Property Research Analysis ABPL90363

Role of Shadow Banking in Housing Market Affordability

THESIS – DRAFT

 

Introduction

The notion of shadow banking had garnered much attention from both professionals in the industry and in the academia. Literatures have explored the characteristics of shadow banking entities, its related activities and its implications to better understand the imminent characteristics that had led-up to the largest global financial meltdown or known as the Global Financial Crisis (GFC) of 2007 and 2008. A number of studies have asserted the root of cause of the GFC stemming from mortgage markets, where the housing market (as in the case of the United States) acted as a principal catalyst (Carmassi, Gros & Micossi, 2007; Obstfeld & Rogoff, 2009) in incubating the financial meltdown. In retrospect to key indicators of the lead-up, the present residential market in Australia displays strikingly similar attributes as such of the financial crisis which had exerted an immense paralysis effect on the functionality of the global economy. Although, Australia had suffered economic slowdowns during those periods, repercussions of these effects were largely buffered.

Over the last decade, the Australian property market had observed historically exceeding value growth rates, of which of these upturns were predominantly captured in its residential housing market. Favourable economic performance fuelled by easing monetary policy initiatives along with sustained market confidence, in tandem to liberalisation of the credit economy in housing finance have contributed to demand proliferation within its economy and housing stocks in particular. Furthermore, the Australian taxation system purportedly benefits landlords within avenues of various concessional tax incentives. In comparison to other OECD countries, Ellis (2006) asserts that the Australian property market had created a favourable investment haven for domestic and international investors alike. Resultantly, the Australian booming property market has culminated in the emergence of heightened risk-taking strategies (such as negative gearing) and amplification of financial liquidity leading to exponential growths in its house prices and demand for its stock. However, this rapid appreciation was perceived to be unsustainable and characterised as an asset property bubble. Nonetheless, a substantial disconnect between house prices and income levels of boom cycles in the residential market evidently manifests itself in a distinct affordability deterioration in first-home buyers (FHB).

            Following an elongated series of positive house price growths, the Australian residential market currently displays a declining trend in house prices. The Australian Bureau of Statistics Established House Price Index note property prices at 0.7% quarter-on-quarter decrease to date from 2018Q1 while a 0.6% year-on-year decline was observed from the corresponding quarter of previous year. Additionally, property prices have declined at approximately 3.7% following the housing market boom peaking at 147.6 index points (CoreLogic, cited in Kehoe, 2018). Corrections to the residential market can be attributed to the royal commissions of the Australian Prudential Regulation Authority (APRA) reinforcing compliance lending policies and curbing excessive lending to borrowers at credit-risk. The introduction of regulatory controls has seemingly demonstrated a lag time in its effects. At its initial intervention of a credit squeeze, the House Price Index, number of financing commitments of FTB and number of loans issued by traditional banks suffered a slight initial shock in the following quarter before swiftly gaining traction in an upward trend. In such an environment, there are implications of mortgage financing on housing affordability, particularly in FTBs. The conceptualisation of affordability measures has primarily revolve around purchase affordability and the ability to borrow. As house prices are subdued, the emergence of a paradox arises as FTBs are unable to benefit from the market correction. Instead, the prominence of housing affordability distress is more pronounced as austerity measures were enforced, with FTB housing commitments and bank loans issued falling circa 20% following 2017Q4. With Gishkariany, Norman & Rosewall (2017) indicating an increase of shadow banking associated activities supplying credit avenues in the housing industry, affordability in FTBs is faced with a dichotomy as access to the residential market is significantly challenged.

            Constraints to mortgage access concurrent to price-to-income retrenchment may exacerbate the housing affordability condition in Australia. In contrast to banking literatures rejecting the utilisation of shadow banks in credit intermediation, Lemma (2016) and Ehlers, Kong & Zhu (2018) affirms that the productivity of shadow banks instead assists the mainstream market in ameliorating housing affordability distress. This paper inspects the relationship between housing affordability and shadow bank financing and examines the potential effects of liberalized credit access influencing housing affordability in FTBs over the period of 2006Q2 – 2018Q2. Firstly, shadow banking and housing affordability is defined and introduced in the context of the Australian residential market. Next, the paper addresses the relationship between the housing affordability and shadow banks, identifying ramifications to the housing market in a more liberated credit access environment. Lastly, the paper concludes.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Literature Review

 

This study reframes shadow banks as informal mortgage provider entities (non-banks) in the context of housing affordability. This is narrowed under the definition of the shadow bank lending by the Financial Stability Board (Gishkariany, Norman & Rosewall, 2017, p.1) that is, “credit intermediated outside of the regulated banking sector.” In similar fashion to traditional banking sectors, shadow bank lending typically involves transformation of credit liquidity and extending leveraging capacities to systems or individuals in difficulty obtaining credit access.

