Episode Details

Federal Treasurer, Josh Frydenberg has asked the Council of Financial Regulators to investigate the fact that credit growth is materially outpacing growth in household income and to advise on any policy responses.

In lay terms, the Treasurer is worried that people are borrowing too much money compared to their incomes and that could be risky for the economy.

Increase in home lending is pronounced

It has been well documented that house prices in Australia have been rising at a fast pace over the past year. But this isn’t unique to Australia. This is also a global phenomenon, as illustrated in Knight Frank’s Global House Price Index report released last week. This report ranks the house price growth in 56 countries and Australia ranks 18th.

It is higher loan volumes that have caused higher property prices. The ABS chart below shows that most of the increase in lending has been driven by owner-occupiers (being the dark blue line), not investors.

CHART ON WEBSITE

The monthly volume of home loans has been rising significantly since mid-2020. The average volume of lending between December 2020 and August 2021 was $21.7 billion per month. The average for the 10-year period prior to June-2020, was only $11.6 billion per month.

Approximately 60% of the increase in lending over the past 9 months has been driven by an increase in the number of borrowers. And 40% has been driven by an increase in the average loan size i.e. people borrowing more. This makes sense as higher income earners have largely been (economically) unaffected by the Covid lockdowns.

Level of household debt is a worry

The chart below illustrates how the level of household debt (blue line) has increased over the past three decades. The green line depicts the interest cost of this debt. The interest cost has remained relatively contained for the past decade, thanks to falling interest rates.

CHART ON WEBSITE

Household budgets will clearly be more sensitive to future interest rate increases because they have more debt. This means that any future increases in the RBA Cash Rate will be more effective in containing inflation (by cooling consumer spending). As such, it is entirely possible, even likely that interest rates may never return to pre-GFC levels. That is, it’s possible that interest rates will permanently remain below 6% p.a.

The upshot of this is the government is rightly concerned about households’ higher indebtedness. This may be acceptable whilst interest rates are unusually low, but it could cause problems for some borrowers when interest rates inevitably rise.

Likely intervention: income to debt cap

The banking regulator considers a high debt-to-income ratio as anything above 6 i.e. borrowings greater than 6 times your family’s gross annual income. Therefore, if your family’s income is $200k p.a. and you have borrowings more than $1.2 million, the regulator considers you to be a riskier borrower.

The chart below (from

an APRA report) highlights that high debt-to-income lending (dark blue) has increased since last year. In fact, it grew by 2.8% in the June 2021 quarter which is the highest increase on record.

CHART ON WEBSITE

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