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Improving Consumer Outcomes and Enhancing Competition In Credit Cards

The Treasurer has released for public consultation the Government’s response to the Senate Economics References Committee Inquiry into matters relating to credit card interest rates.  The Government’s response outlines reforms to provide greater legislative protection to vulnerable consumers, to exert more competitive pressure on credit card issuers and to provide consumers with the information they need to make the best choices about how they use their credit cards.


There are currently around 16 million credit and charge card accounts in Australia (or 1.8 cards per household). Around two-thirds of outstanding credit card debt (by value) is accruing interest. This proportion has fallen over recent years (from above 70 per cent in 2011). The decline likely reflects that credit cards are an expensive form of credit and their relative price has increased in recent years as interest rates on other forms of credit — such as household mortgages and personal loans — have fallen. Increasing use of debit cards, and the growing availability of discounted balance transfer offers, may also have been important, whilst reforms enacted under the National Consumer Credit Protection Act in 2009 and 2011 may have contributed to improved repayment behaviour.

Available data indicate that the debt-servicing burden associated with outstanding credit card balances falls more heavily on households with relatively low levels of income and wealth. Households in the lowest income quintile hold, on average, credit card debt equal to 4 per cent of their annual disposable income, while those in the highest income quintile hold debt equal to around 2 per cent of disposable income. Low income households are also more likely to persistently revolve credit card balances (and, therefore, pay interest) than high income households.

Cards-Proposals-2The ABS’ Household Income and Expenditure surveys show that households in the lowest income quintiles also pay more in interest charges relative to their incomes than higher income households, although overall differences between quintiles are small. Households in the bottom two quintiles by net worth also pay the most in credit card interest relative to their income.

Cards-Proposals-3Although reliable data on the number of consumers that are in credit card distress are not publically available, a range of evidence supports the conclusion that carrying large credit card debt is a significant cause of financial vulnerability and distress for a small but sizeable subset of consumers.

Default rates on credit cards give a sense of the proportion of credit card balances that are in severe distress. Recent estimates from the RBA suggest that total (annualised) losses on the major banks’ credit card loan portfolios are around 2½ per cent.5 Other data suggest that many consumers struggle to make the required repayments on credit cards without necessarily defaulting. A 2010 survey by Citi Australia found that 9 per cent of respondents reported that they had struggled to make minimum repayments on credit cards within the past 12 months, with low-income earners being more likely to report this than high-income earners.

Compared to other types of loans, the number of consumers struggling to or failing to make the required repayment is likely to understate the financial distress associated with credit cards. Card issuers set minimum repayment amounts as a very small proportion of the outstanding balance, so that households making the minimum repayment will only pay off their balance over a very long period and incur very large interest costs. Making the higher repayments required to pay off their outstanding balance may be sufficient to cause financial distress for many consumers.

In giving evidence to the Senate’s inquiry into the issue, the Consumer Action Law Centre (Consumer Action) and the Financial Rights Legal Centre (Financial Rights) stated that credit card debt is the most commonly cited problem by callers to Financial Rights’ financial counselling telephone service. Consistent with this, Consumer Action’s telephone service is reported to receive at least 15 calls per day related to credit card debt, with over 50 per cent of callers having credit card debt exceeding $10,000 and 28 per cent with a debt of over $28,000. Credit cards are also the most common cause of consumer credit disputes received by the Financial Ombudsman Service — of the more than 11,000 consumer credit disputes received in 2014-15, almost half were about credit cards.  In contrast to the number of home loan disputes, which fell by 5 per cent over 2014-15, the number of credit card disputes rose by almost 4 per cent.

Apart from its direct financial impact, high and unmanageable credit card debt can have a significant impact on other indicators of wellbeing. An examination of financial stress amongst New South Wales households by Wesley Mission detailed the impact that financial stress can have on the household and individual, including impacts on physical and mental health, family wellbeing, interfamily relationships, social engagement and community participation. More than one quarter of respondents that identified themselves as having been in financial stress indicated that the experience had resulted in sickness or physical illness (31 per cent), relationship issues (28 per cent) or a diagnosed mental illness (28 per cent). While there are many causes of financial stress, Wesley Mission found that financially stressed households owed, on average, 70 per cent more in credit card debt than households that weren’t financially stressed.

In addition, the inflexibility of credit card interest rates to successive reductions in the official cash rate has prompted concern over the level of competition in the credit card market. Since late 2011, the average interest rate on ‘standard’ credit cards monitored by the RBA has remained around 20 per cent, at a time when the official cash rate has been reduced by a cumulative 2.75 percentage points. The average rate on ‘low rate’ cards (around 13 per cent) has been similarly unresponsive to reductions in the cash rate over the period.

Analysis conducted by the Treasury in 2015 showed that effective spreads earned by credit card providers have increased over the past decade. In particular, spreads increased substantially during the financial crisis and have remained high in the years since then.11 The increase during the financial crisis is consistent with a repricing of unsecured credit risk observed in other credit markets and economies. However, the fact that spreads have since remained very high (and have even increased a little further more recently) suggests limitations in the degree of competition in the credit card market and unsecured lending markets more generally.

Proposals For Consultation.

Credit cards are used by many Australians as a valuable tool for managing their financial affairs. The majority of Australians use their credit cards responsibly. There is, however, a subset of consumers incurring very high credit card interest charges on a persistent basis because of the inappropriate selection and provision of credit cards as well as certain patterns of credit card use. For this subset of consumers, credit cards may impose a substantial burden on financial wellbeing.

