. rba. gov. au / speeches / 2018 / sp - ag - 2018 - 09 - 10. html 3 / 13 10 / 09 / 2018 the evolution of household sector risks | speeches | rba graph 3 the risk that difficulties in the residential real estate market translate into stability issues for the financial institutions, however, appears to be currently low. the australian banks are well capitalised following a substantial strengthening of their capital positions over the past decade. while lending standards were not bad to begin with, they have nevertheless tightened over the past few years on two fronts. the australian prudential regulation authority ( apra ) has pushed banks to more strictly apply their own lending standards. and apra has also encouraged banks to limit higher risk lending. lending at high loan - to - valuation ratios has declined as a share of total loans, providing protection against a decline in housing prices for both banks and households. and for loans that continue to be originated at high loan - to - valuation ratios, the use of lenders'mortgage insurance protects financial institutions from the risk that borrowers are unable to repay their loans. overall, arrears rates on housing loans remain very low. but the second potential vulnerability – from high household indebtedness – is that if there were an adverse shock to the economy, households could find themselves struggling to meet the repayments on these high levels of debt. if they have little savings, they might need to reduce consumption in order to meet loan repayments or, more extreme, sell their houses or default on their loans. this could have adverse effects on the real economy – for example, in the form of lower economic growth, higher unemployment and falling house prices – which could, in turn, amplify the negative shock. so what do the data tell us about the ability of households to service their debt? this graph shows the ratio of household mortgage debt to income ( a subset of the previous graph on household total https : / / www. rba. gov. au / speeches / 2018 / sp - ag - 2018 - 09 - 10. html 4 / 13 10 / 09 / 2018 the evolution of household sector risks | speeches | rba debt ) on the left hand panel and various serviceability metrics on the right hand panel ( graph 4 ). the mortgage debt - to - income ratio shows the same pattern as total household debt - to - income – rising up until the mid - 2000s then steadying for a few years before increasing again from

, much of the reason behind it can be attributed to the fallout from the asian crisis of 1997 / 98 and the desire of asian governments to avoid a repeat of it. after the devastation faced by thailand, korea and indonesia ( and observed with interest by china ), asian countries felt they had to make their economies more resilient to international capital flows. the simplest way of doing that was to cut expenditure ( particularly investment expenditure ), keep savings high, run current account surpluses and build up reserves. since the reserves are largely in us dollars, that means lending to the united states. there is a cost to this as it means forgoing spending and building up savings which will be lent at a low interest rate. it is a very expensive form of insurance designed to reassure international investors of the ability of the country to withstand a crisis. i remember that up until a couple of years ago, officials from asian countries ( especially china ) usually started any presentation on their economy by referring to their high level of international reserves. they do not do that any more since the level has become so high that they exceed any likely need. thus, i think that in a world of floating exchange rates and mobile international capital, a number of emerging market economies came to the conclusion that the international financial system was so potentially unstable that the only way they could participate was by paying this large insurance premium in the form of cheap loans to the united states. i have a feeling that this sentiment is starting to change now, but it was a large part of the reason that we have ended up where we have. this is not a new thought of mine, because i was already worrying about it in 1998 when i wrote : “ i fear that a number of emerging market countries will take … ( the ) safety - first policy … ( of ) building up large international reserves - a new type of mercantilism. the problem with this solution is that to build up the reserves they would have to run current account surpluses for the foreseeable future.... the final irony, if this situation eventuates, would be that we would have an international system in which the poor countries lend to the rich so they can spend more than their income. ” 2 sustainability of surpluses i think it is possible to argue that for countries with a fixed exchange rate, surpluses may be more difficult to sustain in the long run than deficits are for some other countries. i speak from experience here as australia faced this problem