The emergence of shadow bank financing had been widely documented. For example, Gabor (2013) and Gishkariany, Norman & Rosewall (2017) observed that policy reforms pertaining to increased regulatory oversight had resulted in increased shadow banking activities in the lending market. Restriction to conventional credit access creates a demand vacuum in the lending market. As such, shadow banks usually respond to this demand, thus resulting in growth in non-banks. Where there is greater reliance on gaining mortgage access from principal lending entities, the greater the substitution effect was found in the growth of non-banks as macroprudential policies restricts credit access (Morris-Levenson, Sarama & Ungerer, 2017). Prior to the implementation of regulatory reforms in 2014 by the APRA, financial policies in concert with a liberalized credit economy had shifted housing policies towards pro-homeownership. Housing polices such as fiscal incentives and unconstrained mortgage access into the residential market has had significant impacts in the property market. Similarly, Ortalo-Magne & Rady (2002) demonstrated that institutional reforms promoting owner-occupation rates had resulted in the proliferation of housing demand. Evidently, house prices in Australia had experienced exponential growth. In Davis & Zhu (2004), they observed that an easing credit access environment had a self-reinforcing positive feedback loop in market demand and liquidity within the mortgage market. Consequently, the supply of ‘cheap’ credit was constantly supplied back into the market, thus sustaining a boom market. This particular aspect manifests within the Australian residential market, with consistent upward trending house prices.  However, there is a widespread concern for such unsustainable price growths forming a price bubble, thus amplifying volatility within the residential market. Nonetheless, a deregulated lending market had positive impacts on alleviating credit constrained households. Campbell & Cocco’s (2003) study revealed that diminished credit restrictions had improved the demand for housing. This signifies a positive relationship in house price increases and deregulations in the lending market. This observation was sustained by Duca, Muelbauer & Murphy (2011) affirming that informal lender entities dynamically extends credit availability as market price increases, in particular to FTBs. The introduction of shadow bank financing dynamics into the regular lending system creates alternative avenues for credit, which leads to greater credit supply and competition amongst lenders. According to Girouard, Kennedy & Andre (2006), a dramatic increase in homeownership rates was observed amongst lower-income demographics, especially FTBs as supply-side innovations utilises international mortgage markets. Following fundamental economic truism, in face of competition non-banks lower costs to consumers, thus improving efficiency within the mortgage system (Scanlon, Lunde, & Whitehead, 2008).

            Fundamentally, shadow bank lenders tend to operate in sub-prime markets (grey area) that governs less regulatory oversight from financial watchdogs. the shadow bank economy is encompassed within the real estate market due to its underlying activities being interconnected to the primary financial system. Instruments of mortgage-loan origination and securitisation of those mortgage products are embedded within processes of financial products (pooling of wealth management products). Through liberization, financial engineering and active involvement within the sub-prime market have innovated multiple financial products, but also introduced repercussions within the financial system. The availability and cost of mortgage lending greatly underpins the performance of a residential market (Gishkariany, Norman & Rosewall (2017). International empirical studies have shown that mortgage availability possess significant stimulus to house price growth (Scanlon et al., 2008). In the case of Australia, the housing boom was driven by favourable economic conditions along with historically low rates confluence to rising demand appetites, however most pertinent to the prevalence of accessible low cost financing from traditional banks. Yet, Kim & Renaud (2009) warns that expectational risks associated to enhanced borrowings are downplayed during up market cycles. Instead, the increased injection of financial stimulus into an overheating market resulted in further inflationary house price bubbles and eroding affordability. On the flipside, the creation of alternative credit access (entry to shadow bank financing or profligate lending practices) manufactures a vicious cycle whereby boosted purchasing power of buyers have buoyed asset appreciation. Securitised lenders vying for market share frequently trades (or transfer liabilities)  these securitised assets to achieve higher returns, particularly during a boom environment. This in turn, serves to propagate participation and extenuate boundaries in high-risk lending strategies. Net benefit gains resultant from deregulations are thereby negated by rapid house prices as widespread finance availability surges market demand, and consequently aggregate market pricings.

 

DEFINIING & MEASURING HOUSING AFFORDABILITY

 

 

 

Empirical Strategy

 

 

Results

 

 Conclusion

References:

Australian Bureau of Statistics. 2018. Residential Property Prices Indexes: Eight Capital Cities, Jun 2018. Australian Bureau of Statistics.  Retrieved from http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6416.0Jun%202018?OpenDocument

Campbell, J. Y., & Cocco, J. F. (2007). How do house prices affect consumption? Evidence from micro data. Journal of monetary Economics, 54(3), 591-621.

Carmassi, J., Gros, D., & Micossi, S. (2009). The global financial crisis: Causes and   cures. JCMS: Journal of Common Market Studies, 47(5), 977-996.

Gishkariany, M., Norman, D. and Rosewall, T., 2017. Shadow Bank Lending to the Residential Property Market. RBA Bulletin, pp.45-52.

Kehoe, J. 2018. RBA, Treasury warn regulatory response to Hayne commission risks credit crunch. Financial Review. Retrieved from https://www.afr.com/business/banking-and-finance/rba-treasury-warn-regulatory-response-to-hayne-commission-risks-credit-crunch-20181001-h16322

 

Obstfeld, M., & Rogoff, K. (2009). Global imbalances and the financial crisis: products of common causes.

Ellis, L. (2006). Housing and housing finance: the view from Australia and beyond (No. rdp2006-12). Reserve Bank of Australia. Retrieved from https://www.rba.gov.au/publications/rdp/2006/pdf/rdp2006-12.pdf

Reserve Bank of Australia. 2018. The Global Financial Crisis. Reserve Bank of Australia. Retrieved from https://www.rba.gov.au/education/resources/explainers/the-global-financial-crisis.html

Lemma, V. (2016). The Shadow Banking System as an Alternative Source of Liquidity. In The Shadow Banking System (pp. 37-61). Palgrave Macmillan, London.

Morris-Levenson, J., Sarama, R., & Ungerer, C. (2017). Does Tighter Bank Regulation Affect Mortgage Originations?.

