APRA has announced that capital risk weight for banks using the internal risk-based model will increase from 16% to at least 25% from 1 July 2016. These changes, which chime with the recommendations from the FSI, will apply mainly to the big four and Macquarie and will tilt the playing field slightly back towards a more neutral balance with the smaller players who use the unchanged standard approach. That said the regional’s still have to hold more capital, at around 35%, and still have to pay more for that capital, so it will not create a level playing field.
The changes will require the banks to raise more capital (we think about ~$11bn to meet these revised ratios), throttle back mortgage lending growth or lift interest rates charged to borrowers or cut rates to savers. Further changes will probably follow in the light of evolving international developments, including the upcoming Basel IV. The changes as announced were expected, and it is unlikely overall banking profitability will impacted much at all, though the banks will squeal.
The Australian Prudential Regulation Authority (APRA) has today announced an increase in the amount of capital required for Australian residential mortgage exposures by authorised deposit-taking institutions (ADIs) accredited to use the internal ratings-based (IRB) approach to credit risk.
This change will mean that, for ADIs accredited to use the IRB approach, the average risk weight on Australian residential mortgage exposures will increase from approximately 16 per cent to at least 25 per cent.
The increase in IRB mortgage risk weights addresses a recommendation of the Financial System Inquiry (FSI) that APRA ‘raise the average IRB mortgage risk weight to narrow the difference between average mortgage risk weights for ADIs using IRB risk weight models and those using standardised risk weights’. The increase is also consistent with the direction of work being undertaken by the Basel Committee on Banking Supervision (Basel Committee) on changes to the global capital adequacy framework for banks.
The increased IRB risk weights will apply to all Australian residential mortgages, other than lending to small businesses secured by residential mortgage. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI. In order to provide these ADIs sufficient time to prepare for the change, the higher risk weights will come into effect from 1 July 2016.
The residential mortgage portfolio is the largest credit portfolio for ADIs and, in aggregate, IRB accredited ADIs hold the material share of these exposures. Therefore, strengthening the capital adequacy requirement for residential mortgage exposures under the IRB approach will enhance the resilience of IRB-accredited ADIs and the broader financial system.
The increase in IRB mortgage risk weights announced today is an interim measure. It is not possible to settle on the final calibration between the IRB and standardised mortgage risk weights until changes arising from the Basel Committee’s broader review of this framework are complete. Further changes to IRB mortgage risk weights will be considered over the medium term in the context of these broader international developments.
You can listen to my comments on ABC Radio National today on the APRA move.
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