Getting a job, saving a deposit and applying for a home loan to buy your own property is an Australian institution.
Today, around 60.8% or $1.5 trillion of total national credit is used for mortgage finance and, in the month of April 2015 alone, a total of 19,045 residential property loans were approved (Australian Property Report, RPdata, May 2015).
Our love for property has only really been around for the last few decades. Before that, the mortgage industry looked completely different. So how have home loans changed over the past 130 years?
Late 19th Century
The first incarnation of the property rights we know today were first introduced in 1886 in South Australia.
The purpose of the Real Property Act 1886 was to identify and record the ownership details of land or property in order to reduce the amount of fraud that was occurring at the time.
People were able to register their entitlement to a property, including mortgages, after the introduction of this act.
The Real Property Act spurred on similar legislation in all remaining states of Australia.
Start of the first banking crisis
Australian banks were operating in a free banking system even after the Federal Bank of Australia was established in 1881.
The bank issued the banknotes but it didn’t really perform the function of regulating the financial industry like a central bank.
Around this time, there was huge speculative demand in the property market and a large number of building societies and land banks were been established. The supply far exceeded the demand for property and, as a result, one of the largest building societies in Melbourne, the Premier Permanent Building Association, collapsed in December 1889.
After the collapse of the largest building society in Melbourne, 16 more small banks and building societies shut down in 1891.
When the Federal Bank failed in January of 1893, the banking crisis became apparent. By May of the same year, 11 major commercial banks throughout the country had suspended trading.
1900 – 1950
Central Banking System
The Commonwealth Bank of Australia was founded under the Commonwealth Bank Act on 22 December 1911.
It was the first bank to receive a federal government guarantee. The guarantee meant that the government took on the responsibility of securing all deposits in the bank.
The aim of establishing the Commonwealth Bank was to re-establish the peoples’ faith in the banking system.
The bank received central bank authority in 1920 when the bank took over the responsibility of issuing Australian bank notes from the Department of Treasury.
Start of the recession
The agricultural producers had trouble making a profit in the 1920s. At the same time, the government wasn’t getting the returns it expected from the investment in transportation infrastructure.
As a result, there was a cutback in borrowing as well as government expenditure. The recession became worse because other nations, including the United States, fell into recession.
This cut back foreign investment, lowered the demand for Australian exports and led to the biggest recession in the history of Australia, which peaked between 1931 and 1932.
Heavily-regulated financial system
In an effort to avoid another recession, Australian government authorities decided on interest rates, the maximum number of loans that could be written by one bank and the minimum amount of capital that banks were required to keep in reserve. Almost every financial aspect of a bank was controlled.
In addition to this, financial institutions were specialised. Trading banks lent to businesses while savings banks lent to households.
Other finance companies lent for more risky property loans and consumer credit.
In 1960, the Australian Government established the Reserve Bank of Australia (RBA) following the introduction of the Reserve Bank Act 1959. The RBA took over central banking duties from the Commonwealth Bank (CBA), which had copped a lot of criticism for its dual function as a central bank and a commercial business.
The Housing Loans Insurance Corporation (HLIC) was established in 1965.
Its aim was to assist prospective home buyers in obtaining a home loan at a reasonable interest rate by offering lenders a form of insurance. These insurance policies covered the losses suffered by lenders if a borrower were to default on their mortgage.
This insurance is known today as Lenders Mortgage Insurance (LMI).
Rise of the unregulated intermediaries (non-banks)
Up until the mid-1960s, banks were heavily-regulated and couldn’t respond well to customer needs such as high Loan to Value Ratio (LVR) loans and offering more competitive interest rates.
Unregulated financial intermediaries started springing up to fill this market gap by providing new facilities such as high LVR home loans.
Banks started losing market share of total financial intermediary assets, declining from nearly 90 percent in the early 1950s to 70 percent in 1970 (The State of the Mortgage Market, RBA Assistant Governor (Financial Markets) Guy Debelle, 2010).
With the regulated system starting to become ineffective, the public started shifting to these unregulated intermediaries.
1970 – 1990
Deregulation: The mortgage industry is reborn.
