Our poor hard done by Australian banks, fresh from the Big Four’s record profits for 2016-17 of more than $31 billion, are about to be again reminded that their home lending spree of the past three years – especially in Sydney and Melbourne, and especially to investors and self-managed super funds, has made them more risky.
The lead regulator, APRA, plans to APRA to publish a discussion papershortly addressing the concentration of banks’ exposures to housing. The last minutes of the Reserve Bank’s board meeting for October noted “Members noted that housing loans as a share of banks’ domestic credit had increased markedly over the preceding two decades” as they discussed the about to be released Financial Stability Report in early October.
In a speech in Sydney on Tuesday of this week, APRA head, Wayne Byers revealed why regulators are worried about bank home lending. He told a conference that (http://www.apra.gov.au/Speeches/Pages/Housing-The-importance-of-solid-foundations.aspx)
"Housing loans represent over 60 per cent of total lending within the banking sector. Our goal has been to ensure APRA-regulated lenders are making sound credit decisions which are appropriate, individually and in aggregate, in the context of broader housing market and economic trends…Having run at between 40-50 per cent of new lending for some time, interest-only lending accounted for about 23 per cent of total new lending for the quarter ended September.
"Forecasts for the December quarter suggest something similar again…The trend in non-performing housing loans is upward, despite a relatively benign environment for lenders. With historically low interest rates and an unemployment rate that for the past few years has drifted lower, an a priori expectation might have been for non performing housing loans to return to lower levels.,”he said.
Towards the end of his Sydney speech on Tuesday speech, Mr Byers made it clear that housing with the regulatory focus again in 2018, saying:
"We will need to continue to devote a large portion of our supervisory resources to housing in 2018. The broader environment of high and rising leverage, encouraged by historically low interest rates, requires ongoing prudence. It is easy to run up debt, but far harder to pay it back down when circumstances change.”
The coming discussion paper is part of that as the RBA explained in its second Financial Stability Review of the year in October. It said that APRA will set out modifications to the underlying capital framework, including changes to address banks’ high concentration of residential mortgages.
APRA’s intention is that any changes to this framework will not result in further increases to aggregate capital requirements. APRA’s discussion paper will contain proposed revisions to the capital framework that are expected to be implemented from 2021.
"On this, APRA intends to outline how it will implement changes to the international Basel III capital framework if it is finalised by then. It intends to also address the Australian banking system’s high concentration of residential mortgages. In particular, APRA has indicated that it will seek to target higher-risk lending, building on the revised Basel III framework that will likely modify risk weights for higher loan-to-valuation (LVR) loans and identify separate risk weights for investor lending. APRA expects that any changes to the capital framework will not necessitate further increases to banks’ aggregate capital,“ The RBA said.
That means the banks could be forced to allocate more capital against higher risk home lending, and less against better secured, lower risk loans. So the rapid increase in interest only lending by the banks, currently the big area of concentration, could see APRA raise the capital requirements for this area of lending, and less against convention principal and interest where the Loan to Valuation ratio is less than 10%.
APRA has already forced banks to start lifting their capital buffers to at least 10.5% for the big banks where they would be ‘unquestionably strong” . The RBA is confident that will not be a problem.
"Banks are well positioned to meet the ‘unquestionably strong’ capital targets, having increased capital markedly over recent years in anticipation of higher regulatory requirements. APRA estimates that the major banks should be able to generate the additional required capital from retained earnings, without significant changes to asset growth or dividend policies, or the need for equity raisings. Many smaller ADIs already hold enough capital to meet the effective increase in requirements.” the RBA said in its Stability Review.
