Westpac has announced it will no longer loan money to foreigners wishing to purchase residential property in Australia.
The bank and its subsidiaries (St George, Bank SA and Bank of Melbourne) ceased property lending to all non-residents and temporary visa holders as of April 26. Westpac is the third major bank to clamp down in this way, following announcements from ANZ and Commonwealth Bank earlier in April.
Australian and New Zealand citizens whose main source of income is from overseas will also be affected. They are restricted to loans for new housing only, with the maximum amount that Westpac will lend them falling from 80% to 70% of the total purchase price.
An email sent by Westpac to mortgage brokers said, “At Westpac, helping Australians to achieve their goal of owning a home or investment property is core to our purpose.
“For these reasons, Westpac will no longer lend to offshore customers who are not citizens or residents of Australia with an eligible visa.”
The news may spark fears of a slowdown in residential construction, with developers potentially taking a hit. In particular, Meriton has been targeting the Chinese market and may have to rethink strategy.
MFAA CEO Siobhan Hayden said of Westpac’s decision, “Westpac’s policy change… reflects a prudent decision for a more balanced portfolio at this time and reduced exposure for the bank.”
Tag: Mortgage Industry
Commonwealth Bank tightens criteria on home loans for foreigners
The nation’s largest mortgage lender, the Commonwealth Bank of Australia (CBA), has announced that it is tightening its criteria for home loans for foreigners.
The CBA will no longer approve applications for home loans that cite self-employed foreign income, according to a note sent to mortgage brokers this week.
The bank also says it will no longer accept the foreign-currency income of temporary Australian residents. These individuals can also only borrow up to 70% of a property’s value, compared with the previous rate of 80%.
Home loan applications from foreigners make up a “significantly low proportion of our total home loan applications” according to a CBA statement, adding, “We constantly review and monitor our home loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs.”
The fact that home loans for foreigners make up a relatively small segment of the market means CBA’s new policy should not have major consequences for mortgage brokers, according to principal at Ocean Home Loans, Brad Kirwan.
“This is a very small part of the overall market,” he told Australian Broker. “Self-employed foreign investors are an even smaller part of that market. Most lenders won’t accept foreign self-employed income anyway – I’d suggest that CBA are aligning their policy with the other major banks so as not to be over-exposed to one particular type of applicant.”
When asked what steps brokers might take in response to CBA’s changes, Kirwan added, “There are several large brokerages that focus entirely on the Chinese market and have done very well over the past few years, they will obviously have to reassess how they do business in the future, for the majority of mortgage brokers it will be business as usual.”
Virgin Money unveils unique new home loan
Virgin Money Australia has announced details of its brand new mortgage product, the Reward Me Home Loan, designed to offer customers points of distinction in alignment with the famous Virgin brand, as well as opportunities for brokers.
The home loans, set for launch in May, will initially be sold through mortgage brokers and serviced via a Virgin Money contact centre. Brokers are set to go through an initial accreditation process this week.
Speaking with Australian Broker, Virgin Money CEO Greg Boyle said, “The key rationale for us using the broker channel is that after extensive customer research on home loans, we found that customers expressed a preference for face-to-face interaction. We’re not a branch-based business so the third-party channel was the natural place for us.”
Boyle added that the new home loans take inspiration from Virgin Money in the UK, which does 80% of its lending through third-party channels.
The product will aim to capitalise on the wider reputation of the Virgin name, which demands a certain level of distinction to the rest of the marketplace, says Johnny Lockwood, General Manager of Lending, Cards and Deposits at Virgin Money Australia.
“We have something that has differentiation to what’s on the market at the moment,” Lockwood said. “There is an expectation for Virgin to do things differently at times, and home lending is largely homogenised and I guess regulated at the moment, so we’ve put a lot of consideration into something that’s going to be a little bit different.”
Those points of difference include an array of Virgin-branded benefits, including frequent flyer programs and offers from Virgin Australia, Virgin Mobile, Virgin Wines and Virgin Active. Another unique selling point, says Boyle, will be transparency about what rate discounts are available, with customer research revealing a perceived lack of transparency from lenders regarding discounts.
Boyle added that the target customer will be aged between 25 and 49, based in an urban area and technologically savvy.
The Reward Me Home Loan could also represent a significant development for Australia’s mortgage brokers, thanks to the introduction of a special online tool on the product’s website designed to match brokers with customers.
