It has just been going just two weeks but the royal commission into the banks has had a vastly more material impact than most observers expected.
- Tighter lending rules arising from the royal commission could have the unintended consequences of a credit crunch
- House prices determined by supply and demand of credit, rather supply of housing according to UBS
- Even a mild tightening could see house prices fall 3pc
Banks have been absolutely crunched as evidence of all manner of dodginess and outright fraud mounted up.
The Big Four have lost around 4 per cent of their value since Commissioner Ken Hayne and his redoubtable counsel assisting, Rowena Orr, started turning the screws earlier this month.
But ruthless efficacy of the inquisition could trigger a far bigger and systematic crunch — one that hits not only bank profitability, but potentially the entire economy.
The big investment bank UBS has marshalled its banking and economic analysts to look at the impact on future credit conditions that will inevitably tighten as banks are forced to become more responsible with the loans they have been selling.
The question is how much tighter?
UBS’s base case assumes only a slow and modest tightening of credit conditions due to existing regulatory caps on investor credit growth and interest only loans.
That would see credit growth ease and house price growth moderating.
Under UBS’s modelling that means somewhere between flat and a 3 per cent drop in property prices over the next two years.
However, that is at the benign end of the spectrum.
UBS’s George Tharenou said the “credit crunch” scenario could not be ruled out, even though it would clearly be unintended by regulators and policy makers — and banks for that matter.
“If credit tightening lasts for longer than we anticipate, and evolves into a ‘credit crunch’, there is potential for an economic downturn,” Mr Tharenou said.
Under this scenario, house prices would likely fall over a prolonged period across a few years, according to UBS.
“This is because the price of money [via record low interest rates] becomes less relevant compared with the supply of money [credit availability] or demand for money — that is through employment, income, population,” Mr Tharenou said.
“[This is] particularly [the case] for the marginal new borrower, especially on lower incomes, which sets the price of the stock of existing housing.
“There is a great deal of uncertainty over how ‘bad’ this could become, simply because Australia has never had a fall in house prices of 10 per cent or more.
“Even during the GFC prices ‘only’ fell to 8 per cent over the year, but the RBA slashed rates by 4.25 percentage points and reflated the housing market, and neither have we had a domestic recession in almost three decades.”
Worst case scenario
So what happens if this more severe rationing of credit feeds through to the broader economy?
This is where it gets ugly.
Mr Tharenou said it could then result in higher unemployment and see the RBA even consider cutting rates if it became concerned the slow-down was turning into a recession.
“In this scenario there is a risk of a pick-up in arrears as existing borrowers become financially stressed, and could precipitate a broad-based credit event,” he said.
Certainly there is plenty of evidence tabled before Commissioner Hayne to conclude that lending standards have been lax for a long, long time, and that is putting it kindly for the banks.
Fraud, bribery, false documentation, systematic failure of internal checks and concerted efforts to conceal such things from the regulators also spring to mind.
Commissioner Hayne’s blunt observation of “the very awkward trade-off administrative convenience and obeying the law” is a clear indication that at very least banks will be rigorously policed to ensure they comply with the National Credit Act regarding responsible lending.
The thresholds to get a loan, such as Household Expenditure Measure (HEM), are likely to rise to more realistic levels which would also sharply reduce credit availability, particularly for lower income families, UBS argues.
“While a tightening of mortgage underwriting standards is prudent, especially as the banks move to fully complying with Responsible Lending, it has a material impact on the economy,” Mr Tharenou said.
“It must be remembered that house prices are determined by the demand and supply of credit, not the demand for and supply of housing,” Mr Tharenou warned.