Australia’s household debt, among the highest in the developed world, could exacerbate a severe economic downturn by forcing a pullback in consumption, a Reserve Bank research report showed.
“We find that a severe stress scenario would have a somewhat larger effect on consumer spending today than it would have had a decade or two earlier,” according to the report, lead-authored by Jonathan Kearns, head of financial stability at the RBA. The increased sensitivty reflects higher debt levels, a shift to riskier investments and changes in consumer spending patterns, they said.
Australians racked up enormous debts as rising incomes and falling interest rates allowed them to take out larger mortgages to pursue escalating property prices. This vulnerability is frequently highlighted as a risk to banks and the broader economy in the event of a severe downturn.
Yet the report provides some comfort for policy makers, showing:
- A major reason for the scale of leverage is that the rental market Down Under is mostly owned by households; that contrasts with other countries where a significant share of such properties, and the associated debt, belongs to corporations or governments
- Risks are tilted more toward weaker economic growth than large bank losses as stress tests highlight the resilience of lenders to severe scenarios. This is mainly due to debt being primarily held by households with “relatively low” risk of unemployment
- While household borrowing is a large share of banks’ assets and important for their performance, high lending standards, low loan-to-valuation ratios and banks’ high level of capital mean banks are very resilient to adverse shocks
“The level and growth of household debt reflects high incomes and direct ownership of rental housing, not evidence of widespread excessive leverage,”the report found. “The implications for consumption of household indebtedness are an important mechanism to take into account when targeting macroeconomic policy to respond to economic shocks.”
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