA restricted all interest-only investor loans to a maximum of 30% of total new loans written.
At the time, the average was 40% — too high by international standards, according to APRA. The regulator claimed this step was critical to avoid a US subprime-style housing bubble meltdown.
APRA chairman Wayne Byres said:
‘APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile.
‘We will therefore be monitoring the share of interest-only lending within total new mortgage lending for each [lender] and will consider the need to impose additional requirements…when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.’
In the 12 months since, Aussie house prices have fallen 0.4%. That’s almost a statistically irrelevant percentage. And while it suggests the cap has curbed demand somewhat, it’s by no means significant. In fact, Melbourne’s property market has actually grown by 3.8%.
In any case, knowing fully well that the attention of the nation was fixated on the Royal Commission and the banks, APRA recently seized the moment to change the rules once again.
Less than a month ago, APRA claimed that the 10% lending growth cap was reaching the end of its useful life, suggesting that, at the aggregate level, demand had subsided.
With the banks’ dirty laundry out for all to see, APRA feels lenders are now capable of managing these lending standards themselves.
All of which is to say that the 10% growth cap will be gone shortly. Even though the 30% cap on interest-only investor loans will remain, this will likely open the floodgates again.
APRA is foolish to believe the banks will take it easy on investor loan growth.
I have no doubt many of the smaller banks will take this opportunity to resume lending at high levels once more.
Temporarily, banks may have changed their internal lending standards. But this prudence won’t last long.
Banks are in the business of making loans. And when they account for one third of the economy, Australia can’t afford to have the banks go bankrupt.
To avoid that, APRA will likely continue tweaking the rules to prop up the banking sector and inflating the housing bubble.
Editor, The Daily Reckoning Australia