The Australian Prudential Regulation Authority (APRA) has released drafts of three updated prudential standards for mortgage lending: APS 112 Capital Adequacy: Standardised Approach to Credit Risk; the residential mortgages extract of APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk; and APS 115 Capital Adequacy: Standardised Measurement Approach to Operational Risk. These standards are to be consistent with the guidance included in Prudential Practice Guide APG 223 Residential Mortgage Lending (APG 223).
As well as proposing new risk weighting for standard mortgages APRA has responded to submissions about competition issues.
APRA proposes that an ADI must, prior to loan approval, appropriately document, assess and verify the ability of a borrower to meet their repayment obligations.
This assessment must, at a minimum, include:
• the application of an interest rate buffer of at least 2.5 percent;
• the application of the buffer to both new and existing debt, recognising that for certain types of debt, higher buffers may be appropriate; and
• for interest-only loans, an assessment of the ability of the borrower to repay over the principal and interest period.
Where an ADI’s assessment does not result in a positive determination of a borrower’s ability to meet their repayment obligations, the ADI would be required to classify the residential mortgage exposure as non-standard.
Risk weight differential in mortgage lending
APRA has responded to submissions that, from a competition perspective, there is an unfair differential between standardised and IRB risk weights for mortgage lending by large and small banks. It says that while superficially, a material differential exists, by only examining risk weights for on-balance sheet exposures, the impact of other important differences is ignored.
Beyond prescribed risk weights, differences in capital requirements for mortgage lending are driven by:
• differences in the credit quality of the underlying portfolio;
• differences in the ‘unquestionably strong’ capital benchmarks applied to standardised and IRB ADIs;
• differences in the treatment of credit conversion factors (CCFs) for standardised and IRB ADIs;
• the application of capital requirements for IRRBB to IRB, but not standardised, ADIs; and
• the requirement for an expected loss adjustment for IRB, but not standardised, ADIs.
APRA says that under the current regulatory framework (i.e. before applying the proposals), APRA estimates that the impact of the overall difference in capital requirements on mortgage pricing is likely to be minimal – in the order of 5 basis points.
The analysis does not consider the operational costs arising from investing in developing and maintaining risk management systems to support IRB status by large banks, as well as data requirements.
Furthermore, it says the application of an additional capital buffer to those banks designated a domestically systemically important further narrows, if not completely eliminates, the overall difference for those banks. APRA does not expect its proposed changes to materially change its conclusions. It is APRA’s intention that any differential in overall capital requirements will remain negligible.