Ortalo-Magné, F., & Rady, S. (2002). Tenure choice and the riskiness of non-housing consumption. Journal of Housing Economics, 11(3), 266-279.

Scanlon, K., Lunde, J., & Whitehead, C. (2008). Mortgage product innovation in advanced economies: more choice, more risk. European journal of housing policy, 8(2), 109-131.

Kim, K. H., & Renaud, B. (2009). The global house price boom and its unwinding: an analysis and a commentary. Housing Studies, 24(1), 7-24.

Gabor, D., 2013. Shadow interconnectedness: The political economy of (European) shadow banking.

Duca, J. V., Muellbauer, J., & Murphy, A. (2011). House prices and credit constraints: Making sense of the US experience. The Economic Journal, 121(552), 533-551.

Girouard, N., Kennedy, M., & Andre, C. (2006). Has the rise in debt made households more vulnerable?.

Obstfeld, M., & Rogoff, K. (2009). Global imbalances and the financial crisis: products of common causes.

Property Research Analysis ABPL90363

Role of Shadow Banking in Housing Market Affordability

Final Thesis Report

Chapter 1: Introduction

Research Title:

The title of this research is “To investigate the role of Shadow Banking in Housing Market Affordability: In context of Australia”.

Research Background:

Main purpose of this research is to investigate the role of shadow banking in housing market affordability. In general, shadow banking can be defined as financing and lending activities that are performed by unregulated institutions within the unregulated conditions. In other words, the shadow banking refers to traditional commercial banking services that are provided by the non-bank financial intermediaries. But the banking operations are performed by these intermediaries outside the traditional and regulated banking system. Housing market stands for the real estate and construction sector in a country (Manalo et al., 2015). In this context, the housing market affordability can be explained as price level of commercial and residential properties in context of purchasing power of people/ clients in the market. This research will help to evaluate the exact role and significance of shadow banking in housing affordability in context of Australian market.

The notion of shadow banking had garnered much attention from both professionals in the industry and in the academia. Literatures have explored the characteristics of shadow banking entities, its related activities and its implications to better understand the imminent characteristics that had led-up to the largest global financial meltdown or known as the Global Financial Crisis (GFC) of 2007 and 2008. A number of studies have asserted the root of cause of the GFC stemming from mortgage markets, where the housing market (as in the case of the United States) acted as a principal catalyst (Carmassi, Gros & Micossi, 2007; Obstfeld & Rogoff, 2009) in incubating the financial meltdown. In retrospect to key indicators of the lead-up, the present residential market in Australia displays strikingly similar attributes as such of the financial crisis which had exerted an immense paralysis effect on the functionality of the global economy. Although, Australia had suffered economic slowdowns during those periods, repercussions of these effects were largely buffered.

Over the last decade, the Australian property market had observed historically exceeding value growth rates, of which of these upturns were predominantly captured in its residential housing market. Favourable economic performance fuelled by easing monetary policy initiatives along with sustained market confidence, in tandem to liberalisation of the credit economy in housing finance have contributed to demand proliferation within its economy and housing stocks in particular. Furthermore, the Australian taxation system purportedly benefits landlords within avenues of various concessional tax incentives. In comparison to other OECD countries, Ellis (2006) asserts that the Australian property market had created a favourable investment haven for domestic and international investors alike. Resultantly, the Australian booming property market has culminated in the emergence of heightened risk-taking strategies (such as negative gearing) and amplification of financial liquidity leading to exponential growths in its house prices and demand for its stock. However, this rapid appreciation was perceived to be unsustainable and characterised as an asset property bubble. Nonetheless, a substantial disconnect between house prices and income levels of boom cycles in the residential market evidently manifests itself in distinct affordability deterioration in first-home buyers (FHB).

Following an elongated series of positive house price growths, the Australian residential market currently displays declining trend in house prices. The Australian Bureau of Statistics Established House Price Index note property prices at 0.7% quarter-on-quarter decrease to date from 2018Q1 while a 0.6% year-on-year decline was observed from the corresponding quarter of previous year. Additionally, property prices have declined at approximately 3.7% following the housing market boom peaking at 147.6 index points (CoreLogic, cited in Kehoe, 2018). Corrections to the residential market can be attributed to the royal commissions of the Australian Prudential Regulation Authority (APRA) reinforcing compliance lending policies and curbing excessive lending to borrowers at credit-risk. The introduction of regulatory controls has seemingly demonstrated a lag time in its effects. At its initial intervention of a credit squeeze, the House Price Index, number of financing commitments of FTB and number of loans issued by traditional banks suffered a slight initial shock in the following quarter before swiftly gaining traction in an upward trend. In such an environment, there are implications of mortgage financing on housing affordability, particularly in FTBs. The conceptualisation of affordability measures has primarily revolve around purchase affordability and the ability to borrow. As house prices are subdued, the emergence of a paradox arises as FTBs are unable to benefit from the market correction. Instead, the prominence of housing affordability distress is more pronounced as austerity measures were enforced, with FTB housing commitments and bank loans issued falling circa 20% following 2017Q4. With Gishkariany, Norman & Rosewall (2017) indicating an increase of shadow banking associated activities supplying credit avenues in the housing industry, affordability in FTBs is faced with a dichotomy as access to the residential market is significantly challenged.

