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The Banks Passed their own Stress Tests But will Fail The Real Deal
Topic Started: 7 Oct 2014, 02:15 PM (330 Views)
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The Banks Passed their own Stress Tests But will Fail The Real Deal

6th October, 2014

When it comes to the Australian banking system, if there is any chart on this planet that exemplifies something very fishy going on in Australia’s banking system it is definitely this chart below by ‘Bubble Economics: Australian Land Speculation 1830 – 2013’ co-author’s Philip Soos and Paul Egan.

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In my opinion this chart is the smoking gun that explains how on paper the banking system in Australia can currently be regarded as a safe, well-capitalised banking system whilst taking on an incredible sum of risk by lending to property investors and home buyers. Looking at the above chart definitely raises questions as to how the banking system in Australia can lend such enormous sums of debt to property buyers year-on-year whilst reducing their risk exposure at the same time. Because mathematically it is impossible to reduce risk whilst taking excessive risk at the same time.

In relation to the current lending environment, interest-only debt lending is at an all-time high, whilst tax deductions through negative gearing are at an all-time high which clearly exhibits that the Australian real estate market is in a speculative state. In other words, overloaded with risky debt.

Mathematically, the banking system can simply not be as profitable and well capitalised at the same time without doing something incredibly risky. As Philip Soos suggests, ‘we can thank Basel II’. Why? Because ‘Basel II rules in 2006 allowed for lower risk-weights on mortgages.’

So today every loan that should be regarded as a risky loan is not because the goal posts were moved in favour of the banks reducing the risk profile on paper– but not in reality (E.g. AAA rated CDO’s in 2008). In the meantime, APRA has had all the time in the world to reduce the risk profile of the Australian banking system when it comes to residential mortgages, but has failed to do so. APRA’s Financial Services Inquiry (FSI) which is currently reviewing the financial health of the banking system may want have the banks redo the stress tests, and this time include the mere fact that there is zero chance that there can only be a small fraction of all the loans currently in play that may one day not be repayable. Because today, this is the difference between a risk-weighed asset and a non-risk asset under regulatory terms.

There are loans today where because a first time home buyer managed to have access to funds (e.g. from parents) to make a 30% deposit on a home, but is living paycheck to paycheck, would not hold risk in the eye of the banking system compared to the home buyer who only had a 15% deposit and is living paycheck to paycheck. That is because house prices have increased significantly in recent times. But if the reverse occurs alongside rising unemployment, both loans hold significant risk.

The problem today is that most homebuyers particularly in Sydney and in Melbourne are forced to take loans that are excessively disproportionate to their incomes. And more often than not, are forced to borrow more relative to incomes on top of the deposit than what American’s or Irish were required by their banks during the peak of their property bubbles.

The day this lending binge unravels will be the day Australian’s realise that their banking system was taking excessive risks in order to keep the property market rising. And today there is no margin for error. And for APRA, it is probably too late to reduce the risk-profile of the Australian banking system. Because all the risk in the world has already been taken. The problem is, due to the regulatory framework, its near impossible to see on paper.

Hence my strong view that though the banking system seems to have passed the internal stress tests conducted, when reality arrives, they will simply fail. This is a common historic fixture of failed banking systems of the past.

Read more: http://blog.australiaboomtobust.com/2014/10/banks-passed-stress-tests-will-fail-real-deal/
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