banks facing problems ahead

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    Housing dip cramps banks
    By Duncan Hughes
    September 24, 2004

    Australian banks face severe constraints about where to seek growth as the housing market slowdown puts pressure on margins and intensifies competition in other areas, the Reserve Bank says.

    The central banker yesterday also warned that innovations in the home lending market had increased the riskiness of banks' mortgage portfolios, despite the very low levels of impaired loans.

    It also urged investors to be wary of the risks involved with hedge funds, where diverse strategies used to outperform traditional benchmarks have resulted in funds rising about 65 per cent to $15.5 billion in the past year.

    The bank's twice-yearly Financial Stability Review said the economy remained in good shape, with continued growth giving banks and intermediaries opportunities for expansion.

    Banks were benefiting from low debt expenses while the insurance sector had enjoyed benign claims conditions, better underwriting results and higher investment returns in an environment of rational competition.

    "The change in the housing market is, nevertheless, posing some challenges for banks and other lenders," the RBA said.

    "As growth in housing credit slows, growth in lenders' balance sheets and earnings is also likely to ease. This is leading to an increase in competition in some product areas as banks seek out, or protect, sources of earnings growth."

    House prices have fallen this year after increases of about 20 per cent in 2003 and an average growth rate of 13 per cent during the past four years.

    The bank warned that the riskiness of banks' mortgage portfolios had increased in recent years because of the growing ease of finance, changing market conditions and the banks' possible vulnerability with a small number of mortgage insurers.

    For example, the growth in low-documentation loans - designed to make it easier for those without the documentary proof or work history to borrow - could result in higher risk, particularly where brokers had made it easier to refinance their loans and increase debt.

    The RBA warned that the concentration of some 80 per cent of the total value of outstanding policies with the three largest insurers could create systemic difficulties if there was a major downturn in the housing market.

    The growing popularity of hedge funds since the near-collapse of US-based Long Term Capital Management in 1999 has prompted the bank to warn investors to be aware of their potential volatility.

    Australian investors, like their US counterparts, have been attracted to the funds, which can use diverse strategies, derivatives and leverage, because of their outperformance against major asset-class benchmarks.

    "What is perhaps less well appreciated is the potential for hedge fund returns to be more volatile, and the wide dispersion of returns and volatility across different funds," the report said.

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