Lockwood said, “For brokers who are accredited with us, we are going to provide what we’ve called the ‘Find a Broker’ tool.
“Customers will come to our site and will understand they can access our loans through brokers, so we have created a lead capture and referral tool. Customers put their details in and a map will come up showing accredited brokers in their area, and they can choose one that fits their needs, with customer details sent through to the broker and vice-versa.
“Brokers are an important channel for us as they provide the face-to-face interaction with customers. We’ve been talking to some key aggregator groups for some time now so we’ve certainly taken their feedback on board, and we’ll be looking for broker input into any future product.”
The first mortgage aggregator to partner with Virgin Money will be PLAN Australia. Virgin Home Loan’s interest rates will be announced in May.
Where Did The 10% Investor Mortgage Growth Speed Limit Come From?
An interesting FOI disclosure from the RBA tells us something about the discussions which went on within the regulators in 2014 and beyond, as they considered the impact of the rise in investor loans. Eventually of course APRA set a 10% speed limit, and we have see the growth in investment loans slow significantly and underwriting standards tightened.
Back then, they discussed the risks of investment lending rising, especially in Melbourne.
Macroeconomic: Extra speculative demand can amplify the property price cycle and increase the potential for prices to fall later. Such a fall would affect household spending and wealth. This effect is likely to be spread across a broader range of households than the investors that contributed to the heightened activity.
Concentration risk: Lending has been concentrated in Sydney and Melbourne, creating a concentrated exposure in these cities. The risk could come from a state-based economic shock, or if the speculative upswing in demand brings forth an increase in construction on a scale that leads to a future overhang of supply. In Sydney, the risk of oversupply appears limited because of the pick-up in construction follows a period of limited new supply and it has been spread geographically and by dwelling type. While the unemployment rate has picked up a little over the past 18 months, the overall economic environment in NSW is in a fairly good state. In Melbourne, there has been a greater geographic concentration of higher-density construction in inner-city areas. Some developments have a concentration of smaller-sized apartments that may only appeal to some renters, or purchasers in the secondary market. Economic conditions are not as favourable in Victoria and the unemployment rate is 6.8%.
Low interest rate environment: While a pick-up in risk appetite of households is to some extent an expected outcome given the low interest rate environment, their revealed preference is to direct investment into the housing market. Historically low interest rates (combined with rising housing prices and strong price competition in the mortgage market) means that some households may attempt to take out loans that they would not be able to comfortably service in a higher interest rate environment. APRA’s draft Prudential Practice Guide (PPG) emphasises that ADIs should apply an interest rate add-on to the mortgage rate, in conjunction with an interest rate floor in assessing a borrower’s capacity to service the loan. In order to maintain the risk profile of borrowers when interest rates are declining, the size of the add-on needs to increase (or the floor needs to be sufficiently high).
Lending standards: In aggregate, banks’ lending standards have been holding fairly steady overall; lending in some loan segments has eased a little, while lending in some other segments has tightened up a bit. The main lending standard of concern is the share of interest-only lending, both to owner-occupiers and investors. For investors, 64% of banks’ new lending is interest-only loans and for owner-occupiers the share is 31%. The typical interest-only period is 5 years, but some banks allow the interest-only period to extend to 15 years. During this period, the loan is amortising more slowly than a loan that requires principal and interest (P&I) payments. If housing prices should fall, this increases the risk that the loan balance may exceed the property value (negative equity). There is some risk that the borrower could face difficulty servicing the higher P&I payments when the interest-only period ends, although this is typically mitigated by banks assessing interest-only borrowers on their ability to make P&I payments.
Of course the regulators found underwriting standards were more generous than they thought, at times in 2015 more than half of all new loans were investment loans, and recently banks have reclassified loans, causing the absolute proportion of investment loans to rise. Things were whose than they thought.
Next they discussed how to set the “right” growth rate:
How to calibrate the benchmark growth rate? Household debt has been broadly stable as a share of income for about a decade. National aggregate ratios are not robust indicators of a sector’s resilience because the distribution of debt and income can change over time. But as a first pass, it is reasonable to expect that the current level of the indebtedness ratio is sustainable in a range of macroeconomic circumstances. Therefore there does not seem to be a case to set the benchmark growth rate significantly below the rate of growth of household income, in order to achieve a material decline in the indebtedness ratio. With growth in nominal household disposable income running at a little above 3 per cent, this sets a lower bound for possible benchmarks at around 3 per cent. Current growth in investor credit, at nearly 10 per cent, suggests an upper bound around 8 per cent to achieve
some comfort about the leverage in this market. Within this range, there are several options for the preferred benchmark rate for investor housing credit growth (including securitised credit).a) Around 4½ per cent, based on projected household disposable income growth over calendar 2015. This could be justified as being consistent with stabilising the indebtedness ratio. However, it would be procyclical, in that it would be responding to a period of slow income growth by insisting that credit growth also slow. It would also be materially slower than the current rate of owner-occupier credit growth, which so far has not raised systemic concerns.
