For years, the biggest risk to the Australian economy was the mining boom turning into a bust – and then it happened. The impact will be felt for years to come.
Now, looking forward, the biggest risks are the over-levered consumer and the property market.
The Reserve Bank of Australia (RBA) is watching these risks very closely. If its reluctance to cut policy rates is based on the potential ramifications of a housing bubble, tighter macroprudential controls – i.e., regulations focused on systemic risk – would be one way to help the situation.
However, an even more powerful derisking tool than relying solely on macroprudential policy would be to also force banks to raise common equity. Not retail-targeted hybrids, but good old common equity. By definition, macroprudential controls can only affect the quality of the “flow” of mortgages being originated, whereas increasing common equity also effectively protects the “stock” of mortgages already on banks’ balance sheets from potentially causing systemic stress.
Banking industry leaders themselves have raised concerns in the media over retail investors chasing yield. They also worry that risk is not being priced properly. Yet, so far, no bank has been brave enough to lead the charge, to take advantage of its fully priced stock to truly deleverage its balance sheet and, in turn, help prompt deleveraging in the Australian economy as a whole.
The risks and consequences are mounting. Australia’s banking system is large relative to GDP, the federal balance sheet is deteriorating with budget deficits to the horizon and the risk of any contingent liabilities associated with bank debt should be completely unpalatable.
The Australian economy needs to rebalance, and the RBA must not be sidelined due to property market exuberance from playing a central role in helping this occur.