Constraints to mortgage access concurrent to price-to-income retrenchment may exacerbate the housing affordability condition in Australia. In contrast to banking literatures rejecting the utilisation of shadow banks in credit intermediation, Lemma (2016) and Ehlers, Kong & Zhu (2018) affirms that the productivity of shadow banks instead assists the mainstream market in ameliorating housing affordability distress. This paper inspects the relationship between housing affordability and shadow bank financing and examines the potential effects of liberalized credit access influencing housing affordability in FTBs over the period of 2006Q2 – 2018Q2.Firstly, shadow banking and housing affordability is defined and introduced in the context of the Australian residential market. Next, the paper addresses the relationship between the housing affordability and shadow banks, identifying ramifications to the housing market in a more liberated credit access environment. Lastly, the paper concludes.

Research Aims and Objectives:

Main aim of this research is to investigate role of shadow banking in housing market affordability. Following are different research objectives that are required to be accomplished in order to meet the main aim of this research:

• To understand the concept and meaning of shadow banking: In context of Australian banking market
• To analyse different determinants of housing market affordability: In context of Australia
• To critically evaluate the impact of shadow banking on housing market affordability: In context of Australia

Research Questions:

Following are different research questions that need to be answered in order to accomplish this research effectively and successfully:

• What is meaning of key concepts related to shadow banking?
• What are different determinants of housing market affordability?
• How do the shadow banking impact the housing market affordability in Australia?

Research Rationale or Significance:

This research has significance for different people and organizations. The topic of this research is to investigate role of shadow banking in housing market affordability in Australia. The rationale behind selection of this topic is that housing market affordability has remained a hop issue in the financial markets of Australia. Many financial analysts and economists think that shadow banking concept may prove to be effective for addressing challenges faced by companies in real estate sector of Australia in achieving the housing market affordability (Malatesta et al., 2016). The successful completion of this research will present the exact information about role and influence of shadow banking in housing marketing affordability. It will help to maximize benefits from shadow banking for optimization of housing market affordability optimization for both banking entities and the players in real estate sector of Australia.

This research has significance for researcher itself. It will help the researcher to enhance its theoretical and practical knowledge about different research skills that are required for conducting an academic research project. It will also help to researcher to develop theoretical base of knowledge about selected research topic. In addition to this, the thesis report has significance for future researchers in the similar field of study. It will enhance the knowledge of future researchers about different components or steps that are required to accomplish an academic thesis project in effective way (Turabian, 2018). It will also facilitate theoretical base of knowledge about the selected topic of research for future researchers. Apart from this, the thesis project has significance for existing literature of knowledge in the selected field of research. Success of this thesis project will contribute new facts and information in the existing literature of secondary knowledge on the selected topic of research.

Chapter 2: Literature Review

Introduction:

Literature review is an important part of this thesis project. It will help to elaborate the knowledge about selected topic of research. For this purpose, different information sources will be explored and reviewed in order to design literature review part of this research. Example of these information sources includes scholar research papers, peer reviewed journal articles, books and the authentic websites. The structure or design of different paragraphs under literature review part will be framed as analytical and argumentative (Hart, 2018). It means findings or ideas chosen from one information-source will be cross verified by opinions or comments presented by other writers/ researchers in other sources. This approach is highly effective to enhance validity and reliability of final research outcomes of a thesis project.

Literature Review:

To understand the concept and meaning of shadow banking:

According to Elliott et al. (2015), shadow banking can be defined as the group or network of financial institutions that operating in an unregulated banking environment. Example of shadow banking firms includes money market fund companies, non-banking financial institutions, hedge funds, conduits SIVs or structured investment vehicles and the investment banks. The shadow banking entities do not accept the traditional deposits from customers. In support of this Schwarcz (2011) states that shadow banking institutions are quite different from the traditional or conventional banking firms. Unlike traditional banking firms, the shadow banking entities are not bound by laws and regulatory limits. In this context, the staff or members of shadow banking firms are free to perform their roles and responsibilities without much focus on regulatory insights for different banking activities. Credit default swap (CDS) is one of the examples of unregulated banking activities that are performed by shadow banking firms.

This study depicts that shadow banks are informal mortgage provider entities (non-banks) in the context of housing affordability. This is narrowed under the definition of the shadow bank lending by the Financial Stability Board (Gishkariany, Norman & Rosewall, 2017, p.1) that is, “credit intermediated outside of the regulated banking sector.” In similar fashion to traditional banking sectors, shadow bank lending typically involves transformation of credit liquidity and extending leveraging capacities to systems or individuals in difficulty obtaining credit access.

As per the findings of Adrian & Ashcraft (2012), shadow banking firms used to raise borrowings from market from commercial paper markets, and the short term liquid markets. These short term funds were used by the shadow banking entities for making long term investment in securitized mortgages. But this approach of raising funds worked until the year 2008, when global financial crisis occurred. After incident of financial crisis of 2008, the lenders were exposed to fear and risk of collapse of their investment. In contrast to this, Stein (2010) opines that shadow banking industry consists of different types of components like mortgage companies, investment banks, repurchase agreement markets, ABCP or asset backed commercial papers and the securitization vehicles. The shadow banking entities do not have the banking license. In this context, they do not accept the deposits from customers. Many of the shadow banking institutes are sponsored by banks and parent/ subsidiaries of banks.