b) Around 6 per cent, based on a reasonable expectation of trend growth in disposable income, once the effects of the decline in the terms of trade have washed through. It is also broadly consistent with current growth in owner-occupier housing credit, which as noted above has not been seen as adding materially to systemic risk.
c) 7 per cent, consistent with the system profile for residential mortgage lending already agreed as part of the LCR/CLF process. Unless owner-occupier lending actually picks up from its current rate, however, the growth in investor housing credit implied by the CLF projections would be stronger than this. It is therefore not clear that these projections should be the basis for the preferred benchmark.
Staff projections suggest that only a moderate decline in system investor loan approvals would be required to meet a benchmark growth rate for investor housing credit in the 5–7 per cent range for calendar 2015. The exact size of the decline depends partly on assumptions about repayments through churn, refinancing and amortisation in the investor housing book. For a reasonable range of values for this implied repayment rate, and assuming that investor housing credit growth remains at its current rate for the remainder of 2014, the required decline in investor approvals is of the order of 10–20 per cent. This would take the level of investor housing loan approvals back to that seen a year ago. It is worth noting that investor loan approvals would have to increase noticeably from here to sustain the current growth rate of investor housing credit, even though the implied repayment rate is a little below its historical average. Since credit is not available at a state level, the benchmark can only be expressed as a national growth rate. The flow of loan approvals at a state level can be used as a cross-check to ensure that the benchmark incentive has had its greatest effects in the markets that have been strongest recently.
When the 10% cap (note this is higher than those bands discussed above) was announced, some Q&A’s provide some insights into their thinking.
Isn’t 10 per cent a bit soft? We are not trying to kill the market stone dead. Investor housing credit is currently running at a bit under 10 per cent. Some lenders will have investor credit growth well below this benchmark anyway, so if all lenders do end up at least a little under this benchmark, which we hope they will, then aggregate growth in investor credit will be noticeably below 10 per cent. Setting a benchmark for individual institutions is not the same thing as setting it for an aggregate, and APRA has allowed for that.
Where did the 10 per cent benchmark come from? This was a collective assessment by the Council agencies. We took the view that we did not want to clamp down on the market excessively. We also took the view that in the long run, household credit can expand sustainably at a rate something like the rate of trend nominal household income growth, maybe a bit more or less in shorter periods. Trend income growth is below 10 per cent, more like 6 per cent or thereabouts. But it was important to make an allowance for the fact that some lenders will undershoot the benchmark, so the aggregate result will likely be slower than that.
But isn’t household income growth likely to be below average in the next few years, because of the end of the mining boom? Maybe, but we don’t want to be procyclical and clamp down on credit supply more when the economy growing below trend.
This of course confirms the regulators were wanting to use household debt as an economic growth engine (interesting, see the recent post “Why more-finance-is-the-wrong-medicine-for-our-growth-problem” )
We also see a significant slow down in household income growth, yet credit growth, especially housing has been stronger, creating higher risks if interest rates or unemployment was to rise. Raises the question, were the regulators too slow to act, and did they calibrate their interventions correctly? We will see.
The “deadly embrance” between housing, house prices, and bank mortgages
An interesting IMF working paper “Mitigating the Deadly Embrace in Financial Cycles: Countercyclical Buffers and Loan-to-Value Limits” examines the limitations of Basel III in the home loan market, and makes the point that the risk-weighted focus, even with enhancement, does not cut the mustard especially in a rising or falling property market. Indeed, there is a “deadly embrance” between housing, house prices, and bank mortgages which naturally leads to housing boom and bust cycles, which can be very costly for the economy and difficult for central banks to manage. They find that macroprudential measures may assist, but even then the deadly embrace remains.
