Former RBA governor says APRA may need to lower lending buffers

Former RBA Governor Ian Macfarlane says it’s likely the banking regulator, APRA, will have to relax loan serviceability buffers if fixed rate mortgage holders struggle to refinance their loans.

He also says the federal government may have to step in with additional lending if the situation gets serious.

^{Ian Macfarlane was RBA governor from 1996 to 2006. Picture: Getty}

Interest rates have risen sharply over the past 12 months, trapping many households in what's known as 'mortgage prison'. When assessing a loan application, lenders must stress-test whether borrowers would still be able to meet their repayments on an interest rate that is at least 3 percentage points higher than their initial mortgage rate - known as the serviceability buffer.

For some, that means they no longer meet the requirements to borrow the amount they could 12 months ago, making it impossible to refinance to a different lender with a more competitive interest rate.

The Reserve Bank of Australia estimates around 800,000 fixed-rate home loans are expiring this year, equating to $350 billion in credit set to roll from fixed to variable. Around 270,000 of these loans will expire from this month through to July.

Most of these mortgages will move from fixed rates of 2-2.5% to variable rates of 5.5-6.5%. Current serviceability requirements would see them assessed on an interest rate of almost 10%. 

Macfarlane told a podcast hosted by private wealth firm, Stanford Brown, of which he’s an investment committee member, the fixed-rate mortgage cliff is a serious issue.

“It will be resolved by the bank’s customer - the borrower - taking a haircut, probably APRA bending a few rules, and conceivably, a last resort, the government having to step in.”

Macfarlane says that the last thing that banks want to do is foreclose on a borrower and if things “really got nasty, there would have to be some form of additional lending from government”.

In a wide-ranging interview, Macfarlane also told the podcast that he believes the most probable economic scenario is that inflation will prove sticky and interest rates will have to rise further to tame inflation over the next 2-3 years.

He says another possible scenario is that global economies continue to grow and inflation gradually falls. Macfarlane terms this scenario ‘immaculate disinflation’ and one that’s unlikely to occur. Though it is the outcome that financial markets seem to be betting on, which surprises him.

And a third possible economic scenario is that inflation comes down hard, and interest rates go down sharply with it. Yet Macfarlane says this is only likely to happen if there’s an economic recession.

Though Macfarlane makes it clear that sticky inflation and higher rates are the most probable outcomes for Australia.

He notes that this shouldn’t be a scary scenario as the current period is a return to economic normality after central banks kept rates far too low for too long.

Macfarlane says he’s ‘dubious about bonds’ as an investment, with interest rates more likely to rise than fall over the next 18 months.

And he believes that financial markets are underestimating the resolve of central bankers to bring down inflation. Macfarlane believes the bankers don’t want to be remembered for having failed to tame inflation.

He was asked about his recent comments criticising a review into the RBA and Macfarlane reiterated that he thinks “it’s a poor review” and that he would call it "international worst practice’.

The thing that’s worse than the review is that after the government made it public, it said it would implement all the recommendations without any further consultation, and the Opposition supported this, he says.

Macfarlane penned a newspaper column earlier this month suggesting that many of the RBA review proposals were unhelpful and not supported by empirical evidence.

Macfarlane was the RBA governor from 1996 to 2006.