Tag: APRA

Turning The Screws On Mortgage Lending – The Property Imperative Weekly 17th Feb 2018

Listen, You Can Hear the Screws Tightening On Mortgage Lending.  Welcome to The Property Imperative Weekly to 17th February 2018.

Watch the video, or read the transcript.

In this week’s digest of finance and property news we start with Governor Lowe’s statement to the House of Representatives Standing Committee on Economics.  He continued the themes, of better global economic news, lifting business investment and stronger employment on one hand; but weak wage growth, and high household debt on the other. But for me one comment really stood out. He said:

it would be a good outcome if we now experienced a run of years in which the rate of growth of housing costs and debt did not outstrip growth in our incomes in the way that they did over the past five years.

This is highly significant, given the fact the lending for housing is still growing faster than wages, at around three times, and home prices are continuing to drift a little lower. So don’t expect any moves from the Reserve Bank to ease lending conditions, or expect a boost in home prices. More evidence that the property market is indeed in transition. The era of strong capital appreciation is over for now.

There was lots of news this week about the mortgage industry. ANZ and Westpac have tightened serviceability requirements.  Westpac recently introduced strict tests of residential property borrowers’ current and future capacities to repay their loans. The change is said to be intended to identify scenarios that might affect borrowers’ capacity to pay back their loans. These scenarios include having dependents with special needs that might require borrowers to spend on long-term care and treatment. ANZ has added “a higher level of approval for some discretions” used in its home loan policy for assessing serviceability, reducing approvals outside normal terms.

Talking of lending standards, APRA released an important consultation paper on capital ratios. This may sound a dry subject, but the implications for the mortgage industry and the property market are potentially significant.  As part of the discussion paper, APRA, says that addressing the systemic concentration of ADI portfolios in residential mortgages is an important element of the proposals. They have FINALLY woken up to the risks in the system, just years too late!  We have significant numbers of loans in the system currently that would now not pass muster. More about that next week.

Their proposals, which focus in on mortgage serviceability, would change the industry significantly, as lower risk loans will be more highly prized (so expect low rate offers for lower LVRs), whilst investment loans, and interest only loans are likely to cost more and be harder to find. Combined this could certainly move the market!  The proposals introduce “standard” and “non-standard” risk categories.

As well as increasing the risk weights for some mortgages, they also continue to close the gap between the advanced (IRB) internal approach used by large lenders, and the standard approach used by smaller players. Those in transition (e.g. Bendigo Bank) may find less of an advantage in moving to advanced as a result. You can watch our separate video on this important topic.

Whilst the overall capital ratios will not change much, there is a significant rebalancing of metrics, and Banks will more investment and interest only loans will be most impacted.  So getting an investment loan will be somewhat harder and this will impact the property market. The proposals are for consultation, with a closing data 18 May 2018.

Another data point on the property market came from a new report by Knight Frank which claims that in 2017, one-third of Australian residential development sites were sold to Chinese investors and developers. The share of sales to Chinese buyers has tripled since 2013, but decreased from the 38 per cent recorded in 2016. The level of Chinese investment in residential development sites varied from state to state: in Victoria, 38.7 per cent of residential site sales were to Chinese buyers; in New South Wales, 35.6 per cent of residential site sales were to Chinese buyers, and in Queensland, Chinese buyers comprised 7.4 per cent of total residential site sale volumes. So this is one factor still supporting the market, though in Australia, the Australian Prudential Regulatory Authority has encouraged local financial institutions to impose stricter controls, while in China the government has attempted to moderate capital outflow with China’s Central Bank imposing new rules for companies which make yuan-denominated loans to overseas entities.

The data from the ABS on Lending Finance, the last part of the finance stats for December, really underscores the slowing momentum in investment property lending, especially in Sydney (though it is still a significant slug of new finance, and there is no justification to ease the current regulatory requirements.) The ABS says the total value of owner occupied housing commitments excluding alterations and additions rose 0.1% in trend terms, total personal finance commitments fell 0.2%. Revolving credit commitments fell 1.4%, while fixed lending commitments rose 0.5%. There was a small rise in lending for housing construction, but overall mortgage momentum looks like it is still slowing and the mix of commercial lending is tilting away from investment lending and towards other commercial purposes at 64%, which is a good thing.

There is an air of desperation from the construction sector, as sales momentum continues to ease, this despite slightly higher auction clearance rates last week. CoreLogic said the final auction clearance rate was 63.7 per cent clearance rate across almost double the volume of auctions week-on-week (1,470). Over the week prior, a clearance rate of 62.0 per cent was recorded across 790 auctions. Both auction clearance rate and volumes were lower than what was seen one year ago, when a 73.2 per cent clearance was recorded across 1,591 auctions. There is significant discounting going on at the moment to shift property, and some builders are looking to lend direct to purchases to make a sale. For example, Catapult Property Group launched a new lending division that will help first home buyers get home loans with a deposit of only $5,000. The Brisbane-based company encourages first home buyers in Queensland to enter the real estate market now by taking advantage of the state government’s $20,000 grant that is ending on 30 June 2018. This is at a time when lenders are insisting on larger deposits, and are applying more conservative underwriting standards.