The financial history of the last eight centuries is replete with devastating financial crises, mostly emanating from large increases in financial leverage. The latest example, the Global Financial Crisis of 2008-09, saw the unwinding of a calamitous run-up in leverage by banks and households associated with the housing market. As a result, the financial supervision community has acknowledged that microprudential regulations alone are insufficient to avoid a financial crisis. They need to be accompanied by appropriate macroprudential policies to avoid the build-up of systemic risk and to weaken the effects of asset price inflation on financial intermediation and the buildup of excessive leverage in the economy.
The Basel III regulations adopted in 2010 recognize for the first time the need to include a macroprudential overlay to the traditional microprudential regulations. Beyond the requirements for capital buffers, and leverage and liquidity ratios, Basel III regulations include CCBs between 0.0 and 2.5 percent of risk-weighted assets that raise capital requirements during an upswing of the business cycle and reduce them during a downturn. The rationale is to counteract procyclical-lending behavior, and hence to restrain a buildup of systemic risk that might end in a financial crisis. Basel III regulations are silent, however, about the implementation of CCBs and their cost to the economy, leaving it to the supervisory authorities to make a judgment about the appropriate timing for increasing or lowering such buffers, based on a credit-to-GDP gap measure. This measure, however, does not distinguish between good versus bad credit expansions and is irrelevant for countries with significant dollar lending, where exchange rate fluctuations can severely distort the credit-to-GDP gap measure.
One of the limitations of Basel III regulations is that they do not focus on specific, leverage-driven markets, like the housing market, that are most susceptible to an excessive build-up of systemic risk. Many of the recent financial crises have been associated with housing bubbles fueled by over-leveraged households. With hindsight, it is unlikely that CCBs alone would have been able to avoid the Global Financial Crisis, for example.
For this reason, financial supervision authorities and the IMF have looked at additional macroprudential policies. For the housing market, three additional types of macroprudential regulations have been implemented: 1) sectoral capital surcharges through higher risk weights or loss-given-default (LGD) ratios;3 2) LTV limits; and 3) caps on debt-service to income ratios (DSTI), or loan to income ratios (LTI). Use of such macroprudential regulations has mushroomed over the last few years in both advanced economies and emerging markets. At end-2014, 23 countries used sectoral capital surcharges for the housing market, and 25 countries used LTV limits. An additional 15 countries had explicit caps on DSTI or LTI caps. The experience so far has been mixed.in a sample of 119 countries over the 2000-13 period find that, while macroprudential policies can help manage financial cycles, they work less well in busts than in booms. This result is intuitive in that macroprudential regulations are generally procyclical and can therefore be counterproductive during a bust when bank credit should expand to offset the economic downturn.
Macroprudential regulations are often directed at restraining bank credit, especially to the housing market. They do not, however, take into account the tradeoffs between mitigating the risks of a financial crisis on the one side and the cost of lower financial intermediation on the other. In addition, given that these measures are generally procyclical, they can accentuate the credit crunch during busts. More generally, an analytical foundation for analyzing these tradeoffs has been lacking. MAPMOD has been designed to help fill this analytical gap and to provide insights for the design of less procyclical macroprudential regulations.
The MAPMOD Mark II model in this paper includes an explicit housing market, in which house prices are strongly correlated with banks’ credit supply. This corresponds to the experience prior and during the Global Financial Crisis. This deadly embrace between bank mortgages, household balance sheets, and house prices can be the source of financial cycles. A corollary is that the housing market is only partially constrained by LTV limits as the additional availability of credit itself boosts house prices, and thus raises LTV limits.
The starting point of the MAPMOD framework is the factual observation that, in contrast to the loanable funds model, banks do not wait for additional deposits before increasing their lending. Instead, they determine their lending to the economy based on their expectations of future profits, conditional on the economic outlook and their regulatory capital. They then fund their lending portfolio out of their existing deposit base, or by resorting to wholesale funding and debt instruments. Banks actively seek new opportunities for profitable lending independently of the size or growth of their deposit base—unless constrained by specific regulations.
In MAPMOD, Mark II, we extend the original model by introducing an explicit housing market. We use the modular features of the model to analyze partial equilibrium simulations for banks, households, and the housing market, before turning to general equilibrium results. This incremental approach sheds light on the intuition behind the model and simulation results.
