Banks will be required to set aside more capital for higher risk interest-only and investor mortgages, under long-planned changes to regulation that are aimed at making the sector more resilient to future shocks.
The Australian Prudential Regulation Authority (APRA) on Monday finalised its new framework for bank capital, which acts as a critical buffer to protect the financial system in economic crises.
APRA’s new capital rules will give banks an incentive to write more loans to owner-occupiers paying principal and interest.Credit:Rob Homer
The new regime, which APRA has been consulting on for four years, will start in 2023, and it will cement reforms that originated in the 2014 financial system inquiry led by former Commonwealth Bank chief David Murray.
APRA said its new framework would not force banks to raise more capital, but confirmed that it would impose higher capital requirements on mortgage lending deemed to be higher risk.
The changes are unlikely to come as a shock to banks, as they had been repeatedly flagged to the market. In response, banks have in recent years charged higher interest rates to property investors, interest-only borrowers and customers with smaller deposits. At the same time, banks are offering the lowest rates to owner-occupiers with larger deposits who are paying principal and interest.
Bank capital refers to funds held by the bank that can act as a shock absorber against risks, such as borrowers defaulting.
APRA said Australian banks’ top-tier capital had roughly doubled since the global financial crisis to more than $260 billion, and its new framework was aimed at reinforcing this strength.
In mortgages, the largest asset class for Australian banks, the regulator said its new framework would aim to better distinguish between higher and lower-risk lending.
To do this, it is changing the banks’ “risk weights” – financial models used to determine the riskiness of a loan, which influences how much capital is set against different types of lending.
Under the changes, loans to owner-occupiers who are repaying both interest and principal will attract lower risk weights, while loans to investors and interest-only borrowers will attract higher risk weights.
Banks have already incorporated these changes into their pricing in recent years, but APRA’s new framework is likely to embed these practices permanently.
APRA chairman Wayne Byres said the changes were aimed at ensuring the nation’s banking system remained strong compared with banks overseas. “Capital is the cornerstone of the banking system’s safety and stability. It protects depositors during periods of stress, ensures banks can access funding, facilitates payments and helps banks to keep lending to their customers during good times and bad,” Mr Byres said.
“Although Australia’s banking sector is already strongly capitalised by international standards, the new capital framework will help ensure it stays that way,” he said.
Smaller banks have long complained that Australia’s capital framework gives the big four banks and Macquarie Group an unfair advantage in the home loan market. This is because “advanced” banks with more sophisticated risk systems receive more favourable capital treatment.
APRA said its new framework tried to better support competition, but it had not closed the capital gap entirely between the “advanced” banks and others because it supported giving lenders an incentive to invest in advanced modelling.
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