In a speech “Has the Way We Look at Financial Stability Changed Since the Global Financial Crisis?“, Michele Bullock, RBA Assistant Governor (Financial System) discussed the RBA’s perspective on macroprudential.
Referring to APRA’s 2014 “tightening” of mortgage lending, she says that whilst borrowers risks may have lowered, “the initial effects on credit and some other indicators we use to assess risk may fade over time”.
Agreed. It is clear that the regulators have not done enough to tame housing credit growth, conflicted as they are between seeing housing momentum as a replacement for the fading mining boom on one side, and the risks to households, their high levels of debt, and broader financial stability on the other. Actually, we think the Council of Financial Regulators (that shadowy body, chaired by the RBA, and including APRA, ASIC and Treasury) has failed to manage the fundamentals in the past few years. Did they not see the risks, or did they choose to ignore them? In that light, Bullock’s comments have a hollow ring!
Post-GFC, there is now more acceptance of the need to take action when system-wide risks are rising. This is reflected in the increasing use of what are commonly known as macroprudential policies.
As my colleagues David Orsmond and Fiona Price note in a Bulletin article in December 2016, there is no universally accepted definition of macroprudential policy. They define it as ‘the use of prudential actions to contain risks that, if realised, could have widespread implications for the financial system as a whole as well as the real economy.’ They also note that the use of such tools has increased in a number of countries post-GFC.
In Australia, we see macroprudential policy as part and parcel of the financial stability framework. As we have set out on other occasions, the essence of macroprudential policy is that prudential supervisors recognise potential system-wide risks in their supervision of individual institutions and react accordingly. APRA can and does take an active supervisory stance, modifying the intensity of its prudential supervision as it sees fit to address institution-specific risks, sectoral risks or overall systemic risk. A recent example might help to illustrate this.
In 2014, the Australian regulators took the view that risks were building in the residential housing market that warranted attention. There was very strong demand for residential housing loans, particularly by investors. Price competition in the mortgage market had intensified and discounts on advertised variable rates were common. There also seemed to be a relaxation in non-price lending terms. The share of new loans that were interest only was drifting up and the growth of lending for investment properties was accelerating. Unsurprisingly in this environment, the growth in housing prices was strong, particularly in Melbourne and Sydney.
The regulators judged that more targeted action was needed to address the risks – to put a bit of sand in the gears. So APRA tightened a number of aspects of its supervision. It indicated that it would be alert to annual growth in a bank’s investor housing lending above a benchmark of 10 per cent. It also set some more prescriptive guidelines for serviceability assessments and intensified its scrutiny of lending practices. ASIC also undertook a review of lending with a focus on whether lenders were complying with responsible lending obligations.
There is no doubt that the actions did address some of the risks. Nevertheless, the early experience suggests that, while the resilience of both borrowers and lenders has no doubt improved, the initial effects on credit and some other indicators we use to assess risk may fade over time. We are continuing to monitor their ongoing effects and are prepared to do more if needed.
Where to from here? With the GFC close to 10 years ago now and a substantial amount of regulatory reform having been undertaken, the focus is turning to implementation and taking stock of the effectiveness of the reforms. This is reflected in the FSB’s current agenda. But there is also some thinking to be done about how monetary policy considerations should factor in financial stability issues, and the role that macroprudential policies might play in addressing system-wide risks in a low interest rate environment.
In conclusion, I would like to return to the question I posed at the beginning of this talk, and in fact the question I posed myself when I first came into this area a few months ago – has the way we look at financial stability changed since the GFC? While the basic way we look at financial stability has not changed, experience with the GFC reinforced the need to focus on system-wide issues. We need to spend time analysing them and thinking about whether policy responses might be required. We are still learning how best to do this.