The housing market is characterized by liquidity-constrained households that require financing to buy houses. A house is an asset that provides a stream of housing services to households. The value of a house to each household is the net present value of the future stream of housing services that it provides plus any capital gain/loss associated with future changes in house prices. We define the fundamental house price households are willing to pay to buy a house the price that is consistent with the expected income/productivity increases in the economy. If prices go above the fundamental house price reflecting excessive leverage, we refer to this as an inflated house price. The supply of houses for sale in the market is assumed to be fixed each period. House prices are determined by matching buyers and sellers in a recursive equilibrium with expected house prices taken as given. We abstract from many real-world complications such as neighborhood externalities, geographical location, square footage or other forms of heterogeneity.
Bank financing plays a critical role in the determination of house prices in the model. If banks provide a larger amount of mortgages on an expectation of higher household income in the future, demand for housing will go up, thus inflating house prices. Conversely, if banks reduce their loan exposure to the housing market, demand for houses in the economy will be reduced, leading to a slump in house prices. House prices therefore move with the credit cycle in MAPMOD, Mark II, just as in the real world.
Nonperforming loans and foreclosures in the housing market occur when households are faced with an idiosyncratic, or economy-wide, shock that affects their current LTV or LTI characteristics. Banks will seek to reduce the likelihood of losses by requiring a sufficiently high LTV ratio to cover the cost of foreclosure. But they will not be able to diversify away the systemic risk of a general fall in house prices in the economy. Securitization of mortgages in MAPMOD is not allowed. And even if banks were able to securitize mortgages, other agents in the economy would need to carry the systemic risk of a sharp fall in house prices. At the economy-wide level, the systemic risk associated with the housing market is therefore not diversifiable. The evidence from the Global Financial Crisis on securitization and credit default swaps confirms that this is the case, regardless of who holds mortgage-backed securities.
This paper presented a new version of MAPMOD (Mark II) to study the effectiveness of macroprudential regulations. We extend the original MAPMOD by explicitly modeling the housing market. We show how lending to the housing market, house prices, and household demand for housing are intertwined in the model in a what we call a deadly embrace. Without macroprudential policies, this naturally leads to housing boom and bust cycles. Moreover, leverage-driven cycles have historically been very costly for the economy, as shown most recently by the Global Financial Crisis of 2008–09.
Macroprudential policies have a key role to play to limit this deadly embrace. The use of LTV limits for mortgages in this regard is ineffective, as these limits are highly procyclical, and hold back the recovery in a bust. LTV limits that are based on a moving average of historical house prices can considerably reduce their procyclicality. We considered a 5 year moving average, but the length of the moving average used should probably vary based on the specific circumstances of each housing market.
CCBs may not be an effective regulatory tool against credit cycles that affect the housing market in particular, as banks may respond to higher/lower regulatory capital buffers by reducing/increasing lending to other sectors of the economy.
A combination of LTV limits based on a moving average and CCBs may effectively loosen the deadly embrace. This is because such LTV limits would attenuate the housing market credit cycle, while CCBs would moderate the overall credit cycle. Other macroprudential policies, like DSTI and LTI caps, may also be useful in this respect, depending on the specifics of the financial landscape in each country. It is, however, important to recognize that all these macroprudential policies come at a cost of dampening both good and bad credit cycles. The cost of reduced financial intermediation should be taken into account when designing macroprudential policies.
Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
BOQ lifts variable home loan interest rates
BOQ today announced it will increase interest rates on its variable home loan products by 0.12 per cent per annum for owner-occupiers and 0.25 per cent per annum for investors.
The increase will see the Bank’s Clear Path variable rate home loan lift to 4.72% per annum for owner-occupiers and 5.14% per annum for investors. The standard variable rate home loan will move to 5.86% per annum for owner-occupiers and 6.28% per annum for investors. CEO Jon Sutton said the changes were driven by the need to balance growth, risk and margins over the longer term. “This is not a decision that was made lightly and we were very mindful of the impact on our customers even in an environment where interest rates remain at very low levels,” he said. “However, given the fiercely competitive market and increased funding spreads and hedging costs, these increases are necessary to help us achieve the appropriate balance between growth, asset quality and profitability,” he said “We still retain very competitive products and pricing, particularly with our lead mortgage product Clear Path, which will enable us to continue to compete strongly in the segments we want to target. “Clear Path is a full-featured, low-fee product which, after these changes, still offers one of the best comparison rates in the market to our customers.”
The new rates will be effective from 15 April 2016.
Former mortgage broker admits home loan fraud
According to ASIC, Ms Emma Feduniw (also known as Emma Khalil) of Brisbane, Queensland, a former mortgage broker with AHL Investments Pty Ltd (trading as Aussie), has admitted through her solicitor to eight charges brought by ASIC. The charges related to the falsification of employment documents to secure approvals for home loans, submitted to Westpac.