Economic data out this week showed that according to the ABS, trend unemployment remained steady at 5.5%, where it has hovered for the past seven months.  The trend unemployment rate has fallen by 0.3 percentage points over the year but has been at approximately the same level for the past seven months, after the December 2017 figure was revised upward to 5.5 per cent. The ABS says that full-time employment grew by a further 9,000 persons in January, while part-time employment increased by 14,000 persons, underpinning a total increase in employment of 23,000 persons. The fact is that while more jobs are being created, it is not pulling the rate lower, and many of these jobs are lower paid part time roles – especially in in the healthcare sector. In fact, the growth in employment is strong for women than men.  A rather different story from the current political spin!

In a Banking Crisis, are Bank Deposits Safe? We discussed the consequences of recently introduced enhanced powers for APRA to deal with a bank in distress this week. There were several well publicised Government bail-out’s of banks which got into problems after the GFC. For example, the UK’s Royal Bank of Scotland was nationalised. This costs tax payers dear, so there were measures put in place to try to manage a more orderly transition when a bank gets into difficulty and raises the question of “Bail-in” arrangements.  Take New Zealand for example. There regulators have specific powers to grab savings held in the banks in assist in an orderly transition in the case of a failure, alongside capital and other bank assets.  And, given the New Zealand position (and the tight relationship between banking regulators in Australia and New Zealand), we should look at the position in Australia.  Are deposit funds in Australia likely to be “bailed-in”? Well, the Treasury confirmed that because deposits are not classified as capital instruments, and do not include terms that allow for their conversion or write-off, they cannot be ‘bailed-in’. But we have a catch all clause in APRA’s powers that says they can grab “any other instrument” and deposits, despite the Treasury reassuring words, is not explicitly excluded. So I for one cannot be 100% convinced savings will never be bailed-in. And that’s a worry! I recall the Productivity Commission comment last week, that financial stability had taken prime place compared with competition (and so customer value) in financial services. The issue of bail-in of deposits appears to be shaping the same way. You can watch our separate video discussion on this important topic.

The first round of public hearings for the Banking Royal Commission will focus on lending, including mortgages, credit cards and car loans; we heard during the opening session. The Commission highlighted the large size of the lending market, and the significant number of submissions they have already received on misconduct in this area, including relating to intermediaries, commission and advice. In addition, as part of the opening address, we were told that some of the major players were unable to provide the full range of misconduct information that Commission requested. Some players offered a few case studies, and were then asked to provide more detail over the past 5 years (as opposed to 10) but said they could not meet the required deadline. Based on the opening round, Banks are going to find this a painful process. Not least because The Commission is publishing information on the sector. In its first release, it pointed to declining competition in the banking sector, with the number of credit unions falling due to consolidation and the major banks holding 75 per cent of total assets held by ADIs in Australia. The paper noted that five of the 20 listed companies that make up the ASX20 are banks, noting that the major banks have “generally achieved higher profit margins than other types of ADIs” with a profit margin of 36.4 per cent in the June quarter 2017. They also underscored that Australia’s major banks are “comparatively more profitable” than some of their international peers in Canada, Sweden, Switzerland and the UK.

We expect to hear more from the Royal Commissions on unfair and predatory practices. To underscore this there was some good news for Credit Card holders, with new legalisation passed in parliament to force Credit card providers to scrap unfair and predatory practices. However, the implementation timetable is extended into 2019. The reforms include:

Requiring affordability assessments be based on a consumer’s ability to repay the credit limit within a reasonable period (from July 2018).  This tightens responsible lending obligations for credit card contracts.

Banning unsolicited offers of credit limit increases (from January 2019). At the moment, whilst the law forbids providers from making these sorts of offers in writing, offers can be made by phone and other mediums. This loophole has been exploited, but will now be closed.

Simplifying how credit card interest is calculated, especially, banning the practice of backdating interest rate charges. Currently, some providers were attracting new customers with promotional low rate, or no rate offers, say for the first month. But, if a customer failed to pay off in full a credit card bill after the first month, the credit card company was often retrospectively applying the new interest rate to previous purchases. This was allowed in the banks’ small print, but the government said the practice did “not align with consumers’ understanding and expectation about how interest is to be charged”. This will be banned, from next year.

Requiring credit card providers to have online options to cancel cards or to reduce credit limits (from January 2019). At the moment, some card providers force customers to come into a bank branch to reduce limits or terminate cards, and when they did come in were often persuaded not to do it. The asymmetry between fast credit card approvals online, and slow cancellation will end.

So another week highlighting the stresses and strains in the banking sector, and the forces behind slowing momentum in the property market. And based on the stance of the regulators, we think the screws will get tighter in the months ahead, putting more downward pressure on mortgage lending home prices and the Banking Sector. Something which the RBA says is a good thing!

APRA Homes In On Mortgage Risk

As part of the discussion paper, released today APRA, says that addressing the systemic concentration of ADI portfolios in residential mortgages is an important element of the proposals. They have FINALLY woken up to the risks in the system, just years too late!  We have significant numbers of loans in the system currently that would now not pass muster.

