The following is a submission to the Senate Inquiry into The Worsening Rental Crisis in Australia.
*****************************************************
This submission addresses the term of reference,
“actions that governments can take to reduce rents or limit rent rises”
The submission outlines a vision that only governments can realise with the cooperation and leadership of the Reserve Bank.
A Vision
The Reserve Bank, in cooperation with the Federal Government, Treasury, ASIC, APRA, and the ATO, can persuade Banks to increase the financial productivity of home loans. Financial productivity means it costs less to repay a loan with a given interest rate. The savings from the productivity gain is given to the borrower, allowing lending Banks to send the following notice to home loan borrowers without dropping the Bank’s immediate profitability.
Notice to Home Loan Borrowers
Currently, to address inflation, the Reserve Bank increases interest rates. Instead of changing the interest rate, the Reserve Bank could request banks to share the interest between the Bank and the Borrower. With most loans today, the Bank keeps 100% of the interest the Borrower pays. With sharing, the Bank collects the interest and gives some back by reducing the amount still owed.
For example, assume a $10,000 loan repayment of $200 removed $100 from the amount owing and paid $100 of interest, then the amount owing drops by $100 to $9,900. To share 50% of the interest, the amount owing would drop a further $50 to $9,850. This decreases the time to pay off the loan. Sharing keeps the interest fixed but shares the interest between the bank and the borrower.
Banks could implement 50% interest sharing and send the above “Notice to Home Loan Borrowers” to control inflation as a coordinated activity monitored by the Reserve Bank.
Why Sharing Interest on Home Loans Will Reduce Inflation
It’s no secret that inflation happens when an excess of money is chasing too few goods. This is particularly evident in the housing market, where prices keep rising despite more than enough houses being available in Australia. Each night, there are 13,000,000 empty bedrooms! So it’s not a matter of supply. It is non-occupier investor demand funded by Bank Loans that increases house prices and makes them unaffordable.
The Effect of Sharing on Borrowers
Sharing 50% interest on a home loan drops the monthly cost of a home loan by about 20% (see example above). The CPI includes 22% for housing, and the drop in housing costs will immediately affect the CPI and, if widely adopted, is likely to drop inflation to zero within a couple of months.
The Effect of Sharing on Renters
A reduction in the cost of Capital should pass on as lower-priced rentals. It should also reduce the demand for rentals as more people can afford to purchase their own homes. If the Reserve Bank can reduce inflation to near zero and keep interest rates fixed, housing becomes less attractive to investors and more accessible to home buyers. Many renters will become buyers.
The Effect of Interest Sharing on House Prices
House prices will stabilise. For non-occupiers, it will make investing in new properties more attractive than investing in existing homes. Investors will build new homes and sell them to ower occupiers.
The Effect of Sharing on Banks
Increases in the interest rate increase Banks’ Profits. This extra profit is taxed, and the remainder may go to Bank shareholders as extra dividends or, more likely, an increase in the share price.
If the bank does not increase interest rates and maintains the same level of loans, its profits will stay unchanged with sharing. However, sharing allows borrowers to receive future profits today and invest them immediately. Without sharing, future profits may or may not become available to shareholders through increased share prices. With sharing, the community benefit comes from the increased speed of the circulation of money, which reduces inflation and increases productivity.
Banks who decide to share interest with borrowers can gain a competitive advantage without reducing their profits. All are expected to move voluntarily to sharing once one or more start as borrowers will move their business to banks with the best loan terms.
The Effect of Sharing on Bank Shareholders
Sharing increases the efficiency of the financial system by speeding up the circulation of money. This increases Bank profits, but the extra profits go to borrowers. However, the degree of sharing can stabilise the returns to investors and borrowers as interest rates go up or down. Today the variation in shareholder returns is reflected in the Bank share price. With sharing, there will be little variability in the Bank share prices, and they will move with inflation.
The Reserve Bank Stated Policy
“The policy objective is to keep consumer price inflation between 2 and 3 per cent, on average, over the business cycle”. This submission recommends that the Reserve Bank change this to “The policy objective is to keep consumer price inflation at zero and move to a steady increase in productivity and standard of living”. This new objective can be achieved by changing the share of interest to borrowers in consumer products, starting with housing. In the short term, sharing interest on home loans will reduce the cost of housing without reducing the price and achieve zero consumer price inflation.
What the Senate Inquiry Can Recommend
Implementing interest-sharing is a courageous act for any Bank. The management of a Bank is unlikely to implement or experiment to change a long-lasting status quo favouring Bank shareholders over borrowers. However, they will do it if borrowers start to ask for it, other lenders offer it, and it has the approval of the Reserve Bank, Treasury, APRA, ASIC and the ATO. Sharing will increase competition in the Home Loans Market Place.
Recommendation
It is recommended that the Reserve Bank establish a group to trial/model interest-sharing. The group should work with one or more Banks and other government entities to run trials with home loan clients in limited geographic areas. The experiments are to be open, transparent and well-publicised. The results should be fully evaluated and the results published.
