Australia’s Central Bank Cautions Households on Over-Borrowing as Rates Decline – Reuters

Australia’s Central Bank Warns Borrowers Against Excessive Debt

Australia’s central bank has issued a warning to borrowers about the risks of taking on excessive debt when interest rates begin to decline. However, it assessed that the financial system remains robust overall.

In its semi-annual Financial Stability Review, the Reserve Bank of Australia (RBA) noted the strength of households, businesses, and banks despite facing the highest interest rates in a decade and ongoing inflation challenges.

The report highlighted that a small but rising number of mortgage holders are struggling with payments, while some are making the difficult decision to sell their homes to avoid default. Despite these issues, the proportion of borrowers facing severe financial stress is still low, estimated at under 2%. Additionally, only 0.5% of loans in arrears are also experiencing negative equity.

The RBA anticipates that household financial pressures will ease once interest rates start to fall but warned of potential risks associated with this easing. The bank expressed concern that households might respond to improved financial conditions by accumulating excessive debt, a situation that could be aggravated if lending standards were relaxed.

Despite these warnings, the RBA believes that most borrowers will be able to manage their debts across various scenarios, including some potentially selling their properties to settle their loans. This situation suggests that overall risk to the financial system is limited.

The central bank has maintained interest rates at a steady level since November, with the cash rate currently at 4.35%, a significant increase from the record-low of 0.1% during the pandemic. Policymakers are waiting for inflation to decline further before considering a reduction in rates.

Recent data indicated that headline inflation slowed to 2.7% in August, returning to the target range, while core inflation decreased to 3.4%. This trend leaves room for potential interest rate cuts by the end of the year, with market indicators suggesting a 72% likelihood of easing in December.

Much of the review also focused on external risks, such as operational vulnerabilities associated with digitalization, imbalances in China’s financial sector, and unpredictable shifts in global asset prices that could affect Australia’s financial landscape.

The RBA noted potential vulnerabilities stemming from widespread adoption of AI and cloud computing, which rely heavily on a limited number of third-party providers, increasing exposure to outages and cyber threats.

Domestically, the RBA reassured that banks are well-capitalized. Although non-bank lenders have seen a rise in arrears, risks to financial stability are still deemed manageable. The report also acknowledged a slight increase in business insolvencies, which remain only marginally above levels seen before the pandemic.