Regulators tend to talk in convoluted riddles, deliberately torturing the language such that one is able to read into their official statements almost anything one wants. Who can forget the patron saint of regulators, Alan Greenspan, who described the collapse of the stock market during the dot-com bubble as merely ‘irrational exuberance’?

But when regulators drop their carapace of incomprehensibility, it is time to take notice.

Last week in a speech to Australian business economists, Wayne Byres, Chairman of APRA, was for a regulator almost blunt. His comments were aimed not only at the major banks but also government.

The title of Mr. Byre’s speech was ‘Banking on Housing’, linking, if not killing, two birds with one stone. He noted first that housing lending accounts for around 40% of banking industry assets and almost two thirds of the aggregate loan portfolio, and concluded that ‘with such a concentration in a single business line, we are all banking on housing lending remaining as safe as houses’.

Stripped of the natty pun, Mr Byres was saying that ‘we’, ie the Australian taxpayer, are betting that banks are lending prudently.

As would be expected, Mr Byres, lauded the steps that APRA had taken over the past five years to ensure that the bad lending practices that led to the GFC would not appear in Australia. Among those steps were a number of reminders to the Boards of the largest banks of their responsibilities in ‘actively monitoring housing lending portfolios and credit standards’. The use of the word ‘actively’ is, for regulators, fairly blunt and means that directors must be doing, and be seen to be doing, their duties. No hiding place, if things go pear-shaped.

Mr Byres then listed some of the things that keep regulators awake at night. He lamented the fact that although housing lending conditions were one of their major worries, there was in fact little APRA could do to ‘influence them directly’. In this, Mr Byres was stating the obvious that regulators cannot directly impact the housing market, merely check that banks are behaving properly. In other words, don’t blame us if the housing market implodes, it’s the banks and the government.

Echoing a recent report from ASIC, Mr Byres noted that interest-only loans, most often for investment properties, were growing in popularity. The two regulators noted that the majority of interest only loans were taken out by wealthy investors, over 80% with income over $100,000 with almost 1/3rd on $200,000 or more. On the other hand, over 80% of principal and interest loans are provided to people on $100,000 or less. But interest only loans appear to be less risky than other loans, with a lower Loan to Valuation Ratio (LVR) than normal loans and also much less likely to be in arrears.

Though Mr Byres did not say so explicitly, investors (especially the wealthy) in the Australian housing market are behaving perfectly rationally. With low deposit rates, volatile stock markets and the housing market on an apparently inexorable upswing, it makes sense to invest, or even borrow to invest, in the housing market, provided that the negative gearing and capital gains taxation rules remain unchanged.

Mr Byres then reported on the much publicised attempt by APRA to contain the growth in investment lending to less than 10% per year, categorising this as actually ‘not placing a foot on the credit brake but rather easing off the accelerator’. This means that investment lending will continue to grow only not as fast.

The regulator also gave some credit to banks for at least not being too lead footed on the accelerator and ‘re-pricing’ investment loans upwards. However, it appears that creditworthy investors are not price sensitive to the cost of mortgages - why would they be, if they can claim any additional interest back in tax breaks? Mr Byres warned the government that with house prices rising, he is like King Canute, with only a limited capacity to turn back the investment loan tide.

What APRA and ASIC can do is ensure that the banks are lending responsibly. The ASIC report noted that while record keeping was pretty crummy as regards what is called ‘conduct risk’, there appears to be no widespread misconduct in mortgage lending.

But that does not mean that there is no risk.

On the contrary, there is an unusually benign interest rate environment (one can borrow money at historically low rates) and although households have loaded up on debt to unprecedented levels, they are currently able to continue to make their monthly repayments. But if rates were to rise, many mortgage holders would be stressed to keep up their payments, which then becomes a problem for banks. Ominously, stress would also rise if unemployment were to increase - a situation regulators have no control over but must nonetheless consider a real risk.

Mr Byres concluded by warning banks not only to tidy up their paper work, but to scrutinise their lending in an environment of ‘heightened risk’. Despite its mild tone, this is as close as a regulator gets to shirt-fronting anyone.

In June, ASIC chief, Greg Medcraft, told a Senate Committee that the regulator was considering the use of section 12.2 of the Commonwealth criminal code to prosecute firms that have a deficient culture. The existing criminal code allowing for prosecution of ‘recklessness’ in risk taking has a pretty low bar, that “a "risk is substantial if a reasonable observer would have taken it to be substantial at the time the risk was taken”.

Assuming that the heads of ASIC and APRA are ‘reasonable observers’ and have been pretty blunt in their assessments of the substantial risks in the current housing market, the directors and senior managers of banks are on notice that if they do not ‘actively’ manage these risks, there is always the legal option of quite serious personal consequences for them.

The government is also on warning that the regulators believe they are doing as much as they can and can only slow down, not stop, the runaway housing train. Governments cannot just outsource management of the housing market to regulators and hope all will be well.