The Australian Prudential Regulation Authority’s decision to penalise banks who write risky loans will make some mortgages more expensive and is being viewed as a win for the big banks.
The changes are being rolled out to ensure the Australian banking system reaches its goal of “unquestionably strong” and will build on APRA’s common equity tier 1 (CET1) benchmark of 10.5 per cent. They are designed to encourage the banks to write lower risk loans.
APRA chairman Wayne Byres said the changes to risk weights for different loan types were an attempt to guard against the concentrated exposure banks have to property but will not force the banks to raise additional capital.
“The proposals announced today will not require ADIs [authorised deposit-taking institutions] to hold any capital additional beyond the targets already announced in relation to the unquestionably strong benchmarks, nor do we expect to see any material impact on the availability of credit for borrowers,” Mr Byres said.
However, APRA says the proposal which it aims to roll out in 2022 will require banks to hold more capital against residential mortgages and many require them to reallocate capital from other areas of their business.
Critics say the proposed changes which direct the big banks to hold 25 per cent more capital against investor loans than owner-occupier loans inevitably will have ramifications on pricing.
Bell Potter analyst TS Lim said with bank margins already under considerable pressure, the banks were unlikely to absorb the cost of writing riskier loans.
“If the risk weights go up, the banks will have to fund it somehow,” Mr Lim said. The new framework for risk weights also included a flagged change to the risk weights of smaller banks.
Deutsche Bank analyst Matthew Wilson said the change did not do enough to address a perceived longstanding imbalance between the two groups.
“This appears to be a win for the majors and a loss for the regionals as the gap between standardised and IRB banks (internal ratings based) is not narrowed.”
Smaller banks had previously applied an average flat risk weight of 35 per cent for almost all mortgages and had complained larger banks which applied a weighting of at least 25 per cent had an unfair advantage.
The regulator said in the proposal that this interpretation of the differential was superficial because the larger banks have higher CET1 benchmarks, invest heavily in risk management systems and are more geographically diverse.
“APRA estimates that the impact of the overall difference in capital requirements on mortgage pricing is likely to be minimal – in the order of five basis points” the proposal states.
The regulator said additional capital buffers applied by domestically and systemically important banks further narrows – if not completely eliminates – the pricing advantages they enjoy It said the differential was small and intended it to stay that way.
Customer Owned Banking Association CEO Mike Lawrence described the regulator’s description of the advantage as “negligible” as a valuable contribution in the debate over competition in banking but said more needed to be done to even the playing field.
“APRA is proposing tougher capital requirements than those that currently apply for home loans with higher loan-to-valuation ratios. These proposals are even tougher than the global benchmarks set out in the Basel framework,” Mr Lawrence said. Under the new rules smaller banks will no longer be required to apply risk weights of around 35 per cent to most loans.
Instead have a sliding scale of risk weightings starting at 20 per cent for the least risky mortgages and rising to 95 per cent for the riskiest standard loans. Other loans such as reverse mortgages, loans to self managed super funds and shared equity mortgages would attract a risk weight of 100 per cent as the regulator attempts to shepherd banks away from the riskier end of the market.
Smaller banks who only sell the least risky loans such as those to owner-occupiers paying principal and interest with more than 50 per cent equity in their homes will now arguably have a level playing field with their larger rivals. Larger banks with internally rated based (IRB) approaches have been asked to apply a similar, yet simpler, overlay across their mortgage portfolio.
APRA has asked the big banks to revert to an international standard known as Basel III and apply a multiplier of 1.5 times for owner-occupiers paying principal and interest and a multiplier of two times for riskier mortgages such as investor or interest-only loans.
“These multipliers have been calibrated to target increased capital for residential mortgages, in line with the objectives of unquestionably strong. APRA considers that this approach is simpler to implement” the proposal states.
A spokeswoman for NAB said the bank was pleased to achieve more clarity around the framework, which is due to be implemented in 2022. “This is an important next step in completing the detailed implementation of the previously set ‘unquestionably strong’ capital ratio targets” the spokeswoman said. “NAB notes that additional consultation and analysis will be required prior to the finalisation of the capital prudential standards.”
Larger banks weakened over the course of the day with ANZ down 1.4 per cent, CBA down 1.3 per cent, NAB down 0.8 per cent and Westpac down 0.9 per cent at the close. The performance of regional banks was more mixed, with Bendigo and Adelaide Bank down 0.5 per cent, BOQ down 0.8 per cent and Suncorp up 0.5 per cent.
Article appeared in The Australian Financial Review on 12 June 2019.
Article written by James Frost.