Historically when credit growth slows, it is because the economy is tanking. The last time this happened in a serious way was in 1991.

Latest Reserve Bank numbers show the housing sector growth is slowing to about 1% annualised for investors and about 5% for owner occupiers. Both these growth rates were around double digit at the peak in 2014/5. So, this is a sharp fall. However, the economy is not tanking; despite the problem of natural disasters, commodity prices and volumes are high which is feeding positively into national income and the terms of trade. As a result, GDP growth is around 2.25% annualised and a budget surplus looms after 12 years of deficit. Interest rates of course are at a historical low. So, what is going on?

Many pundits believe that the banks have driven this change due to the twin effects of scandals and reputational damage coming out of the Royal Commission and the renewed efforts of SSIC and APRA who were also found wanting. We warned last year that Royal Commissions were good at diagnosis but not at solutions and the concern was that if you kick a dog too many times (in this case a bank), then it will turn and bite you. Or in this case not actually bite you but decline to lend to you or change the terms on which it will lend to you. Even the governor of the Reserve Bank put out a warning to the effect that banks needed to keep lending. This is all very well, given that some commentators say the Reserve Bank should carry some responsibility for keeping interest rates too low and provoking an unsustainable rise in house prices that occurred on the back of the high level of credit growth several years ago. But of course, cause and effect are difficult to isolate in economic analysis.

For all the increases in house prices, defaults are very low, and the home loan business has been a huge money spinner for all banks. That has not stopped the banks from drastically tightening credit policy, particularly around the aspect of income verification and verification of assets and liabilities, with the result that borrowers are finding they cannot borrow what they expected. The mortgage brokers have been charged with facilitating the so called “liar loans” and the Commissioner came down against them and the way they are paid. Ironically the brokers have only grown so much because the banks encouraged them as a low-cost distribution channel to bring deals to the bank.They are also a vital source of business for smaller banks that can offset the dominance of the big four.

So, trail commissions notwithstanding,The Stump believes the brokers play a vital role. Now that house prices are succumbing to the force of gravity, the tightening of credit is only accelerating the price falls. In relation to business lending, for the banks this is lower volume but higher margin business. We are seeing the banks apply the same sort of heightened scrutiny to business borrowers, but because the security over business loans may not be as sound as for home mortgages, there is an extra level of wariness. This is playing out in several ways:

· Longer, more detailed and slower approvals

· Tighter loan to value ratios

· Higher risk margins

All this is contributing to a sentiment amongst business borrowers that it will all be too hard and so investment decisions are being put off. Does this amount to a credit crunch? In the Stump’s opinion, yes it does. The thing is that bank bosses can down play it, but a bank is a massive hierarchy that is very sensitive to risk and not just risk to the bank, but risk to the banker if a deal goes bad. The bosses will not cut across the credit process otherwise they undermine the integrity of their own institution. So, deals stop down the line at the same time a bank boss might be saying “we are open for business”.

After observing this phenomenon many times, the Stump has come to the view that as a whole, banks are poor risk managers. Surprising, given you would think it is part of the core business, but they do rely heavily on their internal models (which they guard closely) and either lack the expertise at the coal face to assess a deal, or they fail to support that expertise as they should. It is not so evident when times are good and credit is easy, but it is certainly evident now. There has been an adverse institutional reaction.

We have not seen this point made strongly anywhere during the royal commission or other commentary. People ask questions of the regulators, and they have been found to be wanting, but at the end of the day, this is about the banks themselves. Where a bank has developed a specialised unit in certain sectors, we find the risk assessment is better, but the major banks still have a one size fits all approach to SME lending. Until they are prepared to resource this properly, with experienced people on client files supported by management, nothing will change. In relation to housing, the present verification process is unrealistic and will need to change. Until then, we will just need to ride this one out.

So, the Stump argues that the credit crunch is more due to institutional and regulatory failure than to economics. But the present over reaction will apply brakes to economic growth until corrected.

Best wishes to all readers

-Jim Wheeler