Kevin O’Grady

Economics Editor

THE Reserve Bank has flagged the risk of spiralling household debt — to households themselves as well as to the financial system — if interest rates suddenly rise.

In its latest biannual Financial Stability Review, released yesterday, the Bank reinforced the message spelt out recently by Bank governor Tito Mboweni that the bias is towards higher interest rates. And the Bank warns that although banks and their clients are currently able to cope with record levels of household debt, this might change.

“Although households are able to service outstanding debt quite comfortably, borrowers need to be aware that the benign environment may not continue indefinitely,” the Bank said.

Household debt as a percentage of disposable income has soared in recent years, as interest rates have sunk to a 25-year low. The review points out that in the fourth quarter of last year, this ratio was at 65,6%, compared with 63,5% in the third quarter and 62% in 1997.

This debt remained manageable, with households using a relatively small fraction of their disposable income to service it. There was thus “no clear threat to financial stability arising from any inability of households to service their debt obligations”, the Bank said.

However, “the level of households’ indebtedness could entail risks should the current benign environment change”.

The Bank also pointed out that a change had already occurred in the ability of borrowers to repay mortgage loans.

Mortgage loans “overdue” — those that are more than 180 days overdue and either inadequately secured or uncollectible — declined in December, even while mortgage debt continued to rise.

“This trend appears to have subsequently changed as mortgage loans overdue increased by 5,5% in the year to February 2006,” the Bank said, while the ratio of overdue mortgage loans to total mortgage advances increased from 1% in the third quarter of last year to 1,2% in the fourth quarter.

“It is expected that the demand for housing will continue to be supported by rises in disposable income, favourable financial conditions and structural changes in the economy.

“However, it should be noted that a sudden increase in the cost of credit could cause problems for overly indebted households in servicing debt obligations,” the Bank said.

“Although not posing a threat to financial stability currently, lenders would be well advised to guard against complacency as experience has shown that the worst loans are made near the top end of the business cycle.”

The review, which aims to identify and analyse potential risks to financial system stability, also warns of a “number of key risks to global economic and financial stability”.

These include high and volatile energy prices, global imbalances and abnormally high residen-tial property prices in some areas.

“In addition, the abundance of global saving and the associated search for yield, as well as the possible mispricing of risk as a result of an extended period of favourable economic conditions and relatively low levels of volatility in financial markets, are causes for concern,” the Bank said.