Australia’s debt service ratio ‘extraordinary’: CBA

The change in the debt service ratio has been ‘extraordinary’, according to the major bank.

The Commonwealth Bank of Australia’s (CBA) latest report into the Australian household sector when compared to other countries has found that Australia’s debt-to-service ratio currently sits at a record high.

The debt servicing ratios are based on the methodology derived from the Bank of International Settlements (BIS), which reflects the share of income used to service debt for households, non-financial corporations, and the total private non-financial sector.

According to CBA head of Australian economics Gareth Aird, the combination of more household indebtedness and a “predominantly floating rate mortgage market” has seen the debt service ratio rise “more swiftly in Australia than in any other region”.

Aird added that the cumulative change in the debt service ratio in Australia since the global co-ordinated tightening cycle began is “extraordinary relative to other jurisdictions”.

“The change in debt service ratios captures the impact of the magnitude of the hit to household finance from monetary policy,” Aird added.

“The change in the debt service ratio in Australia since 2022 dwarfs that of any other major region due to the structure of the mortgage market and directness of the transmission of monetary policy.”

The International Monetary Fund (IMF) reflected on this sentiment as fixed-rate mortgages have gained more global prevalence.

“Our results indicate that monetary policy has greater effects on activity in countries where the share of fixed-rate mortgages is low,” IMF said.

“This is due to home owners seeing their monthly payments rise with monetary policy rates if their mortgage rates adjust.

“By contrast, households with fixed-rate mortgages will not see any immediate difference in their monthly payments when policy rates change.”

Furthermore, the effects of monetary policy were found to be stronger in countries where mortgages are larger compared to home values and in countries where “household debt is high as a share of GB, according to the IMF.

“In such settings, more households will be exposed to changes in mortgage rates, and the effects will be stronger if their debt is higher relative to their assets,” IMF said.

While Australia’s debt levels remain higher than in most major regions, the Reserve Bank of Australia (RBA) found that the majority of borrowers are still able to service repayments on time.

In its Financial Stability Review – March 2024, the RBA noted that although housing and personal loan arrears have increased since late 2022, they still remain below pre-pandemic levels, however, the central bank has noticed a rising share of borrowers requesting temporary hardship arrangements from lenders.