The Government finds that these outcomes reflect, among other things, a relative lack of competition on ongoing interest rates in the credit card market (arising partly because of the complexity with which interest is calculated). These outcomes also reflect behavioural biases that encourage card holders to borrow more and repay less than they would otherwise intend leading to higher (than intended) levels of credit card debt.

These views are consistent with the findings of the recent Inquiry into matters relating to credit card interest rates by the Senate Economics References Committee released in December 2015. On 18 December 2015, the Senate Committee released its report entitled Interest Rates and Informed Choice in the Australian Credit Card Market. The Government has carefully considered the recommendations made by the Senate Committee. This consultation paper also constitutes the Government’s response to that Inquiry.

The Government proposes a set of reforms that it considers are proportionate to the magnitude of the identified problems. It has drawn upon lessons and insights from regulatory developments in other jurisdictions as well as available empirical evidence, including relevant insights from behavioural economics. The Government has further drawn on evidence given by stakeholders at the Senate Inquiry hearings and its own consultation with card issuers and consumer representatives.

The proposed measures form part of a wider package of reforms that should improve competition and consumer outcomes in the credit card market. A number of aspects of the Financial System Program announced by the Government in October 2015 — including measures to improve the efficiency of the payments system and support access to and sharing of credit data — should also have a material and positive impact on consumer outcomes in the credit card market. There are already signs that reforms enacted in January 2015 to open up the credit card market to a wider pool of potential card issuers are beginning to have a positive impact on competition in the market.

Relatedly, on 19 April 2016 the Government released the final report of the review of the small amount credit contract (SACC) laws. Consistent with its approach to the credit card market, the Government wants to ensure that the SACC regulatory framework balances protecting vulnerable consumers without imposing an undue regulatory burden on industry. The final report made recommendations to increase financial inclusion and reduce the risk that consumers may be unable to meet their basic needs or may default on other necessary commitments. The Government is undertaking further consultation before making any decisions on the recommendations.

The Government recognises the importance of financial literacy in supporting good consumer outcomes in the financial system and is committed to raising the standard of financial literacy across the community. The Government provides funding to the Australian Securities and Investments Commission (ASIC) to lead the National Financial Literacy Strategy and undertake a number of initiatives to bolster financial literacy under the ASIC MoneySmart program.

The package consists of two phases. For Phase 1 (measures 1 to 4), the Government seeks stakeholder feedback with a view to developing and releasing associated exposure draft legislation in the near term. For Phase 2 (measures 5 to 9), the Government plans to shortly commence behavioural testing with consumers to determine efficacy in the Australian market and to ensure they are designed for maximum effect. Testing will be led by the Behavioural Economics Team of the Australian Government. The decision to implement these measures will be subject to the results of consumer testing and the extent to which industry presents solutions of its own accord. The Government intends to commence consumer testing in the near term and will report on the outcomes of that testing and make a final decision on implementation in due course.

Cards-Proposals-1The closing date for submissions is Friday, 17 June 2016.

RBA May Monetary Statement – Inflation Lower For Longer

The RBA has released its latest statement on monetary policy. Essentially, inflation will be lower for longer, and they see home lending still running at around 7% growth whilst competition to lend grows more intense.

The March quarter underlying inflation outcome was around ¼ percentage point lower than expected at the time of the February Statement.

The broad-based nature of the weakness in nontradables inflation and the fact that wage outcomes were lower than expected over 2015 has resulted in a reassessment of the extent of domestic inflationary pressures, leading to downward revisions to the forecasts for inflation and wage growth. Underlying inflation is now expected to remain around 1–2 per cent over 2016 and to pick up to 1½–2½ per cent at the end of the forecast period.

RBA-May-01Given data observed over the past few months, the recovery in wage growth and labour costs underpinning the inflation forecasts has been revised lower.

Within the household sector, they say that household consumption growth increased in the second half of 2015 to around its decade average in year-ended terms, driven by relatively strong growth in New South Wales and Victoria. Factors supporting the pick-up in consumption growth include solid employment growth and low interest rates, as well as the ongoing effects of lower petrol prices and a further increase in household wealth.

With growth in household disposable income remaining below average, the saving ratio has continued to decline.

Retail sales volumes grew at a similar pace in the March quarter as in late 2015, although other timely indicators of household consumption have eased of late. Motor vehicle sales to households have continued to decline in early 2016, though at a slower pace than in late 2015, and households’ perceptions of their own finances have declined of late, although they remain around their longrun average. However, in the past these indicators have had only a modest correlation with quarterly aggregate consumption growth. Liaison suggests that trading conditions in the retail sector have softened in recent months, but remain generally positive.

Conditions in the established housing market have stabilised somewhat over the past two quarters or so. Housing prices increased in the early months of 2016, after easing slightly in the December quarter of 2015. Auction clearance rates are above average in Sydney and Melbourne, although they remain lower than a year ago. The average number of days that a property is on the market is a little higher than the lows of last year, while the eventual discount on vendor asking prices is little changed. Housing turnover rates are below average.

Housing credit growth has eased a little in recent months, after stabilising in the second half of 2015. This follows an earlier period of rising credit growth, driven in large part by investor lending. This moderation has been consistent with the increases in mortgage interest rates implemented by most lenders towards the end of 2015 and the tightening of lending standards.