These proposals, which focus in on mortgage serviceability, would change the industry significantly, as lower risk loans will be more highly prized (so expect low rate offers for lower LVRs), whilst investment loans, and interest only loans are likely to cost more and be harder to find. Combined this could certainly move the market!  The proposals introduce “standard” and “non-standard” risk categories.

The proposals are for consultation, with a closing data 18 May 2018.

As well as increasing the risk weights for some mortgages, they also continue to close the gap between the advanced (IRB) internal approach used by large lenders, and the standard approach used by smaller players. Those in transition (e.g. Bendigo Bank) may find less of an advantage in moving to advanced as a result.

Also they are proposing some simplification for small ADI’s as the cost of these measures may outweigh the benefit to prudential safety. Proportionate and tailored requirements for small ADIs could reduce regulatory burden without compromising prudential safety and soundness. Calibration of a simpler regime would be broadly aligned to the more complex regulatory capital framework, yet would be designed to suit the size, nature, complexity and risk of small ADIs.

Here are some of the key paragraphs from their paper.

APRA’s view is that there are potential systemic vulnerabilities to the financial system created from high levels of residential mortgage lending for investment purposes. As noted by the RBA, investment lending can amplify borrowing and house pricing cycles:

Periods of rapidly rising prices can create the expectation of further price rises, drawing more households in the market, increasing the willingness to pay more for a given property, and leading to an overall increase in household indebtedness.

Similarly, the significant share of interest-only housing lending, including to owner-occupiers, is a structural feature that increases the risk profile of the Australian banking system. Interest-only borrowers face a longer period of higher indebtedness, increasing the risk of falling into negative equity should housing prices fall.  Borrowers may also use interest-only loans to maximise leverage, or for short-term affordability reasons.  Even though loan servicing ability (serviceability) is now tested at levels that include the subsequent principal repayments, borrowers may face ‘payment shock’ when the interest-only period ends and regular repayments increase, in some cases significantly. This payment shock is particularly acute when interest rates are low.

Over the past two decades, residential mortgages in Australia as a share of ADIs’ total loans have increased significantly, from just under half to more than 60 per cent. While losses incurred on residential mortgage portfolios in this period have been limited, this level of structural concentration poses prudential and financial stability risks, particularly in an environment of high household debt, high property prices, weak income growth and strong competitive pressures among lenders. In such circumstances, households, individual ADIs and the broader banking sector are vulnerable to economic shocks.

Similar to other jurisdictions facing comparable risks, APRA has undertaken a series of actions to help contain the risks associated with ADIs’ residential mortgage portfolios. These actions include promoting significantly strengthened loan underwriting practices, increasing the amount of capital held by IRB ADIs for residential mortgage exposures and establishing benchmarks to moderate lending for property investment and lending on an interest-only basis. As set out in APRA’s July 2017 information paper on unquestionably strong capital, APRA also intends to further strengthen capital requirements for residential mortgage lending to reflect the concentration risk it poses to the banking sector.

A key focus is the appropriate capital requirement for investment and interest-only mortgage loans. Although, as a class, investment loans have typically performed well under normal economic conditions in Australia, this segment has not been tested in a nationwide downturn. Further, an increasing proportion of highly indebted households own investment property relative to past economic cycles. Experience in the United Kingdom and Ireland during the global financial crisis, for example, showed that previously better-performing investment loans can fall into arrears in higher volumes than loans to owner-occupiers in times of stress.

So now they propose to target higher-risk residential mortgage lending, balanced against the need to avoid undue complexity. Under the proposals, residential mortgage exposures would be segmented into the following categories with different capital requirements applying to each segment:

  • loans meeting serviceability requirements made to owner-occupiers where the borrower’s repayment is on a principal and interest (P&I) basis;
  • loans meeting serviceability requirements made for investment purposes or where the borrower’s repayment is on an interest-only basis; and
  • other residential property exposures, including those that do not meet serviceability requirements.

Specifically, for the standard approach, APRA proposes that APS 112 would require ADIs to designate as non-standard eligible mortgages those where the ADI:

  • did not include an interest rate buffer of at least two percentage points and a minimum floor assessment interest rate of at least seven per cent in the serviceability methodology used to approve the loan;
  • did not verify that a borrower is able to service the loan on an ongoing basis (i.e. positive net income surplus); and
  • approved the loan outside the ADI’s loan serviceability policy.

APRA is also considering excluding certain other categories of loans considered higher risk from the definition of standard eligible mortgages, such as those with very high multiples of a borrower’s income.

APRA proposes to formalise through amendments to APS 112 its existing requirement that loans to self-managed superannuation funds secured by residential property should be treated as non-standard loans, reflecting the relative complexity of these loans and the fact that ADIs do not have recourse to other assets of the fund or to the beneficiary.

APRA also proposes that reverse mortgages, which are currently risk-weighted at 50 per cent (where LVR is less than 60 per cent) or 100 per cent (for LVRs over 60 per cent), would be treated as non-standard in light of the heightened operational, legal and reputational risks associated with these loans.