ASIC’s investigation found that between March 2013 and February 2014, Ms Feduniw submitted eight loan applications, totalling $2,720,400, containing false borrower employment letters. Of the eight loan applications, five were approved and disbursed, totalling $1,608,400. Ms Feduniw received commission on those five loans of $6,847.53.
The eight loan applications ranged in value from $250,000 to $480,000.
Ms Feduniw appeared before Beenleigh’s Magistrates Court and through her solicitor admitted to providing documents knowing they were false or misleading.
ASIC Deputy Chairman Peter Kell said, ‘The credit laws are designed to ensure borrowers do not take out loans they cannot afford. Actions by mortgage brokers to circumvent the laws, for their own financial benefit, erode trust and confidence in the mortgage broking industry and will not be tolerated’.
Ms Feduniw next appears in court on 3 June 2016 for sentencing.
The Commonwealth Director of Public Prosecutions (CDPP) is prosecuting the matter.
Background
Ms Feduniw was authorised to provide credit services as a credit representative to consumers from 1 July 2010 to 4 April 2014, when Aussie terminated her authorisation.
Ms Feduniw received her commission through Miga Loans Pty Ltd (ACN 106 962 467) a company controlled and owned by her.
Ms Feduniw was charged by ASIC under section 160D of the National Consumer Credit Protection Act 2009 whilst she was engaging in credit activity on behalf of Aussie. Section 160D makes it an offence for a person engaging in credit activities to give false or misleading information or documents to another person. She appeared in Court and pleaded guilty to the charges on 1 April 2016.
Ms Feduniw faces a maximum penalty of two years imprisonment or a fine, for each charge.
Unqualified advice a growing problem, warns FBAA
The Finance Brokers Association of Australia (FBAA) is warning brokers about offering unqualified advice which isn’t covered by their Professional Indemnity (PI) insurance.
The FBAA has cited a recent case in which a broker was found to have breached his duty of care by the Credit Ombudsman Service and forced to pay more than $115,000. The Ombudsman claimed the broker had given incorrect and unqualified advice.
In addition, the client – who was forced to sell an investment property at a substantial loss – took the legal action against the broker.
The chief executive of the FBAA, Peter White, says in this instance the broker went outside the bounds of his role by providing property advice and acting as a real estate agent when he did not have a licence to do so.
“This should serve as a warning to brokers. If you give unqualified advice, your Professional Indemnity insurance won’t cover you,” he said.
White is now urging brokers to educate themselves and update their knowledge of PI insurance.
“I would plead for any broker who may have let their education slide to update their knowledge on the rights and wrongs when it comes to advice and insurance.”
According to White, unqualified advice is potentially a growing problem as the line between financial planners and real estate property sales and other arms of the broking industry become blurred in an endeavour to diversify revenue streams.
“If you are only a qualified finance broker, act as a broker and do your best to meet your client’s needs. If you also want to assist a client in other areas like property purchasing, get the necessary qualifications and training otherwise you may be at risk of a life changing personal pay out,” White said.
How Does Bank Capital Affect the Supply of Mortgages?
The Bank for International Settlements just released a working paper – “How Does Bank Capital Affect the Supply of Mortgages? Evidence from a Randomized Experiment.” Given the intense focus on banks lifting capital ratios, this is an important question. They conclude that higher bank capital is associated with a higher likelihood of application acceptance and lower offered interest rates, whilst banks with lower capital reject applications by riskier borrowers and offer lower rates to safer ones. In other words, changing capital ratios directly and indirectly impact lending policy, but not necessarily in a linear or expect way.
The recent financial crisis refocused the attention on how the health of banks affects financial stability and macroeconomic growth. In particular, the academic and policy debates currently center on the effects of bank capital on lending and risk-taking. Indeed, both macroprudential and the microprudential regulatory reforms propose to raise bank capital ratios and strengthen bank capital buffers, with the aim of preventing “excessive” lending growth and increasing the system’s resilience to adverse shocks.
Yet, there is only a limited degree of consensus on the effect of higher bank capital on lending. On the one hand, higher bank capital increases both the risk-bearing capacity of banks and incentives to screen and monitor borrowers, in this way boosting lending. On the other hand, as debt creates the right incentives for bankers to collect payments from borrowers, lower debt and higher capital may reduce banks’ lending and liquidity creation.
