see_change said:
One aspect I know little about is the supply of money. I know this has been a factor in some previous property downturns.
What factors control money supply, and do you have any thoughts on how this might impact the current property market.
As Peter posted
here there are some who believe that banks caused the property boom by way of their influence in the supply of money.
SC, essentially the question you are asking is almost the opposite.
If an increase in the money supply caused (or was, at the least, a major contributor) to the boom, could a decrease in the money supply cause a downturn?
Short answer - yes.
What is the money supply?
The
RBA defines the money supply (broad money) as:
The widest definition of money published by the Reserve Bank of Australia (RBA). Broad money is defined as currency plus bank current deposits of the private non-bank sector, plus all other bank deposits of the private non-bank sector plus borrowings from the private sector by non-bank financial intermediaries (NBFIs), less the latters' holdings of currency and bank deposits.
So how could the money supply change?
Well it can change in numerous ways, such as:
- more notes are printed and coins issued than are taken out of circulation
- deposit levels change
- lending levels change
How do banks influence the money supply?
Most notably through a process called "the multiplier"
There are a number of different ways of expressing
the multiplier, and one of them is as follows:
total change in bank deposits = (1 / reserve ratio) x initial change
So if banks have a reserve ratio of 20%, then a $500 million initial change in bank deposits will (in this simple model) result in a total change of $2.5 billion in bank deposits.
What is a reserve ratio?
The
Australian Prudential Regulation Authority acting in cooperation with the RBA sets minimum % of deposits that deposit-taking institutions are required to keep in specified asset classes.
If the reserve ratio changes, this could very well flow through to the money supply.
Why would the multiplier change?
- Changes in the reserve ratio
- Changes in lending practices
So where to from here?
Clearly, because most property is bought with borrowed funds, changes to either the reserve ratio of deposit taking institutions, or to lending practices, have the capacity to impact upon the supply of funds for lending.
Reserve Ratios
As far as I know no-one really talks about reserve ratios. The reason being that (my understanding) r/r's are institution specific. The r/r of the CBA will not neccesarily be the same as the r/r of the NAB, ANZ, or Westpac. Reserve Ratio's reflect APRA's assessment of each banks risk. If you are assessed to be "riskier", you're r/r goes up, and vice-versa. Of course, no-one wants to be seen publicly as being more risky than someone else, so it is all hush-hush.
Lending Policies
The property "market" (as a whole) is past its peak at this stage of the cycle and indeed price falls have been seen in the market (and there is lots of evidence in Sydney and Melbourne - 40% of Australia's population - to support that). From a lender's perspective, this is obviously cause for concern.
So how do lenders react?
They increase servicibility requirements, decrease LVRs, or stop lending on some types of property altogether, and so on.
This restriction (reduction) on lending reduces the money supply.
I haven't gone to the trouble of checking what the top economists at the big banks are saying at the moment, but I would be surprised if any of them are predicting the next property boom is due to start next month. Last I looked into it the general consensus was that property would be in the doldrums for a few years.
Now, it does not seem to be too big an assumption to make that if the Chief Economist at ACME Bank is saying "property is off the boil" that the Bank's attitude towards lending for property will be more risk-averse than at times when the Economist is saying "property is getting hot again".
Of course, by the time that same bank economist comes out and again says that "property is heading for a boom", you can bet that the boom is well and truly underway.
But it will be at
that time that lenders will fall over themselves to loan money to property investors. Lending requirements will ease and the masses will jump on the bandwagon and the roller-coaster ride will begin all over again.
But by that stage, the smart investors (ie. people on this forum) will have already taken up their positions in the market. And it is they who will benefit the greatest from the masses that follow.
* * *
For those that are interested in the money supply and the reserves ratio, check out the attachment (something I first posted many moons ago in
this thread. Again, full acknowledgement to
Associate Professor Glen Otto at the University of New South Wales (he is the author of the document).
Mark