BIS: Household debt threatens financial stability

by YIP19 Dec 2017
A decade after breakdowns in mortgage markets plunged the global financial system into crisis, household debt levels in several countries – including Australia – are once again rising to unsustainable levels, according to a new report from the Bank for International Settlements (BIS).  

The central banks of Canada, the United Kingdom, and Australia have all expressed concerns over the threats posed by high household debt levels to macroeconomic and financial stability in their respective jurisdictions.

To be clear, BIS isn’t against debt, and acknowledges the positive role it plays when harnessed properly. “Debt lets households smooth shocks and invest in high-return assets such as housing or education, raising average consumption over their lifetimes,” BIS said in its report.

However, Australia is particularly vulnerable to unforeseen disruptions due to its high and rising debt levels. “High household debt can make the economy more vulnerable to disruptions, potentially harming growth,” BIS said.

“As aggregate consumption and output shrink, the likelihood of systemic banking distress could increase, since banks hold both direct and indirect credit risk exposures to the household sector.”

Elevated levels of household debt could pose a threat to financial stability, as well as place unreasonable stress on financial institutions. “In most jurisdictions, this is chiefly because of sizeable bank exposures. These exposures relate not only to direct and indirect credit risks, but also to funding risks,” BIS said.

“The direct exposure to credit risk associated with household debt reflects the likelihood that borrowers will default. Defaults occur when debt service costs become hard to bear because interest rates increase or incomes fall. There is some evidence that this may be occurring in Australia, where high-DSR [debt service ratio] households are more likely to miss mortgage payments.”

While the Reserve Bank likes to dismiss the threats posed by high household debt due to the significant amounts of money stored in mortgage offset accounts, as well as the average Australian’s commitment to meeting their debt repayments, BIS has pointed out that new mortgages have much smaller buffers.

“In Australia, the liquid pre-payment buffers on mortgage-offset accounts are heavily concentrated on older mortgages with less time to maturity,” BIS said. “For one third of mortgages, available repayment buffers cover no more than one month's worth of loan payments.”

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