Subject to final calibration, APRA proposes that all non-standard eligible mortgages would be subject to a risk weight of 100 per cent.

APRA proposes to segment the standard eligible mortgage portfolio into lower-risk and higher-risk exposures in addition to assigning risk weights according to LVR. This approach is aligned to, but deliberately not strictly consistent with, the Basel III ‘material dependence’ concept, to appropriately reflect Australian conditions.

For the lower-risk segment, APRA proposes to broadly align the risk weights with those under the Basel III framework loans where repayments are not materially dependent on cash flows generated by the property securing the loan. This category would include owner-occupied P&I loans and would apply after consideration of any lenders mortgage insurance (LMI).

The higher-risk segment would include interest-only loans, loans for investment property and loans to SMEs secured by residential property. The determination of higher risk weights for this segment would be either by way of a fixed risk-weight schedule, or a multiplier on the risk weights applied to owner-occupied P&I loans. The benefit of a multiplier is that APRA could more easily vary the capital uplift for these higher risk loans over time depending on prevailing prudential or financial stability objectives or concerns.

Table 3 shows the indicative proposed risk-weight schedule based on the Basel III risk weights for materially dependent residential mortgage exposures.

APRA is also considering whether exposures to individuals with a large investment portfolio (such as those with more than four residential properties) would be treated as non-standard residential mortgage loans or as loans secured by commercial property. APRA invites feedback on this issue.

APRA expects to continue to incorporate relatively lower capital requirements in the standardised approach for exposures covered by LMI. LMI can reduce the risk of loss for an ADI, subject to meeting the insurer’s conditions for valid claims and the financial capacity of the LMI to pay claims. APRA is considering the appropriate methodology to recognise LMI in the capital framework for both the standardised and IRB approaches. For the standardised approach to credit risk, APRA expects that any capital benefit would continue to apply to loans with an LVR over 80 per cent. APRA’s preferred approach is to increase the Table 3 risk weights (as finally calibrated) for standard loans with an LVR over 80 per cent that do not have LMI. For the IRB approach, APRA is considering potential options for the recognition of LMI.

For IRB Bank (those using their own internal models, APRA believes that material changes are required in Australia in order to:

  • improve the alignment of capital requirements with risk for particular exposures;
  • further address the FSI recommendation that the difference in average mortgage risk weights between the standardised and IRB approaches is narrowed; and
  • ensure an appropriate overall calibration of capital for residential mortgage exposures given the concentration of IRB ADI portfolios in this segment.

On their own, however, these IRB mortgage risk-weight functions are not expected to result in a sufficient level of capital to meet APRA’s objectives for increased capital for residential mortgage exposures. However, any further increase in correlation for the IRB mortgage risk-weight function creates inconsistencies with correlation factors for other asset classes.

As a result, other adjustments are likely to be necessary to meet unquestionably strong capital expectations. For residential mortgages, this is expected to be through additional RWA overlays on top of the outputs of the IRB risk-weight function, including both an overlay specifically for residential mortgages and an overlay for total RWA.

The exact form and size of these overlays will be determined after APRA has completed its QIS analysis. In determining final calibration of the regulatory capital requirement for residential mortgage exposures, APRA will consider the appropriate difference in the average risk weights under the IRB and standardised approaches, consistent with recommendation 2 of the FSI. As detailed in the final report of the FSI, given the IRB approach is more risk sensitive, some difference between the average risk weights for residential mortgage exposures under the different approaches to credit risk may be justified; however, it should not be of a magnitude to create unwarranted competitive distortions.

SME exposures secured by residential property that meet certain serviceability criteria would be included in the same category of exposures as residential mortgages for investment purposes and interest-only loans.

In APRA’s experience, these exposures have historically had higher losses than non-SME owner-occupier residential mortgage exposures.

For SME exposures that are not secured by property, APRA proposes to reduce the 100 per cent risk weight currently applied under APS 112 to 85 per cent. This gives some recognition to the various types of collateral, other than property, that SMEs provide as security. APRA does not propose to implement the Basel III 75 per cent risk weight for retail SME exposures, as there is insufficient empirical evidence that retail SME exposures in Australia exhibit a lower default or loss experience through the cycle than corporate SME exposures. SME exposures in this category would be limited to corporate entities where consolidated group sales are less than or equal to $50 million.

 

APRA Kicks Off Capital Framework Discussion

The Australian Prudential Regulation Authority (APRA) has released two discussion papers for consultation with authorised deposit-taking institutions (ADIs) on proposed revisions to the capital framework.

The key proposed changes to the capital framework include:

  • lower risk weights for low LVR mortgage loans, and higher risk weights for interest-only loans and loans for investment purposes, than apply under APRA’s current framework;
  • amendments to the treatment of exposures to small- to medium-sized enterprises (SME), including those secured by residential property under the standardised and internal ratings-based (IRB) approaches;
  • constraints on IRB ADIs’ use of their own parameter estimates for particular exposures, and an overall floor on risk weighted assets relative to the standardised approach; and
  • a single replacement methodology for the current advanced and standardised approaches to operational risk.

