RBA releases its half-yearly Financial Stability Review for 2023
The Reserve Bank of Australia (RBA) released its half-yearly Financial Stability Review for 2023 this month, reassuring Australian households and businesses that the nation’s financial system remains strong and well positioned to support the economy despite vulnerabilities in the global banking system.
The Financial Stability Review details the RBA’s assessment regarding the existing state of the nation’s financial system and considers any potential risks to financial stability. Some of the key themes that the Review explored are outlined below.
Insurers’ profits remain strong despite claims related to natural disasters
Insurers’ capital positions have remained well above APRA’s prescribed capital amount and their profits have continued to recover over the past six months. These profits have been made possible by a recovery in investment income, driven by higher interest earnings on fixed-income securities, while increases in premiums have only partly offset the rise in costs associated with claims. Low unemployment has also been a factor contributing to profits for lenders mortgage insurers (LMI).
Claims from natural disasters remain at a high level. This pattern has continued into 2023, with Australian-based insurers facing large claims from flooding and cyclone-related damage in New Zealand. The cost of reinsurance – which domestic insurers use to protect themselves against large events – has increased sharply, reflecting larger payouts in Australia and globally. Insurers have passed these costs on to customers via increased premiums, raising concerns about the availability and affordability of insurance in some locations.
There is a credit squeeze thanks to the increase in interest rates
The growth in housing credit has continued to moderate, and the share of new, higher risk lending has continued to fall as interest rates have increased. Lending at a Loan-to-Value Ratio (LVR) greater than 90% has continued to decline to new lows. Non-bank lenders have maintained similar lending standards to regulated lenders, but there remains strong competition amongst lenders, particularly for high-quality borrowers.
Business sector is stronger than before the pandemic
The balance sheets of non-financial businesses have strengthened over the last three years up to June 2022 – which is the latest available annual data. However, the rate of cash buffers being accumulated has slowed since early in the pandemic and has an uneven distribution across the business sector. Cash buffers of larger businesses have grown more in proportion to smaller businesses.
Most businesses have rebuilt their profit margins since the pandemic
Strong demand after the pandemic has allowed most businesses to rebuild their operating profit margins, despite rising input costs. This trend is broadly consistent with large listed companies’ profit results for the second half of 2022. However, this is not true for all businesses. Operating profit margins are lower in the building construction industry.
Some businesses are more exposed to higher interest rates than others
Indebted smaller businesses are more exposed to rising interest rates than larger businesses. Around 50% of small business lending is collateralised with a residential mortgage. Most of these loans are also on variable rates, which means higher interest rates have already impacted these borrowers. Small businesses have also been more impacted by ongoing cost pressures, and some may find it difficult to service their loans.
Leasing conditions remain challenging in office markets
Vacancies are high for office spaces and most retail properties, especially in the CBD area. Due to these high vacancies, market rents in these sectors are about 10% below than where they were back in 2019. In contrast, tenant demand for industrial property remains strong and rents have skyrocketed.
The commercial property market is walking a tightrope
Currently, landlords appear to be coping with soft leasing conditions and higher interest rates. However, if rental income were to fall sharply or drastically due to an economic downturn, some landlords are likely to become financially distressed.
You can read the full Financial Stability Review at the RBA website.