Reserve Bank echoes concerns from the IMF that low interest rates are fuelling property bubbles

Updated

The Reserve Bank has joined a growing chorus of local and global authorities to signal that record-low interest rates have the potential to fuel a property-price bubble.

In the minutes of its September meeting, the central bank's board mirrored last week's warning from the Australian Prudential Regulation Authority for banks to be vigilant about their lending standards.

"In the current environment of low interest rates and slow credit growth, members agreed that it was especially important that banks maintained prudent lending standards," the minutes said.

The minutes say the RBA board was briefed on the recent intervention by the Reserve Bank of New Zealand, which has introduced a stricter loan-to-value ratio as it deals with signs of a property price bubble.

Earlier today, the International Monetary Fund signalled that the current era of low inflation and low interest rates around the world had the potential to create a price bubble.

In calling for the wider use of macro-economic tools, the IMF said the access to cheap money "encourages households to borrow more and can make them more vulnerable to shocks".

RBA says Australian households are showing "prudence"

However, the RBA appears confident that the Australian banking system remains in "a relatively sound position" and "profitability remains strong compared with that seen in other advanced economies."

"Households continue to show prudence in managing their finances with higher levels of saving and a slower pace in credit growth for some time.

"The continued high rate of excess home loan repayments was consistent with low rates of financial stress among households with mortgages."

But the RBA appears less comfortable about the growing use of property in self-managed superannuation funds, which are gaining popularity in Australia.

"Property gearing in self-managed superannuation funds was one area identified where households could be starting to take some risk with their finances," it said.

According to the minutes, the rising risk "would be closely monitored" by RBA staff.

The RBA left the cash rate on hold at 2.5 per cent earlier this month, saying the current setting was "appropriate".

It has cut the cash rate by 2.25 percentage points since November 2011 to breathe life into the economy and to tame the high Australian dollar, which has fallen by 15 per cent since April.

At 11:40 am it was buying 93.26 US cents.

IMF says risks may rise as interest rates climb back

The IMF does not single out Australia, but the message in its report is clear - that "systemic risks can grow under the surface of apparent economic tranquillity".

"Where low policy rates are consistent with low inflation, they may still contribute to excessive credit growth and the build-up of asset bubbles and sow the seeds of financial instability," the IMF report said.

"In small open economies, increases in interest rates may be necessary in the face of inflationary shocks, but can draw in capital flows that may contribute to excessive financial risks."

The IMF argues for a tightening of lending standards around the world.

"A number of countries have found that the pass-through of an increase in capital requirements on mortgage loans to loan growth can be limited when strong increases in asset prices and credit feed each other," the report said.

"This suggests the use of additional tools that act on the demand for credit and directly increase the resilience of borrowers to shocks."

IMF wants tighter controls on lending standards

To use the IMF jargon, this involves wider of use of "macro-prudential" polices to prepare for worst-case scenarios, such as a bubble building or bursting.

One tool is putting caps on loan-to-value ratios, where loans could be limited to a certain portion of a property's value.

Before the global financial crisis, some borrowers could get loans of 100 per cent.

The type of intervention made by Reserve Bank of New Zealand is unlikely to happen here, but there is no doubt that regulators have a property bubble on their radar.

The other big factor is what might happen to financial markets and asset prices, especially in emerging countries, once the US Federal Reserve starts to wind back its money printing program - perhaps as early as this week.

If that party of cheap and easy money ends too abruptly, there is a chance that big investors, including Australian banks, could face share price falls.

Timely reminders of lending risks

The warning from the RBA, APRA and the IMF coincides with the fifth anniversary of the Lehman Brothers collapse, which sparked the global financial crisis.

The seeds of the GFC can be found in weaker lending standards and the creation of a subprime housing market, which burst to spark America's worst housing crash since the Great Depression.

You can follow Peter Ryan on Twitter @Peter_F_Ryan or on his blog.

Topics: business-economics-and-finance, consumer-finance, consumer-protection, corporate-governance, economic-trends, ethical-investment, globalisation---economy, industry, accounting, banking, housing-industry, markets, australia, united-states

First posted