Moreira & Savov (2017) demonstrate that the shadow banking companies are also considered as intermediaries between borrowers and investors. There are different institutional investors in the financial and open markets like pension fund companies that are willing to lend their money. In this case, the shadow banking institutions performs role of channel, which makes flow of money from investors to corporations in the need of capital. The profit of shadow banking firms if the difference amount of money paid by them to investors (as interest on their money) and the interest received by them from corporations. At the same time, Gennaioli et al. (2013) articulate that the shadow banking institutions are highly exposed to liquidity risk, credit risk and market risk. It is so because the liabilities of shadow banking firms are short term in nature and the assets are illiquidity and long term in nature. In addition to this, there is no any source of deposits from customers, as in case of traditional banking firms. There is also no support to these firms (i.e. shadow banking institutions) from central bank in the country. Due to these situations, in case of adverse market periods, the risk of bankruptcy increases with the shadow banking firms.

The emergence of shadow bank financing had been widely documented. For example, Gabor (2013) and Gishkariany, Norman & Rosewall (2017) observed that policy reforms pertaining to increased regulatory oversight had resulted in increased shadow banking activities in the lending market. Restriction to conventional credit access creates a demand vacuum in the lending market. As such, shadow banks usually respond to this demand, thus resulting in growth in non-banks. Where there is greater reliance on gaining mortgage access from principal lending entities, the greater the substitution effect was found in the growth of non-banks as macro prudential policies restricts credit access (Morris-Levenson, Sarama & Ungerer, 2017). Prior to the implementation of regulatory reforms in 2014 by the APRA, financial policies in concert with a liberalized credit economy had shifted housing policies towards pro-homeownership.

Housing polices such as fiscal incentives and unconstrained mortgage access into the residential market has had significant impacts in the property market. Similarly, Ortalo-Magne & Rady (2002) demonstrated that institutional reforms promoting owner-occupation rates had resulted in the proliferation of housing demand. Evidently, house prices in Australia had experienced exponential growth. In Davis & Zhu (2004), they observed that an easing credit access environment had a self-reinforcing positive feedback loop in market demand and liquidity within the mortgage market. Consequently, the supply of ‘cheap’ credit was constantly supplied back into the market, thus sustaining a boom market. This particular aspect manifests within the Australian residential market, with consistent upward trending house prices. However, there is a widespread concern for such unsustainable price growths forming a price bubble, thus amplifying volatility within the residential market. Nonetheless, a deregulated lending market had positive impacts on alleviating credit constrained households. Campbell & Cocco’s (2003) study revealed that diminished credit restrictions had improved the demand for housing. This signifies a positive relationship in house price increases and deregulations in the lending market.

This observation was sustained by Duca, Muelbauer & Murphy (2011) affirming that informal lender entities dynamically extends credit availability as market price increases, in particular to FTBs. The introduction of shadow bank financing dynamics into the regular lending system creates alternative avenues for credit, which leads to greater credit supply and competition amongst lenders. According to Girouard, Kennedy & Andre (2006), a dramatic increase in homeownership rates was observed amongst lower-income demographics, especially FTBs as supply-side innovations utilises international mortgage markets. Following fundamental economic truism, in face of competition non-banks lower costs to consumers, thus improving efficiency within the mortgage system (Scanlon, Lunde, & Whitehead, 2008).

To analyse different determinants of housing market affordability:

In the views of Pierse et al. (2016), housing market can be defined as the group of companies that are involved in developing and selling the commercial and residential properties. In other words, the housing market is also known as real estate and construction sector in an economy. In this context the housing market affordability stands for the relationship between household incomes and the housing expenditure faced by different people in a country. There are different components of housing expenditure such as rents, mortgage payments and price of a new house. As per observations of Teodoro (2018), there are differences between household affordability and the affordable housing. For example, affordable housing refers to social housing or low income housing. On the other hand, household affordability stands for degree of extent to which it is affordable for individuals to purchase a new home in an economy. In contrast to this, the household affordability is also measured in context of household rent market. In this context, the household affordability stands for relationship between household income and level of rent that is required to be paid for hiring a home on rent.

Fundamentally, shadow bank lenders tend to operate in sub-prime markets (grey area) that govern less regulatory oversight from financial watchdogs. The shadow bank economy is encompassed within the real estate market due to its underlying activities being interconnected to the primary financial system. Instruments of mortgage-loan origination and securitisation of those mortgage products are embedded within processes of financial products (pooling of wealth management products) through linearization, financial engineering and active involvement in sub-prime markets have innovated the multiple financial products. The availability and cost of mortgage lending greatly underpins the performance of a residential market (Gishkariany, Norman & Rosewall (2017).

In accordance to Mumm & Ciaccia (2017), there are different types of methodologies or approaches that are generally used in Australia for the measurement of household affordability. Example of these approaches includes the residual measures and the ratio measures. Under the approach of ratio measures, an individual needs to calculate ratio between expenditures associated with households like costs or pricing of houses and household income. The data of household expenditure and household income may be very large. In this context, the mean or median of data may be taken into account for valuation of the ratio. In contrast to this, the ‘residual measure’ approach focuses on evaluation of capacity of an individual to maintain acceptable living standard after meeting the costs and expenditures associated with housing. In this context, the ‘residual measure’ is more complex as compared to ‘ratio measure’ approach. On the other hand, Lee et al. (2018) argued that housing market affordability can also be described by housing market inflation or housing market CPI indicator. There is negative correlation between housing market affordability and housing market CPI rate. With the increase in housing CPI rate, the housing market affordability gets declined. But in reality, the housing market affordability cannot solely depend on the CPI rate of industry or industry inflation rate. It will also be influenced by level of increase in income level of households with the increase in inflation. Direct correlation can only be established between industry CPI and housing market affordability, if there is no change in key factors like household income.

