Why mortgage lending will continue to tighten

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By Leith van Onselen

Labor remains unflappable in the face of the housing bust. In addition to doubling down on its negative gearing and capital gains tax policy, Labor has vowed to implement in full the banking royal commission’s recommendations. From The AFR:

A Labor government will seek to carry out all the recommendations of the royal commission into financial services and both sides of politics will need a “very, very, very good reason” not to adopt any finding, shadow treasurer Chris Bowen says. “Your default position should be if the royal commission recommends it, it shall be done”…

Mr Bowen said he and Opposition Leader Bill Shorten had been “vindicated” for pressing for the inquiry given the misconduct that had been exposed. “It’s one of the big calls we’ve gotten right”…

The most important likely recommendation to arise from the royal commission is the effective banning of the Household Expenditure Measure (HEM) – a relative poverty measure – from being the default credit assessment tool used by lenders.

This is significant as the commission’s interim report found that “three out of every four home loans examined in the course of APRA’s 2016/2017 targeted review into home lending practices… assumed that the borrower’s household expenditures were equal to the relevant HEM”.

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The interim report explicitly attacked the banks for failing to fulfill their legal obligations to make reasonable inquiries about borrowers’ financial situation, as well as properly verifying their information, thus foreshadowing tougher regulatory action down the road.

Already, we have seen banks move away from the HEM in preparation of the royal commission’s final report, due out early next month. For example, CBA and ANZ were pinged for defaulting to the HEM for three quarters of their loan assessments. CBA has already pulled that back to 40-50%, whereas ANZ has vowed to reduce its use of the HEM to one-third of its mortgage applications.

If the HEM does end up being effectively outlawed as a credit assessment tool, then something like one quarter of loans that were formerly rubber stamped would no longer be available, or much smaller, as income and expenses are assessed properly.

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The banning of the HEM would represent the final nail in the housing bubble’s coffin.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.