Tracing back history

In 2007, Australian Prudential Regulation Authority (APRA) conducted a confidential search although this report was never published. The report studied the effect of lower lending standards practices by the banks on credit growth. This was also to understand the ability of borrowers to service home loans given several loans made in 2006. APRA's then-chairman, John Laker, told staff that the report could not be published because it would have panicked the investors while undermining the banks. Some experts believe that the release of the report could have caused Australia to witness recession, increased mortgage defaults, increased unemployment, surge in borrowing costs, and pressure on the economy.
 

Secret report details

The secret report by the banking regulator APRA revealed that lax lending standards by Australian banks threatened to push the number of borrowers who could not pay their home loans to a record level leading to a serious recession and a banking crisis.
 

Housing Lending Rates (Source: The Australian Economy and Financial Markets April 2016 - Reserve Bank of Australia)
 
According to the modelling of the report, lower lending standards had led banks to expand credit significantly delivering 3.4 times more loans than the actual value under the prior conservative lending rules. The model also indicates that the delinquency rates are more than those practical in the recent decade and are often told by several lending institutions to be less than 1% of loan value. Based on the stable economic scenario for the coming three years, the delinquency rate is estimated to be 7.5%. The level of arrears on home loans would have raised a serious concern among investors and affected the offshore funding leading essentially to a home price crash. Since 2007, the mortgage debt has been doubling in Australia and poor lending overseas dragged to global financial crisis. So, Australia in a way averted the recession at the back of the Reserve Bank cutting interest rates and government giving stimulus money at households.
 

Housing Prices (Source: The Australian Economy and Financial Markets April 2016 - Reserve Bank of Australia)
 

Experts’ view on current scenario

The head of APRA comments that home lending practices during the latest property boom are very similar to the period before the global financial crisis. APRA Chairman Wayne Byres reveals that broad issues like buoyant housing lending, commercial property lending standards are all similar to the trends before the crisis. Meanwhile, the former Treasury secretary, who is currently the National Australia Bank chairman, Ken Henry reported that Australia is vulnerable to a new global shock. He further adds that the biggest risk to Australia would be a global financial meltdown and the best solution to this he believes that is a strong public sector balance sheet.
 

Australia property market

Many are comparing the Australian property market to a bubble, escorted by regulatory satisfaction and political inertia, which builds up slowly and lasts longer than expected. When a bubble bursts, the financial market goes down and the effects may impact largely the broader economy.
 
The Australian property market is said to meet all criteria to match it to forming a bubble with valuations reaching sky high levels driven by heavy debt, monetary authorities and accommodating tax regime. It is further reported that sharp corrections in the Sydney and Melbourne real estate values would have a demolishing impact on the country's banking system, given its extraordinary exposure to residential property and thereby shaking the broader economy. As per the latest statistics released by the Australian Prudential Regulatory Authority on home lending, as of December mortgage debt over property issued by Australian banks and other authorised institutions surged to a massive $1.4 trillion as compared to a just $638 billion in 2008 when APRA began compiling statistics. Given the mortgages are variable rate loans, which are delivered for over 25- and 30-year terms, for the next two decades, either interest rates would rise or a recession might occur which would lead to a risk on the economy having increasing defaults on banking system.
 

Australia GDP Chart (Source: Thomson Reuters)
 

Australia vs Global economies

Australia's total debt to GDP ratio stands third only to Japan and the European Union (EU) and based on this, it is likely that there is a ratings downgrade fast approaching. However, the base difference between the economy comparisons are that while Japan and the EU have major levels of government debt, Australia's has a lot of private debt which is all about mortgages. As per Tony Abbott in a parliamentary research, Australian government debt pales into insignificance when compared to Japan and Europe. Net Australian government debt reached $278.76 billion, almost 17% of GDP, based on the latest MYEFO statements. This indicates that the private debt now stands at about 130% of GDP against the $1.4 trillion in outstanding mortgages.
 
Overall, we see that immense pressure is building upon the banks and efforts such as imposing new capital controls and limitations on residential mortgages and lending limits may bring some balance with other macro-level steps necessary to boost the economy.

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