The Australian Prudential Regulation Authority (APRA) has today reaffirmed its objective, announced in 2015, to raise Australian residential mortgage risk weights applied by banks using internal models to an average of at least 25 per cent.
In July 2015 APRA announced changes to the treatment of residential mortgages for banks able to use internal models for capital adequacy purposes. In particular, APRA adjusted the risk weight calculation used by authorised deposit-taking institutions (ADIs) accredited to use the internal ratings-based (IRB) approach to credit risk. The adjustment was intended to increase the average risk weight on Australian residential mortgage exposures, measured across all IRB ADIs, from approximately 16 per cent to an average of at least 25 per cent. The increase in IRB risk weights came into effect from 1 July 2016.
Subsequent to the announcement in July 2015, APRA has also required IRB ADIs to make a range of other changes to their models as part of its routine supervisory processes, with a view to improving their comparability, reliability and risk sensitivity. The impact of these modelling changes, when combined with the adjustment proposed in July 2015, would have been an average risk weight that was well in excess of the 25 per cent risk weight targeted by APRA in its original announcement.
APRA has therefore advised the relevant ADIs that it will recalibrate the adjustment advised in July 2015, with a view to ensuring the original target of an average risk weight for Australian residential mortgages of at least 25 per cent is achieved, while not significantly exceeding this target. In doing so, APRA has taken into account modelling changes that have been instituted, as well as some that are to be completed over the coming quarters; in some cases, this recalibration is conditional on the ADIs completing (offsetting) modelling improvements.
This adjustment to mortgage risk weights remains an interim measure, pending the outcome of the deliberations of the Basel Committee on Banking Supervision (Basel Committee) to finalise reforms to the capital adequacy framework, and APRA’s subsequent consideration of how those reforms should be applied in Australia. In the meantime, APRA continues to target an average residential mortgage risk weight for IRB banks of at least 25 per cent. As modelling changes work through the system, APRA expects the average across all IRB banks will vary somewhat over time, but still be consistent with the objective of achieving an average risk weight of at least 25 per cent.
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