The surge in home and business lending is hindering economic growth, a new economic study suggests.
A report published by the OECD reveals that credit to households and businesses has grown three times as fast as economic activity over the past 50 years. But at these levels, further expansion is likely to slow economic growth in the long term.
“In most OECD countries, further expansion in credit by banks and similar intermediaries slows rather than boosts long-term growth,” the report notes.
“On average across OECD countries, a 10% of GDP increase in the stock of bank credit is associated with a 0.3 percentage point reduction in long-term growth.”
According to the OECD’s modelling, this is because a higher quantity of credit is also likely to bring a lower quality of credit. Further, the proportion of credit going to households, as opposed to businesses, has risen considerably over past decades. This trend matters because credit is a stronger drag on growth when it goes to households rather than businesses.
To avoid credit overexpansion and stalling long-term growth, the OECD encourages the use of macro-prudential instruments to stabilise the financial system – including caps on debt-service-to-income ratios and stronger capital requirements.
Australian banks have made strong headway in implementing macro-prudential tools to tame credit growth recently. A number of large lenders – including the four majors – have announced decreases to maximum LVRs on investor loans.
In addition, the proposed new Basel 4 banking requirements will require the major banks almost double the amount of capital they must hold against mortgages.