The paper also outlines a proposal to simplify the capital framework for small ADIs, which is intended to reduce regulatory burden without compromising prudential soundness.

The papers include proposed revisions to the capital framework resulting from the Basel Committee on Banking Supervision finalising the Basel III reforms in December 2017, as well as other changes to better align the framework to risks, including in relation to housing lending. APRA is also releasing a discussion paper on implementation of a leverage ratio requirement.

In the papers released today, APRA is not seeking to increase capital requirements beyond what was already announced in July 2017 as part of the ‘unquestionably strong’ benchmarks.

During the process of consultation, APRA will undertake further analysis of the impact of these proposed changes on ADIs. This analysis will include a quantitative impact study, which will be used to, where necessary, calibrate and adjust the proposals released today.

APRA Chairman Wayne Byres said that, taken together, the proposed changes are designed to lock in the strengthening of ADI capital positions that has occurred in recent years.

“These changes to the capital framework will ensure the strong capital position of the ADI industry is sustained by better aligning capital requirements with underlying risks. However, given the ADI industry is on track to meet the ‘unquestionably strong’ benchmarks set out by APRA last year, today’s announcement should not require the industry to hold additional capital overall,” Mr Byres said.

APRA has also released today a discussion paper on implementing a leverage ratio requirement for ADIs. The leverage ratio is a non-risk based measure of capital strength that is widely used internationally. A minimum leverage ratio of three per cent was introduced under Basel III, and is intended to operate as a backstop to the risk-weighted capital framework. Although the risk-based capital measures remain the primary metric of capital adequacy, APRA has previously indicated its intention to implement a leverage ratio requirement in Australia. This approach was also recommended by the Financial System Inquiry in 2014.

APRA is proposing to apply a higher minimum requirement of four per cent for IRB ADIs, and to implement the leverage ratio as a minimum requirement from July 2019.

In addition to the two papers released today, APRA will later this year release a paper on potential adjustments to the overall design of the capital framework to improve transparency, international comparability and flexibility.

In A Banking Crisis, Are Bank Deposits Safe?

There were several well publicised Government bail-out’s of banks which got into problems after the GFC. For example, the UK’s Royal Bank of Scotland was nationalised. This costs tax payers dear, so there were measures put in place to try to manage a more orderly transition when a bank gets into difficulty.

In October 2011, the Financial Stability Board (FSB) issued its Key Attributes
of Effective Resolution Regimes for Financial Institutions (Key Attributes). These Key Attributes set out the ‘core elements that the FSB considers to be necessary for an effective resolution regime. There followed legislation in a number of jurisdictions.

For example, the EU introduced  the Bank recovery and resolution – Directive 2014/59/EU, the US The Dodd-Frank  Title II Overview: Orderly Liquidation Authority and in New Zealand the Open Bank Resolution (not to be confused with Open Banking, which we discussed last week). This is a summary from New Zealand.

But note the chilling words “the bank closes temporarily  and some money is frozen. Bank re-opens under statutory manager. Customers can access non-frozen portion of their money, which is now Government protected. Frozen money can be used to help resolve the bank’s issues. Resolution of issues completed. Un-used portion of frozen money is returned to customers”.

Or in other words, customers money, held as savings in the bank are able to be grabbed to assist in the resolution. This is of course what happened to people with bank deposits in Cyprus a few years back.

The thinking behind it is simple. Banks need an exit strategy in case of a problem, and Government bail-outs should not be an option. So a manager can be appointed to manage through the crisis. They can use bank capital, other instruments, like hybrid bonds and deposits to create a bail-in. This approach to rescuing a financial institution on the brink of failure makes its creditors and depositors take a loss on their holdings. This is the opposite of a bail-out, which involves the rescue of a financial institution by external parties, typically governments using taxpayers money.

So, given the New Zealand position (and the tight relationship between banking regulators in Australia and New Zealand), we should look at the position in Australia.  Are deposit funds in Australia likely to be “bailed-in”?

As it happens there has been a long running discussion on this in Australia, and on 16 November 2017, the Senate referred the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 [Provisions] to the Economics Legislation Committee for inquiry and report by 9 February 2018. They just reported back.

It all centered on the powers which were to be given to APRA to deal with a banking collapse.  “The bill seeks to strengthen the powers of the Australian Prudential Regulation Authority (APRA) to facilitate the orderly resolution of an authorised deposit-taking institution (ADI) or insurer so as to protect the interests of depositors and policyholders, and to protect the stability of the financial system in case of crisis”. The Treasurer had argued that by “affording APRA the power to work with ADIs and insurers in order to plan for economic stress events, the cost to the taxpayer will be significantly
reduced in the event of a financial crisis”.

The Senate review and consultation elicited a significant number of submissions,  and they made two main points in opposition to the bill: firstly, they believed that this bill gives APRA the power to ‘bail-in’ depositors’ savings to stabilise a failing financial institution; secondly, in place of the bill, the Australian Parliament should legislate a Glass-Steagall style separation of the banks.

