Risks for big four banks from reliance on mortgages and “elevated” house prices: IMF

Australia is performing better than most “advanced economies” but risks to its financial stability remain due to a concentrated banking sector heavily reliant on residential mortgages and “elevated” house prices, says the International Monetary Fund (IMF).

As part of its regular (every five years) assessment of the Australian economy, the IMF says the current macroeconomic policy stance is “appropriate” and should remain “accommodative” as the first line of defence against “near-term adverse shocks”.

While it says that risks to stability are primarily external (European debt crisis, a hard landing in China, a sharp fall in commodity prices), it warns that the banking system remains “highly concentrated and interconnected”.

“The four major banks are systemic, with broadly similar business models, and their use of wholesale and offshore funding, even at reduced levels, remains a risk.

“Residential mortgages are the banks’ single largest asset but household debt is high and house prices are elevated.

“However, these are long-standing structural issues that will remain sources of risk over the medium-term, and several factors, including relatively low household leverage, mitigate this risk.”

While the IMF says stress testing indicates that the major banks are adequately capitalised and are likely to withstand large macroeconomic shocks, it says they would require “RBA liquidity support to withstand an extreme funding shock”.

“The sector faces the prospect of slower credit growth as businesses and households continue to deleverage, and could take on riskier strategies in an effort to return to pre-crisis credit growth rates and maintain profitability.

“To further bolster financial system stability against these risks, we recommend that the authorities continue to emphasize intensive bank supervision and introduce higher loss absorbency for systemically important banks.”

The IMF warns of the potential impact of a “hard landing in China” being reduce demand for Australian mineral exports, worsening terms of trade, reduced household income, which it says could trigger a fall in house prices.

“This could in turn weaken consumer demand and growth, and negatively affect banks’ balance sheets. However, we consider this type of risk escalation to be a relatively low probability event.”

The IMF reassures that Australian authorities have the monetary and fiscal policy space to respond to near-term shocks, “with monetary policy serving as the first line of defence”

“The Reserve Bank of Australia (RBA) has the scope to lower interest rates and loosen monetary conditions to help buffer against a downside scenario.”

For advice on navigating hotspots, download our free eBook: Tools for Getting Through the Hotspot Maze. This article first appeared on Property Observer.