Although global financial systems have held up during the COVID-19 global pandemic, by April 2022 the Russian invasion of Ukraine and subsequent risk of financial stress caused by sanctions had become a factor in the international financial equation. Thus far any risk for Australia's economy appears to be considered manageable.
However, with interest rates expected to begin to rise again by June 2022, real wages growth still in what has been an 8 year-long stagnation with no light on the horizon, home insurance rates predicted to rise by more than 10 per cent on the back of widespread flooding on the Australian east coast, a continuing shortage of affordable housing stock with overall housing supply also expected to significantly drop and, annual residential rental growth continuing to rise sharply, the next few years may not be as manageable for some households.
Here are excepts from the Reserve Bank’s assessment of household and business finances.
Reserve Bank of Australia, Financial Stability Review April 2022, Household and Business Finances:
The incidence of household financial stress is low and declining, but a small share of households are vulnerable to cash flow shocks …
The share of APRA-regulated lenders’ non-performing housing loans was just 0.9 per cent at the end of 2021 – lower than before the pandemic (see ‘Chapter 3: The Australian Financial System’). Almost all borrowers who have exited loan payment deferral arrangements available earlier in the pandemic are now up to date with their repayments. The recent strength in employment is likely to have offset the unwinding in fiscal policy support for most indebted households. For the small number of borrowers who are currently experiencing repayment difficulties, liaison with banks indicates that the vast majority had been experiencing problems prior to the pandemic, and that early indicators of financial stress in other borrowers (such as households reducing their prepayments) remain very low.
Households in flood-affected areas of New South Wales and Queensland are facing significant challenges. To alleviate near-term financial challenges, government disaster-relief payments and hardship assistance from lenders have been made available. Recent estimates suggest that the number of insurance claims is higher than following the 2011 Queensland floods and Cyclone Yasi; although, to date, the total value of claims has been lower as fewer homes require rebuilding. Banks direct exposures to the most heavily affected households are small relative to total lending.
More broadly, the small share of borrowers with low liquidity buffers are more likely than other borrowers to have their financial resilience tested if they experience an adverse shock to their incomes or expenses, including through higher inflation. The risks for households with low liquidity buffers are likely to be even higher for those whose payment buffers have been declining (as opposed to low and stable) and for those who also have high levels of debt. The Securitisation data indicate that, for owner-occupiers with variable-rate loans, the overall share of borrowers with a loan six or more times their income and a buffer of less than one month of minimum repayments has declined since the beginning of the pandemic, to just below 1 per cent (Graph 2.4). The share of owner-occupier variable-rate borrowers with low and declining buffers has decreased to around 2 per cent over the same period. Declines in the shares of both groups of vulnerable borrowers are partly due to lower interest rates.
Historically, renters have been more likely to experience financial stress than indebted owner-occupiers. According to the Household, Income and Labour Dynamics in Australia (HILDA) survey, around one-third of renters reported at least one instance of financial stress (such as being unable to pay a bill on time or heat their home) in 2020, compared to one-sixth of owner-occupiers (Graph 2.5). Although renters are unlikely to pose direct risks to the stability of the financial system (as they have less debt), financial stress for renters could translate to repayment difficulties for indebted landlords or pose indirect risks by constraining household consumption and so economic activity. Renters with a combination of low liquidity buffers prior to the pandemic (equivalent to less than one month of disposable income) and high housing cost burdens (rental payments equivalent to more than 30 per cent of disposable income) were much more likely to report financial stress than other households. Around 15 per cent of renters were vulnerable based on this metric in 2020.
Although the value of consumer debt has declined over recent years, there has been strong growth in households using buy now, pay later (BNPL) services. BNPL services are generally a form of short-term financing that allow consumers to pay for goods and services in instalments. It is estimated that the value of BNPL transactions increased by around 40 per cent over the year to the December quarter of 2021, and the total number of BNPL accounts was equivalent to around one-third of the adult population (although some people have more than one account). There have been some increases in the incidence of late payments on these products. However, the value of BNPL transactions remains relatively small compared to other forms of personal finance, with the value of domestic personal credit and charge card purchases on Australian issued cards around 15 times larger than BNPL transactions in the December quarter of 2021.
… including a small share of borrowers who could struggle to service their debts as a result of higher interest rates and/or inflation
….Around 60 per cent of all borrowers currently have variable-rate loans, with around two-thirds of these being owner-occupiers. Scenario analysis using information in the Securitisation dataset indicates that if variable mortgage rates were to increase by 200 basis points:
• just over 40 per cent of these borrowers made average monthly payments over the past year that would be large enough to cover the increase in required repayments (Graph 2.6)
• a further 20 per cent would face an increase in their repayments of no more than 20 per cent
• around 25 per cent of variable-rate owner-occupiers would see their repayments increase by more than 30 per cent of their current repayments; however, around half of these borrowers have accumulated excess payment buffers equivalent to one year’s worth of their current minimum repayments that could therefore help ease their transition to higher repayments
• the share of borrowers facing a debt servicing ratio greater than 30 per cent (a commonly used threshold for ‘high’ repayment burdens) would increase from around 10 per cent to just under 20 per cent.
One caveat is that households’ average monthly mortgage payments over the past year may have been larger than might reasonably be expected going forward, especially as previous spending patterns resume alongside the recovery in economic activity. It is difficult to draw inferences about the capacity of investors with variable-rate loans to make higher repayments, as they tend not to make excess mortgage payments (and other forms of saving are less visible in available data).
Most borrowers with fixed-rate loans are also likely to be able to handle the increases in their repayments when their fixed-rate terms expire.
Many borrowers have taken advantage of very low interest rates on fixed-rate products in recent years; in late 2021, almost 40 per cent of outstanding housing lending had fixed interest rates – roughly double the share at the start of 2020. Around three-quarters of currently outstanding fixed-rate loans will expire by the end of 2023……
Read the full analysis here.
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