The pace of housing credit growth has eased in recent months, to around 7 per cent. This follows increases in variable lending rates by most lenders in late 2015 and measures introduced by the Australian Prudential Regulation Authority (APRA) to strengthen lending standards. In particular, loan serviceability criteria have been tightened by lenders, which reduce the amount that some households can borrow. Consistent with these developments, there has been a decline in turnover in the housing market, along with slower growth in the average size of loans. Net housing debt has continued to grow around 11/4 percentage points slower than housing credit due to ongoing rapid growth in deposits in mortgage offset accounts. Recent housing loan approvals data suggest that housing credit will continue to grow at about its current pace.

Prior to the May cash rate reduction, the estimated average outstanding housing interest rate had been little changed since lenders increased interest rates in the second half of 2015. Following the May rate reduction, banks have lowered their standard variable rates by 19–25 basis points.

More broadly, there are signs that competition for both owner-occupier and investor loans is intensifying. New loans are typically benchmarked to standard variable rates, with lenders then offering discounts below these rates. Over recent months, interest rate discounts for new owner-occupier loans have increased and may be offsetting some of the increase in standard variable rates last year.

Discounts for investors on variable-rate housing loans were reduced substantially last year but have increased in recent months. Fixed interest rates for housing loans continue to be priced competitively and, consistent with this, a higher share of mortgages has been taken out with fixed interest rates.

Since the introduction of differential pricing for investor and owner-occupier lending by most major banks in the second half of 2015, growth in investor lending has slowed considerably, while growth in owner-occupier lending has accelerated. As noted previously, a large number of borrowers have contacted their existing lender to change the purpose of their loan, while there has also been a surge in owner-occupier refinancing and a drop in investor refinancing with different lenders.

Conditions in the rental market have continued to soften. Growth in rents has declined and the aggregate rental vacancy rate has increased to around its average since 1990. While the recent increase in the national vacancy rate mainly reflects developments in the Perth rental market, growth in rents has eased in most capital cities.

Dwelling investment has continued to grow strongly, supported by low interest rates and the significant increase in housing prices in recent years. Investment in higher-density housing grew at close to 30 per cent over 2015, accounting for most of dwelling investment growth over that period. More recently, the amount of residential construction work still in the pipeline has continued to rise and points to further strong growth in dwelling investment. The pace of growth is likely to moderate, however, consistent with the decline in building approvals since last year.



Where Did The 10% Investor Mortgage Growth Speed Limit Come From?

An interesting FOI disclosure from the RBA tells us something about the discussions which went on within the regulators in 2014 and beyond, as they considered the impact of the rise in investor loans. Eventually of course APRA set a 10% speed limit, and we have see the growth in investment loans slow significantly and underwriting standards tightened.

Back then, they discussed the risks of investment lending rising, especially in Melbourne.

Macroeconomic: Extra speculative demand can amplify the property price cycle and increase the potential for prices to fall later. Such a fall would affect household spending and wealth. This effect is likely to be spread across a broader range of households than the investors that contributed to the heightened activity.

Concentration risk: Lending has been concentrated in Sydney and Melbourne, creating a concentrated exposure in these cities. The risk could come from a state-based economic shock, or if the speculative upswing in demand brings forth an increase in construction on a scale that leads to a future overhang of supply. In Sydney, the risk of oversupply appears limited because of the pick-up in construction follows a period of limited new supply and it has been spread geographically and by dwelling type. While the unemployment rate has picked up a little over the past 18 months, the overall economic environment in NSW is in a fairly good state. In Melbourne, there has been a greater geographic concentration of higher-density construction in inner-city areas. Some developments have a concentration of smaller-sized apartments that may only appeal to some renters, or purchasers in the secondary market. Economic conditions are not as favourable in Victoria and the unemployment rate is 6.8%.

Low interest rate environment: While a pick-up in risk appetite of households is to some extent an expected outcome given the low interest rate environment, their revealed preference is to direct investment into the housing market.  Historically low interest rates (combined with rising housing prices and strong price competition in the mortgage market) means that some households may attempt to take out loans that they would not be able to comfortably service in a higher interest rate environment. APRA’s draft Prudential Practice Guide (PPG) emphasises that ADIs should apply an interest rate add-on to the mortgage rate, in conjunction with an interest rate floor in assessing a borrower’s capacity to service the loan. In order to maintain the risk profile of borrowers when interest rates are declining, the size of the add-on needs to increase (or the floor needs to be sufficiently high).

Lending standards: In aggregate, banks’ lending standards have been holding fairly steady overall; lending in some loan segments has eased a little, while lending in some other segments has tightened up a bit. The main lending standard of concern is the share of interest-only lending, both to owner-occupiers and investors. For investors, 64% of banks’ new lending is interest-only loans and for owner-occupiers the share is 31%. The typical interest-only period is 5 years, but some banks allow the interest-only period to extend to 15 years. During this period, the loan is amortising more slowly than a loan that requires principal and interest (P&I) payments. If housing prices should fall, this increases the risk that the loan balance may exceed the property value (negative equity). There is some risk that the borrower could face difficulty servicing the higher P&I payments when the interest-only period ends, although this is typically mitigated by banks assessing interest-only borrowers on their ability to make P&I payments.