Specifically, Dr Wilson Sy, a former analyst with APRA, considered that the bill was not clear enough on the topic of depositors’ savings. Dr Sy suggested that deposit protection is to be balanced against financial system stability, without the law clearly stating which has higher priority’. Dr Sy claimed that the bill is ‘designed to confiscate bank deposits to ‘bail-in’ insolvent banks to save the financial system.

It came down to the meaning of “any other instrument” in the draft bill. Treasury said, “the use of the word ‘instrument’ in paragraph (b) is intended to be wide enough to capture any type of security or debt instrument that could be included within the capital framework in the future. It is not the intention that a bank deposit would be an ‘instrument’ for these purposes”. Treasury confirmed that because deposits are not classified as capital instruments, and do not include terms that allow for their conversion or write-off, they cannot be ‘bailed-in’.

The committee concluded:

The committee believes that the protection of depositors’ interests is paramount and does not consider that the bill would allow the ‘bail-in’ of Australians’ savings and deposits. The stability of the financial system depends on its depositors having confidence in its financial institutions. By ensuring the security of depositors’ savings, the overall protection of the financial system can be ensured.

But there are a few questions to consider.

  • Why not expressly exclude deposits from the bill, the current vague wording appears to leave the door open for a deposit grab in case of financial instability? We may have some reassuring words from the regulators, but is it enough?
  • How does this fit with the NZ model, where deposits can be targeted, especially, as the regulators in the two countries are closely aligned, and in fact most banking in New Zealand is provided by Australian Bankers. In case of failure would customers of a bank operating in both countries be different?

And two wider questions.

  • The NZ model expressly says depositors should weight up the risks of placing money with specific lenders but can savers really do this?
  • The issue of hybrid bonds needs more careful consideration, in that in Australia (unlike some other countries) these bonds have been sold to retail investors, people looking to savings with good returns, and who probably do not understand the bail-in risks they may face. So even if deposits are excluded there is a risk that investors in hybrids will get a nasty shock.

Seems to me this is a messy area, and I for one cannot be 100% convinced savings will never be bailed-in. And that’s a worry!

I recall the Productivity Commission comment last week, that financial stability had taken prime place compared with competition (and so customer value) in financial services. The issue of bail-in of deposits appears to be shaping the same way.

 

 

 

 

 

 

APRA on Bank Capital and Housing

APRA Chairman Wayne Byers spoke at the A50 Australian Economic Forum, Sydney.

Significantly, he says the temporary measures taken to address too-free mortgage lending will morph into the more permanent focus on amongst other things, further strengthening of borrower serviceability assessments by lenders, strengthened capital requirements for mortgage lending imposed by us, and comprehensive credit reporting being mandated by the Government.

Bank capital

One area that was of interest to this audience last year was the strengthening of banking system capital. On that front, I’m pleased to say we are getting close to the end of the journey.

As some of you would know, the Australian Government conducted a broad-ranging inquiry into the Australian Financial System in 2014. Amongst other things, that inquiry tasked us with ensuring that Australian banks had ‘unquestionably strong’ capital ratios. In July last year, we published a paper setting out the benchmarks that we considered to be consistent with that goal. At a headline level, this required the four major Australian banks to strengthen their capital ratios, relative to end 2016 levels, by around 100 basis points on average to target CET1 ratio of 10.5 per cent (or about 16 per cent on an internationally comparable basis). We also said we expected that strengthening should be achieved by 2020 at the latest.

As things stand, the major banks haven’t quite hit this target yet, but are well on the way to doing so in an orderly fashion. We set a smaller task for the smaller institutions, and they by and large have it covered already.

That capital build-up is important because, as you’re all no doubt aware, we received a Christmas present from the Basel Committee in the form of the long-awaited package of reforms to finalise Basel III. The changes, in total, represent a significant overhaul of many components of the capital framework1.

We have, however, committed to ensure that changes in capital requirements emanating from Basel will be accommodated within the unquestionably strong target we have set. In other words, given the banking system has largely built the necessary capital, the recent Basel announcement does not have any real impact on the aggregate capital needs of the Australian banks. They will change the relative allocation of capital within the system, but not add to the aggregate requirement beyond what has already been announced.

We’ll begin consultation on the proposed approach to implementing Basel III changes in the next week or two. Our initial public release will include indicative risk weights, but these will be subject to further analysis and an impact study to calibrate the final proposed risk weights and ensure we end up with a capital requirement that is consistent with our assessment of unquestionably strong capital levels. We also have some recent input from the Productivity Commission to feed into our deliberations, which we’ll give consideration to as we work through the consultation process.

In terms of timelines, the Basel Committee has agreed to an implementation timetable commencing in 2022, with further phase-ins after that. As I said earlier, we expect banks to be planning to increase their capital strength to exceed the ‘unquestionably strong’ benchmarks by the beginning of 2020. Whether we implement our risk weight changes in line with Basel timeframes or modify that timeline somewhat, it’s unlikely there will be any need for additional phase-in and transitional arrangements given the industry will be well placed to meet the new requirements.