International empirical studies have shown that mortgage availability possess significant stimulus to house price growth (Scanlon et al., 2008). In the case of Australia, the housing boom was driven by favourable economic conditions along with historically low rates confluence to rising demand appetites, however most pertinent to the prevalence of accessible low cost financing from traditional banks. Yet, Kim & Renaud (2009) warns that expected risks associated to enhanced borrowings are downplayed during up market cycles. Instead, the increased injection of financial stimulus into an overheating market resulted in further inflationary house price bubbles and eroding affordability. On the flipside, the creation of alternative credit access (entry to shadow bank financing or profligate lending practices) manufactures a vicious cycle whereby boosted purchasing power of buyers have buoyed asset appreciation. Securitised lenders vying for market share frequently trades (or transfer liabilities) these securitised assets to achieve higher returns, particularly during a boom environment. This in turn, serves to propagate participation and extenuate boundaries in high-risk lending strategies.Net benefit gains resultant from deregulations are thereby negated by rapid house prices as widespread finance availability surges market demand, and consequently aggregate market pricings.

According to Tran et al. (2015), there are different determinants of household market affordability. Supply and demand are the most important factors that have impact on pricing level as well as household affordability in the market. If the market demand exceeds the total supply of homes in market, the price of new homes will increase and household affordability will get diminished. In contrast to this, if the demand for new homes and properties is poor (low), then price of new homes will decline and household affordability will get increased for normal people. In oppose of this, Stephens & Stephenson (2016) depict that the availability of tax reliefs and subsidies also influences the household affordability in a country. If the government provides subsidies and tax reliefs for purchase of new homes, then household affordability for normal citizens of country will improve. In contrast to this, the household affordability will be poor in a country, where government does not provide any benefits of subsidies and tax reliefs for its citizens for the purchase and development of new homes.

As per the findings of Larionova & Pavlova (2014), the level of competition in housing market can also affect the household affordability in real estate sector of an economy. For example, if there is high level of competition among the market players existing in a city or state, then there will be a race to attract customers through special discounts, promotions and other benefits. The companies will try to avail new homes, villas, flats and commercial spaces at more affordable price as compared to their competitors. This will ultimately enhance the housing affordability for normal citizens of a country. In contrary to this, Teodoro (2018) signifies that location of a residential and commercial property is a key determinant of the price of household properties. If a new household property or villa is in prime location like proximity to main market, close to tourist destinations, connectivity to road, industrial areas and highways etc, the price of property will be very high. In this case, the household affordability for citizens will be low. In oppose of this, the properties that are located in distant areas will be priced at low. This way, affordability of the housing properties will be high.

To critically evaluate the impact of shadow banking on housing market affordability:

As per the findings of Plantin (2014), shadow banking can affect the housing market affordability in different ways. Shadow banking is quite helpful for the companies operating in real estate and construction sector. For example, it can avail funds for the real estate companies that are required in order to run residential and commercial housing projects in effective and efficient manner. It is so because the shadow banking firms performs the role of an investment bridge or channel through which the funds can flow from investors in the financial markets to corporations in the need of capital for business. In support of this Elliott et a. (2015) demonstrates that emergence of shadow banking also contributes positively to the growth of real estate and construction. But with the growth of this sector, the price level of housing sector has also consistently increased due to support from shadow banking institutions. This trend has supported the interest of investors that have invested their money in real estate and housing sector preferably in short run. This has ultimately influenced the housing affordability in an adverse manner. But in the long run, the impact of shadow banking on investor’s return is observed as negative due to the bubble effect of housing market.

In oppose of this, Lee et al. (2018) argue that the financial crisis and market adverse situations like housing bubble have not occurred due to shadow banking. These have occurred due to financial leveraging policies adopted by the traditional banking firms in different countries. Banking and financial markets of different countries should be regulated and controlled through high level of banking and the lending standards. In accordance to Gilson & Kraakman (2014), one of the reasons behind occurrence of financial crisis at global level was the presence of unregulated funding systems in an economy. The lack of an effective judicial system in country gives more raise and pace to the issues of financial crisis and NPL. If the judicial system of country is not much effective to handle cases of loan defaults in timely manner, the criminals of loan default are motivated to conduct similar practices more. In addition to this, other people are also motivated due to such weakness in judicial system of country.

In accordance to Duca (2016), shadow banking stands for the unregulated banking and lending practices in banking and financing sector of an economy. The shadow banking institutions are involved in bank-alike financing activities. But these financing or lending activities are performed out of the limits of traditional banking regulations in a country. The shadow banking entities are also known as credit intermediation business firms. These institutions are involved in the non-bank credit activities. In the opinion of Plantin (2014), shadow banking institutions have emphasizes on the analysing systematic risk concerns while taking credit decisions for any corporate entity. One of the differences of shadow banking entities from traditional banking firms is that they do not accept deposits from customers. Under shadow banking, the investors in financial and non-financial markets tend to invest their money in different types of funds with the liability of their money in the hands of shadow banks. In other words, the shadow banking institutions are involved in banking practices of reinvesting the money of investors into securitized lending instruments. Due to birth of shadow banking concept in financial markets, it has become quite easy for housing and real estate business firms to fulfil their funding needs.

In the words of Ban et al. (2016), the fundamental banking processes have been imitates by the shadow banking institutions. These activities are imitated as asset backed securities (ABS), repurchase agreements (REPOs) and other similar mechanisms. The process of securitization is quite lengthy. This process starts with the step of selling of loans and then next step is development of ABCP (or commercial paper) conduits with same value of loans. The loan instruments under shadow banking are divided into different categories according to the level of risk and return from perspective of investors that have provided their funds for investors and the level of systematic risk. Example of different types of commercial papers developed by shadow banking firms under loan process includes CLOs or collaborated debt obligation, CMBS or commercial mortgage backed securities etc. These securities and loans becomes the liability of shadow banking institutions.