Of course the regulators found underwriting standards were more generous than they thought, at times in 2015 more than half of all new loans were investment loans, and recently banks have reclassified loans, causing the absolute proportion of investment loans to rise. Things were whose than they thought.

Next they discussed how to set the “right” growth rate:

How to calibrate the benchmark growth rate?  Household debt has been broadly stable as a share of income for about a decade. National aggregate ratios are not robust indicators of a sector’s resilience because the distribution of debt and income can change over time. But as a first pass, it is reasonable to expect that the current level of the indebtedness ratio is sustainable in a range of macroeconomic circumstances. Therefore there does not seem to be a case to set the benchmark growth rate significantly below the rate of growth of household income, in order to achieve a material decline in the indebtedness ratio. With growth in nominal household disposable income running at a little above 3 per cent, this sets a lower bound for possible benchmarks at around 3 per cent. Current growth in investor credit, at nearly 10 per cent, suggests an upper bound around 8 per cent to achieve
some comfort about the leverage in this market. Within this range, there are several options for the preferred benchmark rate for investor housing credit growth (including securitised credit).

a) Around 4½ per cent, based on projected household disposable income growth over calendar 2015. This could be justified as being consistent with stabilising the indebtedness ratio. However, it would be procyclical, in that it would be responding to a period of slow income growth by insisting that credit growth also slow. It would also be materially slower than the current rate of owner-occupier credit growth, which so far has not raised systemic concerns.

b) Around 6 per cent, based on a reasonable expectation of trend growth in disposable income, once the effects of the decline in the terms of trade have washed through. It is also broadly consistent with current growth in owner-occupier housing credit, which as noted above has not been seen as adding materially to systemic risk.

c) 7 per cent, consistent with the system profile for residential mortgage lending already agreed as part of the LCR/CLF process. Unless owner-occupier lending actually picks up from its current rate, however, the growth in investor housing credit implied by the CLF projections would be stronger than this. It is therefore not clear that these projections should be the basis for the preferred benchmark.

Staff projections suggest that only a moderate decline in system investor loan approvals would be required to meet a benchmark growth rate for investor housing credit in the 5–7 per cent range for calendar 2015. The exact size of the decline depends partly on assumptions about repayments through churn, refinancing and amortisation in the investor housing book. For a reasonable range of values for this implied repayment rate, and assuming that investor housing credit growth remains at its current rate for the remainder of 2014, the required decline in investor approvals is of the order of 10–20 per cent. This would take the level of investor housing loan approvals back to that seen a year ago. It is worth noting that investor loan approvals would have to increase noticeably from here to sustain the current growth rate of investor housing credit, even though the implied repayment rate is a little below its historical average. Since credit is not available at a state level, the benchmark can only be expressed as a national growth rate. The flow of loan approvals at a state level can be used as a cross-check to ensure that the benchmark incentive has had its greatest effects in the markets that have been strongest recently.

When the 10% cap (note this is higher than those bands discussed above) was announced, some Q&A’s provide some insights into their thinking.

Isn’t 10 per cent a bit soft?  We are not trying to kill the market stone dead. Investor housing credit is currently running at a bit under 10 per cent. Some lenders will have investor credit growth well below this benchmark anyway, so if all lenders do end up at least a little under this benchmark, which we hope they will, then aggregate growth in investor credit will be noticeably below 10 per cent. Setting a benchmark for individual institutions is not the same thing as setting it for an aggregate, and APRA has allowed for that.

Where did the 10 per cent benchmark come from?  This was a collective assessment by the Council agencies. We took the view that we did not want to clamp down on the market excessively. We also took the view that in the long run, household credit can expand sustainably at a rate something like the rate of trend nominal household income growth, maybe a bit more or less in shorter periods. Trend income growth is below 10 per cent, more like 6 per cent or thereabouts. But it was important to make an allowance for the fact that some lenders will undershoot the benchmark, so the aggregate result will likely be slower than that.

But isn’t household income growth likely to be below average in the next few years, because of the end of the mining boom?  Maybe, but we don’t want to be procyclical and clamp down on credit supply more when the economy growing below trend.

This of course confirms the regulators were wanting to use household debt as an economic growth engine (interesting, see the recent post “Why more-finance-is-the-wrong-medicine-for-our-growth-problem” )

We also see a significant slow down in household income growth, yet credit growth, especially housing has been stronger, creating higher risks if interest rates or unemployment was to rise. Raises the question, were the regulators too slow to act, and did they calibrate their interventions correctly? We will see.


Further Confirmation Australian Home Prices Least Affordable

The latest Economist data on global house prices released today, shows Australia sitting at the top the pack (excluding Hong Kong) in terms of average prices to average income. This chart shows Australia, Britain, Canada and USA trends from 1990. This is consistent with findings from Demographia.

Economist-HP1On a different measure, prices against rent, Australia is behind Canada, but above the other two.  Rental growth in Australia has not kept up with house prices.


Prices in real terms show Australia price growth just behind Britain, but well ahead of Canada and USA.


Finally using the price index, movements in Australia are close to those in Britain, but well ahead of Canada and USA.