In this paper we study the effect of bank capital on banks’ propensity to grant mortgages and on their pricing. We also explore how bank capital affects the selection of borrowers and the characteristics of offered mortgages, deriving implications for risk-taking. Finally, to detect possible non-linearities, we provide nonparametric estimates.
We focus on mortgages, whose relevance for both macroeconomics and financial stability has been unquestionable following the 2007-2008 financial crisis. In the first half of the 2000s, a strong increase in mortgage originations fueled a housing boom in several countries (US, UK, Spain, Ireland). That boom in turn led to a high accumulation of risks, which subsequently materialized causing the failure of several banks and a large drop in house prices. Understanding how bank capital affects mortgage originations and the way banks select the risk profiles of borrowers is thus critical to evaluate developments in the mortgage market and the potential accumulation of both idiosyncratic and systemic risks.
We use a new and unique dataset of mortgage applications and contract offers obtained through a randomized experiment. In particular, we post randomized mortgage applications to the major online mortgage broker in Italy (MutuiOn-line) in two dates (October 16, 2014, and January 12, 2015). Upon submitting any application, the online broker requires prospective borrowers to list both their demographic characteristics (income, age, job type) and the main features of the contract requested (amount, duration, rate type). By varying those characteristics, we create profiles of several “typical” borrowers who are submitting distinct applications for first home mortgages. Crucially, through the online broker all participating banks (which include the 10 largest banks in the country accounting for over 70% of the market for mortgage originations) receive the same mortgage applications, defined by the same borrower and loan characteristics. Hence, our estimates are not biased by the endogenous selection of borrowers into contracts or banks and, furthermore, there are no missing data due to discouraged potential borrowers not submitting applications. We then merge those data with the banks’ characteristics from the supervisory reports and, in our empirical analysis, we include several bank-level controls to reduce concerns about omitted variable bias; we exploit the time dimension of our data and we include bank fixed effects to control for unobserved determinants of bank capital in the cross-section; finally, in some specifications, we include bank*time fixed effects, to fully account for all bank specific, time-varying characteristics.
On the one hand, we find that banks with higher capital ratios are more likely to accept mortgage applications and to offer lower APRs. On the other hand, banks with lower capital ratios accept less risky borrowers. However, we cannot rule out that less well-capitalized banks take more risk on other assets (business loans, securities).
We also provide a quantitative estimate of the effect of bank capital ratio on the supply of mortgages, using a nonparametric approach. We find that the capital ratio has a non-linear effect on the probability of acceptance, stronger at low values of the ratio, almost zero for higher values. This non-linearity is more pronounced when the borrower or the contract are riskier.
Note: BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.
Mortgage delinquencies to rise in 2016
A slowdown in house price growth coupled with sluggish economic conditions will result in an increase in mortgage delinquencies in Australia during 2016, according to one global credit rating firm.
According to Moody’s Investor Services, the proportion of Australian residential mortgages more than 30 days in arrears was 1.20% in November 2015, compared with 1.19% in November 2014, and that is expected to rise again in the coming year.
“We expect the Australia-wide delinquency rate for mortgages showing more than 30 days in arrears to increase in 2016, but remain at a low level,” Moody’s assistant vice president and analyst Alana Chen said.
“We also expect that Australia’s GDP growth will likely be towards the upper end of our 1.5% to 2.5% forecast range for 2016, but this will be below the long-term average of 3.5%. We believe this economic backdrop will prompt a slight increase in the Australia-wide mortgage delinquency rate in 2016,” Chen said.
While Moody’s Investor Services is predicting a nation-wide increase in mortgage delinquencies in 2016, it won’t be spread evenly across Australia.
The ratings firm believes there will be further bad news for resource states; Western Australia, the Northern Territory, and to a lesser extent, Queensland, with the bulk of the increase in delinquencies to be found in those markets.
In Western Australia, the rate of mortgage holders more than 30 days in arrears rose by a significant 0.48% over the year to November 2015 to 1.71%, the highest mark in the country.
Though delinquencies will are predicted to rise in those states, performance in New South Wales will help to keep the nation-wide rate of delinquencies relatively low.
“With delinquencies in NSW remaining steady and those in other states set to continue to edge higher, we expect that the Australia-wide delinquency rate will increase slightly over 2016 but remain low,” Chen said.
Moody’s Investor Services claims a slowdown in house price growth in NSW will be balanced out by the “positive effect of healthy economic and labour market conditions.”