According to Lysandrou & Nesvetailova (2015), the total share of shadow banking firms is increasing with the passing of time as compared to share of traditional banking firms. The investors also like to invest their money with the shadow banking institutions, because the average rate of return received from these banks is quite higher as compared to average interest with traditional banks. But on the basis of this fact, the shadow banking can be anticipated to negatively affect the housing market affordability. For example, the companies operating in real estate sector will need to pay interest of loan amount received from shadow banks at high rate. In this context, the cost of financing for real estate companies will be quite high. As a result of this, the companies will increase the price of different residential and commercial properties. Due to increased price, the housing affordability will be reduced.

Chapter 3: Research Methodology or Empirical Strategy

It is a systematic process of analysing the different tools, techniques and methods which support the researchers to collect the data and information related to the research issue. It develops the understanding of the research by observations, studies and different sources from quantitative and qualitative method. A systematic research methodology lends significant credibility to a research work. It also develops the understanding of the research subject as well as various terms of research methodology (Neuman, 2013). In this chapter various research methods are used to collect the appropriate data and accomplish the research objectives.

Research Philosophy:

It is the common viewpoint or phenomena that help the researcher to develop the understanding of the research topic. There are basically three types of research philosophy like Positivism, Realism and interpretivism. Positivism philosophy is based upon the experiments, facts, figures and scientific calculations. On the other hand, interpretvisim is based upon the theory, evidences, observations and human belief and perception on reality. It is important give the brief understanding of the research topic and allows the researcher to act as an interpreter. Lastly, Realism philosophy is based upon the mixture of both the philosophies and it is based on observations, perceptions and thoughts of the people (Lewis, 2015).

In order to identify the role of shadow banking on housing market affordability, the researcher used the interpretivism philosophy which is effective to enhance and develop the subjective understanding of the research issue. Interpretivism philosophy helped the researcher to interpret the results derived from the different sources that enhance the understanding and accomplish the research objectives. It is helpful develop the significant relationship between the research topic and study.

Research Approach:

It is the logical way to present the data to accomplish the research objectives. It provides the logical solutions and conclusions regarding the various research techniques and methods. There are basically two types of research approach i.e. inductive and deductive approach is used by the researcher to provide appropriate justification for the research methods. Inductive approach is based upon the specific observations, views and suggestions related to the subject to reach the particular conclusion. It is appropriate with interpretivism philosophy. In this approach, the researcher derives the valid conclusions and assumptions on the basis of existing research studies and develops the effective study according to the data analysis. On the other side, deductive approach is a flexible approach because it does not require any predetermined theory to collect the data and information. In order carry out the research in an effective manner, inductive approach is beneficial for the researcher as compared to deductive approach (Silverman, 2016). Inductive approach gives the theoretical studies on the particular topic that identifies the role of the shadow banking in Housing Market Affordability which increases the viability of the research study.

Investigation Types:

The main objective of the research is to identify the role of the shadow banking in Housing Market Affordability. Qualitative and quantitative research is the two types of methods which are used by the research methods which are used by the researchers. Qualitative research is based upon the subjective method. It is used to gain an understanding the opinions, motivations and reasons from the study and develop the ideas or hypothesis for particular quantitative research. Similarly, quantitative research is based upon the objective approach, which includes the quantitative data to develop the appropriate outcomes or results. It is used to identify the relationships and cause and effective relationships. In this research, qualitative research study is selected by the researcher, which supports the researcher to adopt the benefits of the quantitative research and eliminates the disadvantages of the quantitative research (BNS and HV, 2013). On the basis of theories, observations and existing studies of the previous researcher develops the effective knowledge in the field of research issue. On the basis of theoretical data, the researcher enabled to perform the detailed solutions to resolve the research issue significantly. On the basis of qualitative research method, researcher develops the views and observations from the studies which give the valid and reliable results.

Data collection method:

It is an important part in the research method that helps the researcher to collect the appropriate data and information through various sources to achieve the research objective. There are two different types of data like primary data and secondary data is used by the researcher in the research study. Primary data is the original data which is collected by the researcher from original sources. It is collected through survey questionnaire, observation, interview and experiments. It is time consuming and costly method. Similarly, secondary data research method refers that the data collected by the researcher from already existing or other sources to accomplish the research objective. It is collected by the researcher from various sources like journals, newspapers, books and websites (Panneerselvam, 2014). It is less time consuming and less expensive as compared to primary resources. The researcher used the existing resources from journals, case studies and existing studies of the researcher and analyses the results and studies related to the research issue.

Sampling method:

It is the process of selecting the participants from the particular population in order to collect the desired data of the research. There are different types of sampling techniques used by the researcher in a thesis project such as probability sampling and non probability sampling. Probability sampling gives the equal chance to the participants in order to carry out the research study effectively. It reduces the biasness in the work but the process control is difficult. Similarly, non probability sampling not gives an equal chance to the respondents in particular group and select the sample according to their own convenience (Neuman and Robson, 2014). In this research researcher selects the non probability sampling according to the own sources, data, information and figures which are convenient for the researcher to carry out the research study.

