Our major banks are lobbying hard to convince both the government and the Murray Financial System Inquiry that raising the mandatory capital reserve requirements will see borrowing costs rise and shareholder returns fall. As with all such special interest pleadings, this argument needs to be taken with a grain of salt, not least because higher capital revenue requirements will still leave our banking system over-invested in residential and commercial property debt.
Judging from recent statements, the banks are relying on increased lending to property developers and purchasers to power their business. Despite assurances to the contrary including via a stress test by one of the big four, this is a high-risk strategy because of booming property prices and a heavy reliance on overseas borrowings at artificially low interest rates to fund the loans.
In this situation, the risks for borrowers are much higher than many realise. Unlike in the US where fixed-rate long-term mortgages are the norm, current low interest rates on loans can rise very quickly. Even those with fixed rate mortgages are protected from rate changes for only a relatively short period.
Variable interest rates loans are the normal way of lending in Australia and put the full risk of loss on the borrower, at least until their collateral is used up. Even a modest 2 per cent rise in interest rates would put many new borrowers into negative equity and cash flow situations when property prices fall as they inevitably will.
The warnings for home buyers and even investors whose borrowing costs are reduced substantially by our negative-gearing tax concessions is that increases in the banks’ capital reserves will provide them with no additional protection. Buying heavily geared real estate is a dangerous proposition because all the risks of interest rate and property price changes are placed on the borrower.
In the event of another financial crisis, even if it wanted to, the government could do little if anything to help heavily geared borrowers. The government’s main priority would be to ensure the survival of the banking system. Borrowers would bear the pain.
There are no indications that the Murray Inquiry will address the options available to assist home buyers in trouble such as allowing the unemployed and disabled people to deposit their super in a mortgage-offset account. Until Australia follows the US and Singapore in providing assistance to taxpayers to acquire their home, Darwinian survival of the fittest rules will continue to apply.
The only strategies available without changes in government policy are to pay off loans as quickly as possible and to ensure there is ample financial room to service debts should interest rates rise substantially.