And just quickly on the other key components of the Basel reforms, we instituted the Basel liquidity and funding requirements in line with the internationally agreed timetable – the Liquidity Coverage Ratio (LCR) from 2015, and the Net Stable Funding Ratio (NSFR) from the beginning of this year – in full and without any transition. So the adjustment process to the post-crisis international reforms in Australia has the finish line well in sight.

Housing

The other topic that generated some questions last year concerned housing, and so I thought I should say a few words about our actions in that area.

The broad environment – high house prices, high household debt, low interest rates, and subdued household income growth – hasn’t changed greatly over the past 12 months (although in more recent times house price appreciation has certainly slowed in the largest cities – Sydney and Melbourne). Those conditions are not unique to Australia – a number of other jurisdictions continue to battle with somewhat similar conditions and imbalances. What’s notable for Australia, however, is the relatively high proportion of mortgage lending on the banking system’s balance sheet.

Against that backdrop, and amidst strong competitive pressures among lenders, the quality of new mortgage lending and the re-establishment of sound lending standards have been a major focus of APRA for the past few years now. We introduced industry-wide benchmarks on (in 2014) lending to investors and (in 2017) lending on interest-only terms. As I have spoken about many times previously, these are temporary measures we have put in place to deliberately temper competitive pressures, which were having a negative impact on lending practices throughout the industry, and help to moderate the volume of new lending with higher risk characteristics. Left unchecked, the drive for growth and market share was producing an adverse outcome as lenders sought ways to accommodate higher risk propositions to grow new lending volumes. Instead of prudently trimming their sails to reflect an environment of heightened risk, lenders were pressured to sail closer to the wind.

Over time, our interventions have served their purpose and we have seen lending standards improve. Our most recent intervention was in relation to interest-only lending. Imposing quantitative limits is not our preferred modus operandi, but over many years we’d seen interest-only loans become easily available, and options for extending or refinancing on interest-only terms allowed borrowers to avoid paying down debt for prolonged periods. Those loans do, however, provide less protection to borrower and lender when house prices soften, and expose borrowers to ‘repayment shock’ when the loan begins amortising (made worse if it occurs at a time when interest rates are rising from a low base).

Our benchmark of no more than 30 per cent of new lending being on interest-only terms is not overly restrictive for borrowers who genuinely need this form of finance – roughly 1-in-3 loans granted can still be on an interest-only basis – but it has required the major interest-only lenders to establish strategies that incentivise more borrowers to repay their principal. The industry has been quite successful in doing so: recent data for the last quarter of 2017 shows that only about 1-in-5 loans were interest-only, and the number of interest-only loans with high LVRs continued to fall to quite low levels. All of that is positive for the quality of loan portfolios.

While the direction in asset quality is positive, we’re not declaring victory just yet. We still want to see that the improvements the industry has made are truly embedded into industry practice. And we can modify our interventions as more permanent measures come into play. That will include, amongst other things, further strengthening of borrower serviceability assessments by lenders, strengthened capital requirements for mortgage lending imposed by us, and comprehensive credit reporting being mandated by the Government. Through these initiatives, we are laying the platform to make sure prudent lending is maintained on an ongoing basis.

Governance and culture

In addition to improvements in financial strength and asset quality, it’s also critical to the long run health of the financial system that the Australian community has a high degree of confidence that individual financial institutions are well governed and prudently managed. What has become more apparent and pronounced over the past year is that – despite their financial health and profitability – community faith in financial institutions in Australia, as has been the case elsewhere, has been eroded due to too many incidences of poor behaviour and poor customer outcomes. None of these have thus far threatened the viability of any institution, but they have certainly not been without commercial and reputational damage.

While most matters of conduct are primarily the responsibility of our colleagues at ASIC, these issues are nevertheless of great interest to a prudential regulator for what they say about an organisation’s attitudes towards risk. So as with the balance sheet strengthening of the financial system over the past few years, we have also taken a greater interest in efforts to strengthen behaviours and cultures. We can’t regulate these into existence, but we have been working to ensure Australian financial institutions have been giving greater attention to these matters than may have traditionally been the case. On these issues, it’s fair to say the journey continues.

7:30 Does Interest Only Loans Problem

A segment on ABC 7:30 discussed the problem faced by many interest only mortgage holders as tighter lending standards bite, forcing some to higher payment P&I loans or to sell.

We discussed this issue some time back, and made an estimation that $60 billion of such loans are likely to fall foul of the tightening.

 

 

ASIC bans mortgage broker from credit for three years

ASIC has banned Michael Wilkins, of Watanobbi, NSW, from engaging in credit activities for three years.

Mr Wilkins was a mortgage broker and helped clients to arrange finance to purchase properties. ASIC found that on five occasions in June and July 2010, Mr Wilkins submitted loan applications on behalf of clients in which he deliberately overstated their savings by between about $130,000 and $179,000.

By submitting these loan applications, ASIC found that Mr Wilkins gave to the bank information or a document that was false or misleading.

Mr Wilkins has the right to appeal to the Administrative Appeals Tribunal for a review of ASIC’s decision.