Analysis of data:

There is different data analysis method used by the researcher to carry out the research study significantly. Different types of methods are content analysis, thematic analysis, descriptive analysis and statistical methods are used by the researcher to collect the appropriate general valid and reliable results. In this research, researcher used the descriptive analysis to carry out the research study significantly (Miller, et al., 2012). Descriptive method is based upon the theory and studies of the secondary sources which are helpful for the researcher to accomplish the research objectives.

Research Ethics:

In general, the research ethics can be defined as the principles of conducting a research in a way that minimizes the harmful results or consequences arising from completion of research in effective and efficient manner. There are different principles of ethics that have been followed in this research. In order to avoid issues resulting from breach of rules and regulations of college/ university, all the principles and policies of college/ university have been followed in this thesis project. In order to avoid issue of similarity or plagiarism, all the information and contents have been written by my own hands. I have not taken any direct quotes or content from online or offline information sources (Harriss & Atkinson, 2015). In addition to this, I have done proper referencing and incitation of different secondary sources of data that have been taken into account for developing different sections of research like literature review and empirical strategy. This approach will help to give credit of every facts and information to the original writer or researcher. Apart from this, data protection is also an important ethics principle that should be followed in an academic research project. I have also complied with this ethics principle while accomplishing different parts of this research project.

Chapter 4: Results and data Analysis

As per the findings of Literature review, there are different types of secondary knowledge that have been identified in context of the selected research topic. It is observed that shadow banking concept is quite distinct as compared to traditional or conventional banking firms. Traditional banking firms deals in both depository banking services and lending services. In contrast to this, the shadow banking institutions do not provide deposit banking services. They are mainly involved in the lending services to corporations. The lending services of these institutions are also quite different as compared to traditional banking firms. They deal in securitized lending services. The shadow banking institutions provides a channel or pipeline, through which the money of corporate and individual investors can flow towards corporations in the need of capital. The rate of interest or rate of return on the investment in corporations through shadow banks is quite high as compared to interest rate offered by traditional banks on the depository banking products.

In general, dwelling price to income ratio is quite helpful to evaluate housing affordability in a country. The dwelling price to income ratio can be calculated by dividing the average dwelling price by the average household income in a country. Low value of this ratio indicates the high level of housing affordability in the economy. At the same time, high value of dwelling price to income ratio indicates poor housing affordability in a country. Following Diagram is quite helpful to understand the historical dwelling price to income ratio (i.e. housing market affordability) in Australia:

(Source: Australia Gov, 2018)

On the basis of above diagram, it can be analysed that the dwellings price to income ratio of Australia has shown an increasing trend from 1977 to 2012. On basis of this result, it can be said that housing affordability in Australia has diminished with the passing of time from 1977 to 2012. From the analysis of graph, it can also be analysed that the maximum growth in this ratio is visible in during the 1990s, 1980s and early 2000s (Australia Gov, 2018). Following table is also helpful to understand the changes in prices of housing sector for different cities of Australia:

(Source: Australia Gov, 2018)

On the basis of above table, it is evidential that the price level of nominal median house prices in different cities of Australia has increased from 1980 to 2016. For example, the average price of houses in Sydney was $64,800 in 1980 that increased to $999,600 in 2016. Similar to this, the average price of houses in Perth city was $41,500 in 1980 that increased to $520,000 in 2016 (Australia Gov, 2018). It means, the average pricing of household sector of Australia has increased significantly from 1980 to 2016. So, it can be said that the household affordability in Australia has significantly diminished in 2016 as compared to 1980.

Following graph is also helpful in understanding the past trends in shadow banking in Australia:

(Source: RBA, 2018)

On the basis of above graph, it can be observed that the shadow banking activity has shown increasing trend until 2008 (RBA, 2018). After this year, the sharp fall is visible in the graph. Following graph is helpful to understand the other details of Australian shadow banking industry:

(Source: RBA, 2018)

On the basis of above chart, it can be said that the market size of shadow banking sector is very small as compared to other international markets. The Australian shadow banking sector is also characterised by very few interconnections with the regulated sector. The Australian shadow banking industry is comprised of different types of entities, the details of which include managed funds, registered financial corporations and the wholesale founders (RBA, 2018). The shadow banking sector of Australia has experienced growth with the situations of increasing tight regulations in traditional banking sector due to substitution effect. But the substitution effect is seen with greater intensity in the countries, in which high dependence exists on the largest banks.

Chapter 5:  Conclusion

Conclusion:

On the basis of above analysis, it can be concluded that a direct role of impact cannot be said to exist between shadow banking institutions and household affordability. It is so because the housing market affordability is also dependent on other factors like change in income level of households, change in inflation, availability of tax benefits and government subsidies etc. In general, the increase in shadow banking entities will lead to enhanced availability of funds for the real estate companies in an economy. This will lead to increase in competition among existing competitors in the real estate market (Duca, 2016). This may result in price based competition. This can result in increased household affordability. If there is lack of market demand for the homes and the number of market players is high than also the price will be reduced by market players in country. This will also result in increase in improvement in household affordability. If the government offers tax benefits and subsidies on the purchase of new homes, then also affordability of houses will be improved.

Research Limitations and Future Research Implications:

There are different limitations of this research. This research is totally based secondary data, as no any primary research techniques have been employed in order to accomplish this thesis. The future similar research can be improved by involvement of primary research techniques like survey or interview (Miller, et al., 2012). Another limitation of this thesis is that it is solely based on Australian housing market. The findings of this thesis cannot be generalized in other countries of the world. In this context, the future similar thesis projects can be improved by selection of another country.

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