Harry Scheule, associate professor of finance at Sydney University of Technology, says that Australian banks appear to be serious denials about the severity of household debt as well as the economic risk mortgage stress poses to their customers.

Scheule pointed this out recent research from the United StatesThis proved that the housing market was not as diverse as originally thought. “This means any house price shocks will likely occur simultaneously across the [United States], causing large cumulative losses to borrowers and banks via mortgage defaults,” Scheule said.

He also quoted a statement by Shayne Elliott, the CEO of Australia and New Zealand Banking Group. last week’s Four Corners report, that “the reality is that housing loans are pretty good because they’re quite diverse in terms of lots of relatively small loans across … the country,” Elliott said.

Elliott’s optimistic view is in direct contradiction to the current state of the housing market, according to Scheule.

Because of the population sizes of Sydney and Melbourne, Australia’s housing markets are likely to be even more concentrated than those in the United States, and housing price shocks in Australia would have more lethal consequences for borrowers and banks. The consequences of defaulting mortgage payments would be worse.

Reduced risks on the housing market

The Australian Prudential Regulation Authority (APRA) has provided guidelines to banks on how to monitor mortgage exposure and limit loans for investors, especially interest only loans.

Stephen Sedgwick (the ex-head of the public sector) recommended that banks stop charging mortgage brokers fees based on how many loans they get. This will reduce the risk.

Scheule said that security is not as easy as it seems.

“Bank losses during the global financial crisis were in large parts driven by borrowers not being able to make their mortgage repayments. After receiving a loan, borrowers may experience income shocks like loss of jobs or demotion and expense shocks like higher petrol prices or interest rates, that affect their ability to service their mortgages,” he said.

The banks do not offer loans with a fixed rate for longer than five years. This makes mortgage contracts in Australia risky. Variable interest rates are the majority of loans currently in existence.

“This leaves Australian borrowers exposed to interest rate increases. In the past few years, interest rates were lowered as Reserve Bank of Australia economists targeted low inflation rates,” Scheule said.

Because of its relationship with interest rates, the Reserve Bank is limited in its ability to stimulate growth.

“There’s the possibility the RBA could raise interest rates, causing shocks to mortgage borrowers. My research shows this shock could increase bank losses substantially.”

“At the moment 23% of consumer expenses are housing related and this number is likely higher for mortgage borrowers and could be growing. Interest rate increases, in combination with the current high debt levels, are therefore likely to increase inflation and trigger further interest increases.”