Explanation from the Economist

Their interactive chart uses five different measures
• House-price index: rebased to 100 at a selected date
• Prices in real terms: rebased to 100 for the selected date and deflated by consumer prices
• Prices against average income: compares house prices against average disposable income per person, where 100 is equal to the long-run average of the relationship
• Prices against rents: compares house prices against housing rents, where 100 is equal to the long-run average of the relationship
• Percentage change: the percentage change in real house prices between two selected dates

The data presented are quarterly, often aggregated from monthly indices. When comparing data across countries, the interactive chart will only display the range of dates available for all the countries selected

Fitch Affirms Australia at ‘AAA’; Outlook Stable

Fitch Ratings has affirmed Australia’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at ‘AAA’. The Outlook is Stable. Australia’s senior unsecured foreign- and local-currency bond ratings are also affirmed at ‘AAA’. The Country Ceiling is affirmed at ‘AAA’ and the Short-Term Foreign Currency IDR at ‘F1+’.

The affirmation of Australia’s sovereign ratings reflects the following factors:

– Australia’s ‘AAA’ rating is underpinned by the economy’s high income, strong institutions and effective governance. The free-floating exchange rate, credible monetary policy framework, low public debt and growing recognition of the Australian dollar as a reserve currency allow the economy to adjust to changing economic conditions.

– GDP growth of 2.5% in 2015 was marginally slower than a year earlier, but still outpaced the median of 1.8% for ‘AAA’ rated sovereigns. A thriving services sector and strong residential investment is helping the economy rebalance away from mining-driven growth, although a recovery in non-mining investment remains elusive. Fitch expects low interest rates to continue fuelling consumption growth, resulting in GDP growth of 2.6% in 2016. Residential investment growth could decelerate from the current fast pace over the next two years, but should be partly offset by a pickup in state infrastructure investment. Increasing production of natural gas and greater spending on education and tourism from non-residents should support export growth. Fitch expects a smaller drag on GDP growth from falling mining investment in 2017, helping push GDP growth up to 2.9%.

– Australia depends more on primary commodity exports, particularly to China, than ‘AAA’ peers. Exposure to Chinese households through the service sector and capital flows is also increasing. A severe slowdown in China, although not Fitch’s base case, could have a widespread negative economic impact. Other downside risks to Fitch’s economic forecasts include continued weakness of non-mining business investment and a sharper than expected property market slowdown. Maintaining the recovery in iron ore prices year-to-date could result in an upside risk to Fitch’s forecasts.

– Despite resilient GDP growth, a sharp fall in the terms of trade has weighed on nominal income growth, reducing tax revenues and slowing the expected pace of fiscal consolidation. As such, the government does not expect an underlying cash surplus until the fiscal year ending June 2021 (FY21). Fitch estimates Australia’s gross general government debt (GGD) at 34.5% of GDP in FY15, still 9.1pp below the ‘AAA’ median of 43.6%. However, the difference has narrowed from 24.5pp in FY11, when Australia’s Foreign-Currency IDR was first upgraded to ‘AAA’. Fitch projects the GGD ratio to peak in FY17 should the budget deficit narrow in line with Fitch’s baseline scenario. However, a negative economic shock without offsetting policy actions could lead to further deterioration in public finances.

– Fitch considers Australia’s external finances a longstanding structural weakness, with the largest net external debt relative to GDP in the ‘AAA’ rated category. Net external debt, including derivatives, increased to 61.0% of GDP in 2015 from 54.4% in the previous year. This is higher than the previous 2009 peak. Fitch expects the current account deficit to narrow only slightly from 4.6% of GDP in 2015 over the next two years and for net external debt to continue growing. A diversified pool of foreign investors willing to lend to Australian entities in local currency, sophisticated currency hedging and maturity mismatches in the financial sector are helping mitigate some of the external liquidity risks arising from Australia’s debt position and reduces the economy’s vulnerability against a sharp depreciation in the Australian dollar. However, a sustained reallocation of capital flows away from Australia by foreign investors could raise financing costs and put downward pressure on economic growth.

– The Australian banking system is one of the strongest globally on a standalone basis, based on Fitch’s Banking System Indicator (BSI) scoring mechanism. Fitch expects banking sector balance sheets to continue strengthening, with solid capitalisation and recently tightened underwriting standards offsetting slower profit growth and modest asset-quality pressures. However, household debt, at 184.6% of disposable income at end of September 2015, is high relative to peers and makes up the majority of banking system lending assets. Low interest rates, high mortgage offset account saving levels and a stable unemployment rate is helping maintain debt sustainability. But a sharp economic downturn, particularly one accompanied by widespread unemployment and a sudden reversal of house prices after two years of strong growth, could lead to banking sector losses and a higher risk that support is required through the sovereign balance sheet. Fitch considers such a scenario a tail-risk and assumes house price growth will moderate to 2% in 2016 from 8% in 2015.

The Outlook is Stable, as Fitch does not currently anticipate developments that pose a high likelihood of a rating change. However, future developments that could individually or collectively result in a ratings downgrade include:

– A sustained widening of the fiscal deficit without remedial policy actions, leading to continued upward trajectory of the general government debt-to-GDP ratio.

– A negative external shock, such as a continued rapid decline in the terms of trade following a severe slowdown in China. This could lead to a sharp increase in the current account deficit and/or a sustained reallocation of foreign capital.

– A sharp economic downturn, which could also be triggered by external events, leading to widespread household defaults, banking system distress and the materialisation of contingent liabilities on the public balance sheet.

-The global economy performs broadly in line with Fitch’s Global Economic Outlook, particularly China, which has become a key destination for Australian exports. Fitch expects the Chinese economy to grow by 6.2% in 2016.

