A financial system with ‘no room for complacency’

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Carrington Clarke (0:37)

It's Health Check Day for the Australian Financial System, with the release of the Financial Stability Review from the Reserve Bank. And despite inflation is still well above target, a fourth interest rate hike this year, and the downturn in the property market, the Reserve Bank seems most concerned about what's happening overseas, particularly the increasingly opaque funding of the AI investment boom. Welcome to ABC Business Daily.

I'm Carrington Clarke.

Alicia Barry (1:06)

And I'm Alicia Barry, ABC Finance journalist and host of The Business on Thursdays.

Carrington Clarke (1:11)

It has been an absolutely packed week this week when it comes to the Australian economy and finance news. We did have the Reserve Bank hand down that fourth interest rate hike. It was expected, but it's still obviously sent reverberations through the financial system and also households, once again, having to deal with higher repayments. We've also had the release of that inflation data a little bit late for the Reserve Bank decision, but still quite interesting to look at exactly what is driving these price rises here in Australia. Now today, the Financial Stability Review, this comes out twice a year. It's the Reserve Bank's chance to kind of have a look at what's going on in the Australian financial system at the moment, but also to set up some kind of worst-case scenarios to see how we might withstand some pressures. Obviously, we knew they would be looking at what's going on in the property market because the downturn in property prices has been such a big story this year.

Take us through that to start off with, and then we can talk about some of the offshore risks that they see starting to potentially rear their heads up on the horizon, although maybe not fully materializing just yet.

Alicia Barry (2:23)

The RBA isn't too worried about a housing downturn in Australia. It is, as you pointed to, much more worried about offshore shocks from the AI boom and the potential profitability not occurring there, as well as sort of what's going on in the bond market, huge sell-off, and we'll get to that. But the RBA, as you say, studied a number of scenarios. The most adverse scenario, where the unemployment rate rose to 6.3% from the current 4.6%, inflation jumped to 7%, we're currently at 4% on a headline basis, and the cash rate surged another 1% to 5.6%.

It says the share of mortgage borrowers at risk of defaulting on their loans was likely to rise to around 5%. Now, that's slightly higher than the last peak we saw in 2023 when the COVID inflation spike occurred. We had rates rapidly rise to 4.35%.

The RBA says though, even if that were to occur, and there's 5% that would be at risk of defaulting, if they don't have cash buffers, they're very likely to have equity buffers because of the huge run up in home prices that we've seen over the last decade or so. So they could essentially sell their house or unit, pay it off in full, and that would pose no financial stability risks. It doesn't go into what would happen to that household then, if they were without jobs, as to where they would live, one would hope they had extra cash to then rent somewhere. But in any case, from a financial stability point of view, the Australian housing market is not posing too much of a risk. At the moment, the RBA says those with mortgages with cash shortfalls are around 2% and that means, perhaps people would have to get extra jobs or find extra cash from elsewhere to pay the mortgage. So Michelle Bullock on Tuesday said there are people pockets of real pain, but on an aggregate level, the people with mortgages are fairly well stable, if you like, not a big risk to financial stability, but that would come as cold comfort to anyone listening to this who's really struggling at the moment. We know there are people really doing it tough, trying to make ends meet.

Carrington Clarke (4:43)

Yeah. And also in that scenario, they looked at property prices also declining, right? So they're still not even worried if we see a major decline in property prices. Was it 20% in addition to what's already happened?