RBA paves way for macroprudential mortgage curbs

In mid-June, RBA Governor Phil Lowe stated that the Council of Financial Regulators (CFR) – i.e. RBA, Treasury, APRA and ASIC – are actively examining macroprudential tools to curb the mortgage/property market in the event that credit accelerates, and that these tools would come into effect before the RBA considers lifting interest rates.

In this month’s Monetary Policy Decision, Phil Lowe also stated that the cash rate will not be lifted “until inflation is sustainably within the 2 to 3 per cent range”. Lowe elaborated that “it is not enough for inflation to be forecast in this range”, rather “we want to see results before we change interest rates”.

Our prediction, as outlined in this month’s member’s report, is that Phil Lowe will use his position as chair of the CFR to implement some form of macroprudential restrictions before the end of the year, the impact of which will dampen mortgage/property price growth heading into 2022.

The RBA already appears to be laying the foundation, releasing a research paper showing that macroprudential measures implemented between 2014 and 2018 were largely successful; albeit later measures worked more effectively than earlier measures:

The Australian Prudential Regulation Authority implemented 2 credit limits between 2014 and 2018. Unlike similar policies in other countries, these imposed limits on particular mortgage products – first investor mortgages, then interest-only (IO) mortgages…

The policies quickly reduced growth in the targeted type of credit while total mortgage growth remained steady…

The investor mortgage limit, announced in December 2014, limited banks’ growth in investor housing credit to 10 per cent per annum… A delay between the policy announcement and its effect is indeed evident in the aggregate data (Figure 2)…

The counterfactuals suggest commitments would have been relatively flat absent the policy…

The interest-only mortgage limit, announced at end March 2017, required banks to limit their new IO lending to no more than 30 per cent of total new housing lending… In the aggregate commitments data, the policy effect appears immediate (Figure 7)…

This immediate reaction contrasts with the 2-quarter delay in the reaction to the investor policy… The results in Sections 6.1 to 6.4 indeed show a faster and neater IO policy reaction than the investor policy reaction…

Figure 8 repeats the counterfactuals exercise in Section 5.1 for the IO policy…

Conclusions

This paper shows that APRA’s 2014 and 2017 macroprudential credit limits quickly reduced housing credit growth in the targeted mortgage products. To conclude, we reiterate how the paper’s empirical findings align with the 3 key results outlined in the Introduction.

1. Banks met the credit growth limits by raising interest rates, enabled by the policies. The policies caused banks to raise rates on targeted mortgage types…

2. Banks’ reactions to the limits depended on their size. Large banks substituted into nontargeted mortgage types by, at least in part, reducing rates on those mortgages (Sections 5.2 and 6.2), while mid-sized banks lowered rates on non-targeted mortgages but experienced no substitution. In turn, large banks’ average mortgage growth did not significantly change, while mid-sized banks’ average mortgage growth significantly declined…

3. Practical implementation difficulties complicated the policy effects… The reaction to the investor policy had a 2-quarter delay… In contrast, banks’ reactions to the IO policy were immediate and more closely related to whether they exceeded the limit…

Final comments. The overarching objective of the policies was to strengthen financial stability given the pre-existing economic environment. The goal of this paper is to examine banks’ reactions, rather than to explicitly gauge the policy success, but our results are consistent with the objective being achieved. Commitments growth in the targeted mortgage products – products that were judged to be contributing to systemic risk at the time – dropped markedly, after growing strongly prior to the policies. Banks now charge higher spreads on the mortgage products that were targeted, and APRA will soon reform capital risk weightings to account for the differential in systemic risk contributions across mortgage types.

The results of this paper will give the CFR confidence to implement macroprudential restrictions to cool the property market.

Again, our prediction is that some form restriction will be implemented by the end of the year, which will result in slowing dwelling value growth over 2022.

Unconventional Economist
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