– Fitch assumes an average iron ore price of $45 per tonne in 2016 and 2017, $50 per tonne in 2018 (62% Fe CFR China reference).

No Overall Real Income Growth Since 2008 – RBA

There were two important charts contained in the speech by RBA Deputy Governor Philip Lowe today covering the resilience of our own economy, the productivity challenge, the balance in the housing market and the inflation outlook. Real disposable income per capita has been static since 2008, and rent inflation continues to fall. Both indicators of ongoing stress in the economy, especially since household debt is higher than ever, and we have a large share of housing in the investment sector, where we already know some households are in real-terms losing money each month.

This data partly explains the relatively low state of household finance confidence.

While we have done a pretty good job of adjusting to our changed circumstances, the not-so-good news is that growth in real income per capita in Australia has stalled (Graph 5). Indeed, average real income is no higher today than it was in 2008. This follows a 17-year period in which growth averaged a remarkable 3.1 per cent per year. During this earlier period, we benefited from: (i) strong productivity growth in the 1990s; (ii) a very large rise in our terms of trade; and (iii) favourable demographics, which helped increase the share of the population in paid employment.

Static Income RBAThe increase in supply now looks to be contributing to some moderation in the rate of increase in housing prices in these cities. It is also putting downward pressure on rents, with the CPI measure of rent inflation running at just 1.2 per cent in 2015, the lowest for 20 years (Graph 8). Whether or not these trends are maintained remains to be seen, and so we continue to watch developments in the housing market very closely.

Rental Income RBAThe latest data from the RBA chart pack shows again growing debt, and the reduced debt interest burden thanks to ultra low rates. If rates were to rise by even a small amount, in the current low income and low rental environment, this will be a problem.


RBA’s Latest Statement Raises Two Interesting Questions

The latest Statement of Monetary Policy, released today, continues to tell the now well rehearsed story. Resources down, China under pressure, local growth slowish, and transitioning from mining, sort of working, whilst home lending continues to grow at above 7% annually. But they kick around two interesting issues. First, why is the unemployment rate so good when growth is sluggish, and second why is the household savings ratio lower now?

Looking at employment first:

…strong employment growth has also been supported by a protracted period of low wage growth which, along with the exchange rate depreciation, may have encouraged firms to employ more people than otherwise. At the same time, growth in the supply of labour has increased through a rise in the participation rate, notwithstanding lower population growth. The unemployment rate declined to around 5¾ per cent in late 2015, having been within a range between 6 and 6¼ per cent since mid 2014. Nevertheless, there is evidence of spare capacity in the labour market, as the unemployment rate is still above recent lows, the participation rate remains below its previous peak and wage growth continues to be low.

Also, the low growth of wages is likely to have encouraged businesses to employ more people than otherwise. Measures of job vacancies and advertisements point to further growth in employment over the coming months. In response to this flow of data, the forecast for the unemployment rate has been revised lower. The fact that the improvement in labour market conditions has occurred against the backdrop of below-average GDP growth raises some uncertainty about the economic outlook. It is possible that the strength in the labour market data contains information about the economy not apparent in the national accounts data, or that the strong growth in employment of late will be followed by a period of weaker employment growth. Alternatively, the strength in labour market conditions relative to output growth may reflect a rebalancing of the pattern of growth towards labour intensive sectors and away from capital intensive sectors.

DFA is of the view that the growth in lower-paid non-wealth producing jobs at the expense of productive jobs is the key – more are now working in the healthcare and services sector (in response to growing demand thanks to demographic shifts), but it just moves the dollar around the system, and does not create new dollars. There is difference between being busy, and being productively (economically speaking) busy.

Turning to the savings ratio:

… after falling for more than two decades, the aggregate household saving ratio in Australia increased sharply in the latter half of the 2000s. While it has since remained close to 10 per cent – which implies that, collectively, households have been saving about 10 per cent of their incomes – the saving ratio has declined modestly over the past three years or so.

5tr-hhinconJan2016Understanding developments in the saving ratio is important because changes in household saving behaviour can have implications for the outlook for aggregate consumption. Trends in the household saving ratio in Australia over recent years are likely to reflect a range of factors, including the effect of the boom in commodity prices and mining investment on household incomes, behavioural changes stemming from the global financial crisis, and the current low level of interest rates. Longer-term factors such as financial deregulation and population ageing have also played a role. Households’ expectations about future income growth and asset valuations, and the uncertainty around those expectations, are also relevant to their saving decisions. Many households accumulate precautionary savings to insure against an unanticipated loss of future income or unexpected expenditure (such as on a medical procedure). At the macroeconomic level, precautionary saving is likely to be particularly important if households are very risk averse or constrained in their ability to borrow to fund consumption when their incomes are temporarily low. For example, the financial crisis is likely to have made households more uncertain about their future employment or income growth and/or led them to reassess their tolerance for risk, which would have encouraged them to increase their rate of saving. Surveys at that time showed an increase in the share of households nominating bank deposits or paying down debt as the ‘wisest place for saving’, although this may have also reflected lower expected rates of return on other financial assets following the financial crisis.

