The Reserve Bank of Australia has issued inner-city apartment owners and their lenders a sharp storm warning as it flagged China’s ballooning debt as the biggest threat facing the global financial system.In its regular survey of risks ahead, the Reserve Bank put a heavy emphasis on China, Australia’s biggest trade partner, noting that its financial system is becoming “increasingly large, opaque and interconnected”. Small and medium sized Chinese banks were a particular risk.
On home soil the RBA raised the spectre of what might happen to banks ,who have lent as much as $85 billion, if apartment prices collapsed by as much as 50 per cent, while also cautioning big lenders away from offsetting the cost of rising regulatory burdens by ramping up risk.
While the central bank doesn’t believe the booming Sydney, Melbourne and Brisbane markets are likely to suffer the same catastrophic plunge that devastated Spain and Ireland’s property markets after the 2008 financial crisis, officials believe the surge in supply of new units could leave many investors exposed if prices slide.
With rental growth showing widespread signs of faltering, the Reserve Bank is particularly concerned by the growing number of apartment deals that are taking longer to settle, as well as a flurry of bank valuations that have come in below the prices agreed to by off-the-plan investors.
Banks have already responded by tightening rules around how much they are prepared to lend to apartment buyers, potentially adding to a slide in demand just as supply of new dwellings explodes.
Settlements taking longer
“Risks around the projected large increases in supply in some inner-city apartment markets are coming to the fore, especially in Brisbane and Melbourne,” the Reserve Bank said in its bi-annual Financial Stability Review on Friday.
“There are signs that some settlements are taking longer and lending valuations are coming in below their contract price, though settlement failures to date remain low.”
Growing jitters around the residential apartment market are a sign that a key driver of the nation’s economy after the end of the resources boom is starting to reach its limits, after being stoked by record-low official interest rates, high population growth and a flood of offshore investor demand.
Westpac economist Matthew Hassan forecast on Friday that another 120,000 units will hit the market in coming years, a “major boom” that he says has few historical precedents that give guidance on how it will end.
He says the long-time frames on big high-rise projects mean investments are locked in for this year and next, with any sharp fall in approvals only likely to appear from 2018 onwards. “The surge in supply in 2017-18 may be difficult to absorb, particularly if it comes through quickly or if there are mismatches in supply and demand.”In looking at the emerging concerns about smaller and mid-sized Chinese banks, Reserve Bank analysts say capital buffers at many lenders may be thinner than official Chinese figures suggest.
“Many smaller banks are exposed to a heightened risk of loan losses, particularly as overall economic growth slows in China.
“The Reserve Bank notes that the Chinese government has a strong incentive and ability to spur economic growth, but warns that their “continued reliance on debt-financed growth and bank forbearance, along with official actions that reinforce perceptions of implicit government guarantees, add to existing vulnerabilities.”
At home, Australian banks would only suffer material losses if apartment prices fall by more than 25 per cent, according to new analysis by the Reserve Bank.
The biggest inner-city apartment exposure of the banks by value was in Sydney – at $20 billion to $30 billion – where the existing apartment supply is greatest and prices are highest. The figure for Brisbane and Melbourne is between $10 billion and $20 billion each.
However, officials also acknowledged the prospect that prices could fall more than 25 per cent, pointing to the experience of Spain and Ireland where prices fell more than 30 per cent and 50 per cent respectively.
“In these situations, the losses to banks would be several times larger than the recent Australian experience,” the Reserve Bank said. “However, Australia is not facing the same economic and financial headwinds as Spain or Ireland did during the financial crisis, where the extent of overbuilding was much greater and prevalent across their entire countries.
“More likely, an oversupply in Australia would be more localised to certain geographic areas, and the potential price falls tempered as the population moved to absorb the new (and cheaper) supply of housing in these areas over time.”
The Reserve Bank estimates that Australians in aggregate were 2½ years ahead on their mortgage payments, but that masked significant differences across individual borrowers – many of whom had little or no buffer, especially “the newest borrowers” and those “with lower wealth and income or higher leverage”.
As in previous reports, the Reserve Bank expressed its concern that commercial property prices were moving out of sync with rental prices as yield-seeking investors bid up values.
“One concern is that the current low level of yields could prove unsustainable, particularly if global interest rates were to increase or if demand from foreign buyers were to decline.”
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