Banks were no longer slaves to capital requirements set by the RBA meaning that they were free to set their own interest rates.
The Mortgage Finance Association of Australia (MFAA) was established to provide representation and accreditation to all operators in the mortgage industry.
Foreign banks were allowed to enter the Australian residential lending market which meant more competition in the mortgage industry.
The distinction between savings and trading banks was removed which meant that a bank could develop many different home loan types from residential to commercial finance.
The recession that we had to have
In the 1990s, the unemployment rate rose to 11 percent and interest rates reached as high as 17.00% in the early 1990s.
Many businesses collapsed and the demand for credit in the corporate sector declined.
Banks suffered huge losses because of businesses going bankrupt. However, they didn’t suffer much loss in residential lending.
This is largely the reason that the banking system shifted its focus from business lending to home loans.
By 1995, the share of residential lending increased from 30% to 46% and the share of business lending fell from 63% to 48% (RBA, 2010).
Rise of wholesale lenders
Wholesale lenders were small compared to banks but they competed aggressively for market share by offering more competitive interest rates.
They also introduced new mortgage products such as home equity loans, interest only loans and low doc loans (borrowers now had the option of providing alternative income evidence in order to apply for a home loan, which was beneficial to self-employed Australians who couldn’t provide traditional income evidence).
Housing loan approval market share for wholesale lenders increased from 2% in 1993 to 8% in 1996 (RBA, 2010).
On 1 July 1998, the Australian Prudential Regulation Authority (APRA) was established to oversee the actions of banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies and most members of the superannuation industry.
Its job was to establish and enforce prudential standards and practices designed to ensure that financial promises made by institutions were met within a stable, efficient and competitive financial system.
In the early 2000s, banks began increasing the discounts offered on their standard interest rates.
Various lenders offered a new range of products to meet the needs of those who could not meet standard lending criteria.
By 2004, 10% of home loans approved in Australia were low doc loan products (Banks’ Annual Reports, Australian Bureau of Statistics, 2006).
The Australian Securities and Investment Commission (ASIC) was established to regulate Australia’s corporate markets and financial services sectors.
The Global Financial Crisis (GFC)
Largely fuelled by the US ‘housing bubble’ that peaked in 2004 and the rise of home loans being recommended to borrowers that were not in a position to meet their repayments (subprime mortgages), the GFC hit Australia around mid-2007.
Although the Australian mortgage market continued to grow more than 8% annually over this period the GFC was bad news, especially for the wholesale lending market, which relied heavily on specialised loan products.
The demand for such products drastically declined and, as a result, the market share of wholesale lenders fell from 13% in mid-2007 to about 2% by early 2009. At this time, several large wholesale lenders were bought by major banks.
Banks replaced wholesale lenders as the lender of choice for Australians and their market share rose from 60% to 80% over the two years following the start of the GFC.
Although the financial crisis didn’t affect the quantity of loans that were available in the market, it did bring about some tighter lending policies.
For example, the LVR for full doc loans was as high as 97% at the start of 2007 but fell to 90% by mid-2008.
No doc loans were thrown to the kerb after the GFC because lenders were not willing to take on unnecessary risks.
In addition, the number of low doc loans being written fell from 10% in 2009 to 7% in 2011 and non-conforming loans (bad credit) fell from 2% to nearly zero over the same period. Specialist lenders entered the space to fill this market gap.
Over this time, supply and demand became an increasing problem in the Australian property market, particularly in Sydney and parts of Melbourne.
To avoid a potential market crash, the RBA was continually cutting the official cash rate and the Australian Government began offering grants and schemes to entice first home buyers to buy a new property.
By 2014/15, the RBA began introducing stricter lending policies for investment loans, making it tougher to get approved and eventually required each lender to cap investor lending to no more than 10% per annum of their total loan book.
In a further effort to make property growth more sustainable, the Australian Government began cracking down on foreign investors by increasing the penalties for those who breached foreign investment rules.
In 2015, they proposed a levy or tax for foreign investors wanting to buy residential property, with legislation expected to be introduced in the spring session of Parliament 2015.
The cash rate has remained at a historical low of 2.00% since April 2015 and property prices have continued to increase in most capital cities.
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