The level of interest rates can also influence the saving ratio. On the one hand, the current low level of interest rates reduces both the return to saving and the cost of borrowing, which encourages households to bring forward consumption; this might explain some of the recent decline in the aggregate household saving ratio. Low interest rates also support the value of household assets, which increases the amount of collateral households can borrow against, and potentially reduces the incentives for households to save. On the other hand, the household sector in aggregate holds more debt than interest-earning assets, so cyclically low interest rates provide a temporary boost to disposable income through a reduction in net interest payments, some of which may be saved. Households also need to save more to achieve a given target level of savings when interest rates are low.

Structural changes to the Australian financial system have been important longer-term drivers of changes in household saving behaviour. Financial deregulation in the 1980s and a structural shift to low inflation and low interest rates in the 1990s allowed households that were previously credit constrained to accumulate higher levels of debt for a given level of income. This rise in indebtedness was accompanied by strong growth in housing prices and a reduction in the household saving ratio to unusually low levels. In this way households were able to support consumption via the withdrawal of housing equity.  Innovation in financial products – such as credit cards and home-equity loans – also gave households much better access to finance. The adjustment to these structural changes in the financial system appears to have largely run its course by the mid 2000s.

The ageing of the population is another longer-term influence on the saving ratio. If shares of younger and older households in the population were constant over time, the different saving behaviours of these households would not affect the aggregate saving ratio. However, Australia’s baby-boomer generation is a larger share of the population now and has been entering the retirement phase since around 2010. Because households save less in their later years, this is expected to have a gradual but long-lasting downward influence on the aggregate household saving ratio. However, a potentially offsetting influence is rising longevity, which may lead households to save more during their working years to finance a longer period of retirement.

Pop-By-AGe-BandsThe amount that each of these drivers have contributed to recent trends in the aggregate household saving ratio is unclear. It is also uncertain how they will evolve over the next few years, although the Bank’s central forecast embodies a further modest decline in the saving ratio, that reflects, in part, the unwinding of the impact on saving from the earlier boom in commodity prices and mining investment.

Using data from the DFA household surveys, we note three factors in play. First, household confidence levels still below long term trends, so we would expect households to continue to save, if they can, against perceived future risks. Second, older households hold the bulk of the savings, and they are indeed growing as a proportion of the total, so again we would expect to see a rise, not a fall in the ratio. But, the third factor, is in our view, the most significant.  That is that many are relying on income from savings, and as deposit interest rates have fallen (and alternative investment options become more risky), some have switched savings into investment property and others are having to eat into capital to survive.  The RBA’s policy settings of low interest rates, and high house prices are being reflected back in lower savings ratios.

Living Costs Growth Highest For Self-Funded Retirees

The ABS published their data on living costs by household type today, to December 2015. It is worth reading the ABS information about these indices:

The Analytical Living Cost Indexes (ALCIs) have been compiled and published by the ABS since June 2000 and were developed in recognition of the widespread interest in the extent to which the impact of price change varies across different groups of households in the Australian population.

ALCIs are prepared for four types of Australian households:

  • employee households (i.e. those households whose principal source of income is from wages and salaries);
  • age pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
  • other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension); and
  • self-funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the Household Expenditure Survey (HES) defined reference person is ‘retired’ (not in the labour force and over 55 years of age)).

A living cost index reflects changes over time in the purchasing power of the after-tax incomes of households. It measures the impact of changes in prices on the out-of-pocket expenses incurred by households to gain access to a fixed basket of consumer goods and services. The Australian Consumer Price Index (CPI), on the other hand, is designed to measure price inflation for the household sector as a whole and is not the conceptually ideal measure for assessing the changes in the purchasing power of the disposable incomes of households.

Looking at the data, we see that whilst the living costs have fallen through 2015, they are now on the rise, and self-funded retirees have the higher cost growth rate.


There are subtle differences in spending patterns and household mix which contribute to the differences. For example, self-funded retirees spend less on housing, but more on health care and recreation activities.

Table 1 from the ABS,  illustrates significant differences in expenditures, both in total and at the individual commodity group level across the household types. Although differences in incomes are likely to be a major reason for this, other factors such as the demographic make-up of the households and dwelling tenure would also play a part. For example, age pensioner households have on average the lowest number of persons per household and self-funded retiree households have a higher than average rate of outright home ownership.

Table 1: Estimated average weekly expenditure during 2009-10, Household type by Commodity group(a)(b)

Age pensioner
Other government transfer recipient
Self-funded retiree
Commodity group

Food and non-alcoholic beverages
Alcohol and tobacco
Clothing and footwear
Furnishings, household equipment and services
Recreation and culture
Insurance and financial services(d)
All groups
1 557.77
1 022.72
1 371.30

(a) Based on 2009-10 Household Expenditure Survey (HES) at June quarter 2011 prices.
(b) Figures may not add up due to rounding.
(c) House purchases are included in the CPI but excluded from the population subgroup indexes.
(d) Includes interest charges and general insurance. Interest charges are excluded from the CPI and general insurance is calculated on a different basis.

Household Debt Higher Than Ever

The latest RBA chart pack, to December 2015 was released today. Households remain under financial pressure, as shown by the updated data relating to household debt as a percentage of household disposable income continues to move higher, and well above 175% . Whilst interest rates are low, so interest paid is on average a little above 8%, this masks significant differences across household segments, and highlights the risks to households if interest rates were to rise.

6tl-hhfin Dec 2015

We also see that income growth is as at the low-end of trend in the past 20 years, and the savings ratio continues to fall. Consequently consumption is on the low-side.

5tr-hhinconNot a pretty picture.