Westpac Updates On Capital And Asset Quality

Westpac has released its December 2018 (1Q18) Pillar 3 update, which highlights a strong capital position, and overall benign risk of loss environment. They also provided some colour on Interest Only Loans.

They say that the Common equity Tier 1 (CET1) capital ratio 10.1% at 31 December 2017 down from 10.6% at September 2017. The 2H17 dividend (net of DRP) reduced the CET1 capital ratio by 70bps. Excluding the impact of the dividend, the CET1 ratio increased by around 20bps over the quarter.

Risk weighted assets (RWA) increased $6.1bn (up 1.5% from 30 September 2017) mainly in credit risk from changes to risk models and loan growth, partly offset by improved asset quality across the portfolio. Changes to risk models also contributed to an increase in the regulatory expected loss, which is a deduction to capital. Internationally comparable CET1 capital ratio was 15.7% at 31 December 2017, in the top quartile of banks globally.

Estimated net stable funding ratio (NSFR) was 110% and liquidity coverage ratio (LCR) was 116% which is well above regulatory minimums. They are well progressed on FY18 term funding, $15.4bn issued in the first four months. Westpac will seek to operate with a CET1 ratio of at least 10.5% in March and September under APRA’s existing capital framework and will revise its preferred range once APRA finalises its review of the capital adequacy framework.

The level of impaired assets were stable with no new large individual impaired loans over $10m in the quarter. Stressed assets to TCE 2bps lower at 1.03%. Australian mortgage delinquencies were flat at 0.67%. Australian unsecured delinquencies were flat at 1.66%.

The bulk of mortgage draw downs are in NSW and VIC, with an under representation in WA compared with the market.

90+ day delinquencies are significantly higher in WA, compared with other states, reflecting the end of the mining boom.

There is a rise in delinquencies for personal loans and auto-loans, compared with credit card debt.

Flow of interest only lending was 22% in 1Q18 (APRA requirement <30%). Investor lending growth using APRA definition was 5.1% and so comfortably below the 10% cap.

They provided some further information on the 30% cap.

The 30% interest only cap incorporates all new interest only loans including bridging facilities, construction loans and limit increases on existing loans.

The interest only cap excludes flows from line of credit products, switching between repayment types, such as interest only to P&I or from P&I to interest only and also excludes term extensions of interest only terms within product maximums. Product maximum term for Interest only is 5 years for owner occupied and 10 years for investor loans.

Any request to extend term beyond the product maximum is considered a new loan, and hence is included in the cap.

So does that mean I could get an P&I loan, then subsequently switch it to an IO loan, so avoid the cap?

Also they highlighted key changes in their interest only mortgage settings.

Note that investors are paying more than owner occupiers, and interest only borrowers are paying even more!

APRA releases CBA Prudential Inquiry Progress Report

The Australian Prudential Regulation Authority (APRA) today released the Progress Report by the Panel appointed by APRA to conduct a Prudential Inquiry into the Commonwealth Bank of Australia (CBA).

In August last year, APRA established the Prudential Inquiry to examine the frameworks and practices in relation to the governance, culture and accountability within the CBA group, in light of a number of incidents which damaged the reputation and public standing of CBA. The Panel was subsequently appointed in September and the Inquiry began work in October.

The Progress Report provides an update on the status of the Inquiry and outlines the methodology that the Panel has adopted to address the Terms of Reference.

The Panel notes in its report that: ‘issues of governance, culture and accountability in a large financial institution are complex and interwoven, and the Panel does not consider it appropriate to draw conclusions, even preliminary ones, before this work is completed and all relevant evidence collected and carefully evaluated. Accordingly, the Panel will reserve its substantive findings and recommendations for inclusion in the Final Report, which will be provided to APRA by 30 April 2018.’

APRA Chairman Wayne Byres welcomed the update provided by the Panel on the extensive investigations currently underway.

“As the Panel has noted, issues of governance, culture and accountability in large organisations are complex to assess. APRA is pleased the Panel is taking a thorough and considered approach to the important task it has been given,” Mr Byres said.

The Panel comprises Dr John Laker AO, Professor Graeme Samuel AC and Jillian Broadbent AO.

The Panel is due to provide a final report to APRA by 30 April 2018.

The Progress Report is available here: CBA Prudential Inquiry Progress Report (PDF)

APRA’s 2018 Priorities

APRA released their Policy Agenda 2018 today which sets their priorities and agenda.

Looking at banking, they outlined the following:

  • Capital adequacy tweaking will likely continue for the next 2-3 years, plus  revisions to the prudential standards for operational risk, interest rate risk in the banking book and market risk, and associated changes to reporting and public disclosure requirements. APRA is considering changes to its overall approach to capital requirements in a number of areas where APRA’s methodology is more conservative than minimum international requirements.
  • APRA does not anticipate the need to incorporate BEAR expectations into the prudential standards or prudential practice guides in 2018 but will provide guidance where appropriate, potentially in the form of published Frequently Asked Questions.
  • They will finalise arrangements to licensing some new ADIs through a phased approach.
  • Expect more changes to APG 223 Residential Mortgage Lending, revising underwriting standards and the development of a prudential practice guide for commercial property lending.