Australian Household Debt Reaches Record Highs at $245,000

Average Australian household debt is four times what it was in 1988, rising from $60,000 to $245,000 after inflation, according to the latest AMP.NATSEM Income and Wealth report – Buy now, pay later: Household debt in Australia.

AMP-DebtThe ratio of household debt to disposable income has almost tripled, from 64 per cent to 185 per cent during the same time. Declining interest rates, low unemployment and a strong economy have driven Australians to take on more debt and at the same time cushioned the impact of repayments.

But if interest rates were to rise by 2.5 percentage points, interest payments for Australia’s most indebted households with mortgages would rise to at least 58 per cent of household income, up from the current 42 per cent. These households would need to find an extra $16,615 a year just to cover interest payments, which would increase from $43,926 to $60,541 a year. For households with mortgages and typical levels of debt, a 2.5 percentage point increase would mean debt repayments would rise from 16 per cent to 23 per cent of income, taking annual interest payments from $15,464 to $21,687, or an extra $6,223 per year.AMP-Debt-2

Other findings from the report include:
• Typical households headed by 30 to 50 year olds have been hit the hardest with their debt to income increasing from 149 per cent to 209 per cent during the past 10 years.
• For people aged over 65, mortgages make up almost a third of their household debt – up significantly from 20 per cent 10 years ago.
• For low-income households, debt is 43 per cent of their disposable income, almost doubling since 2004.
• The top 10 per cent most leveraged Australian households now have an average debt to disposable income ratio of 600 per cent.

Household debt in Australia has increased considerably
• In 1988, the average household could have paid off all its debt with the after-tax income it earned in eight months – it would now take almost two years.
• Australian household debt has grown at 5.3 per cent above inflation each year, outstripping income growth of 1.3 per cent.
• Australia’s most leveraged households have six times as much debt as their annual disposable income.

Australians are taking more debt into retirement
• Of the top 10 per cent most indebted households, it’s the over 65 year old households that have increased their level of debt the most – their repayments to income have almost doubled from 9 to 17 per cent.

First home buyers are taking on considerably more debt
• Rising house prices have seen first home buyers doing it tough with their debt levels at 3.6 times their annual disposable income, up from 3.1 since 2004.
• Typical first homebuyers would feel the greatest impact from rising interest rates – a 2.5 percentage point rise in rates would increase interest repayments as a percentage of disposable income from 21.2 per cent to 30.2 per cent or an extra $8,047 a year.

Lower income families have also taken on a lot more debt
• Among the top 10 per cent of indebted households, low-income households are in the most vulnerable position with their interest payments increasing from 40.8 per cent to 59.9 per cent of disposable income during the past 10 years.

The debt picture is precarious for the most leveraged households
• Australia’s debt boom has impacted all households, but it is the most indebted who have ramped up their leverage the most – for households with the top 10 per cent of debt levels, debt to income has increased from 4.4 to six times income, compared to the typical household which increased from 0.7 to 0.88 times income.

Australian households are among the most indebted in the world
• Australian households have the fifth highest debt levels in the world, with more average household debt than comparable economies like Canada.

Mortgage debt is highest for households headed by a 30-50 year old and over 65s have the most investor debt
• Home mortgages make up almost 63 per cent of debt for households headed by a person aged 30 to 50.
• Investor debt is highest for over 65 year old households at almost 60 per cent of their total debt.

Ninety per cent of Australian household debt is being used to buy a home or to build wealth through investing
• 56 per cent on mortgage and 36 per cent on investing (e.g. rental properties or shares).

Many Australian households experience financial stress
• A quarter of Australians currently experience financial stress from things like paying bills, raising emergency money or having to ask friends for financial assistance.
• Low income families experience six times the rate of financial stress than higher income families.

Single parents face significant financial stress
• Nearly two in three single parents are facing at least one financial stress, compared to just 13 per cent of couples who have children.
• Single parents are 10 times more likely to be experiencing at least three forms of financial stress compared to couples with children.

Regions with the highest typical repayment to income are in the outer suburbs of Sydney, Perth and Melbourne
• For households with the top 10 per cent of debt, it’s the inner city suburbs of Sydney, Perth and Melbourne with the highest repayment to income.

Tasmania and NSW households have the greatest share of mortgage debt
• As a share of debt, mortgage debt is highest in Tasmania, with almost 66 per cent of household debt tied to mortgages and New South Wales has the second highest level of mortgages at just over 58 per cent of total debt.
• The combined territories (Australian Capital Territory and Northern Territory) have the lowest share of mortgage debt at almost 50 per cent.
• Investor debt is highest in Australia’s territories, at 44 per cent, followed by Queensland and Western Australia at around 38 per cent each.

Of the most leveraged households (those with the top 10 per cent of debt) debt is 5.4 times household income in New South Wales, but Western Australia leads the way with debt levels at 6.1 times household income
• Highly leveraged households in the combined territories carry debt levels 5.7 times annual income and for Queensland households debt comes in at 5.5 times income.

Regions with the highest typical debt repayment burden are found in the outer ring suburbs of major capital cities
• Looking at households with typical repayments in each region, households in northern Perth are the most burdened with interest repayments at $15,100 per year or 14 per cent of disposable income. A 2.5 percentage point increase would push up repayments by $6,400 a year.

AMP publishes these reports to help the community make informed financial and lifestyle decisions and to contribute to important social and economic policy debate.