Smaller lenders are being forced to write riskier loans as a capital disadvantage prevents them from competing on price with the majors.
With the Australian mortgage market increasingly being driven by price in a low-rate environment, the capital inequality between the advanced accredited big four banks and the standard accredited regionals and smaller banks is leading to riskier lending practices, according to the J.P. Morgan Australian Mortgage Industry report.
Speaking at the report’s release yesterday, Digital Finance Analytics (DFA) founding principal Martin North said that riskier lending practices were a direct result of an uneven playing field.
“The current disparity between the majors and the regional and smaller banks mean that some of those smaller banks have to look to write higher risk loans because they cannot compete on price or standalones because their capital is higher and therefore their costs are higher,” Mr North said.
“So essentially the way that the capital structures currently work, it actually pushes some smaller banks particularly perhaps away from where you would like to see them lending,” he said.
A collaboration between J.P. Morgan and DFA, the report found that the proposed measures under the Murray Inquiry – which could see the big banks hold additional capital – would be a considerable headwind to the improved funding conditions they have lately enjoyed.
J.P. Morgan banking analyst Scott Manning said measures proposed under the FSI could lead to potential costs for Australia’s major banks of up to $2 billion.
Recent price discounting would also be impacted.
“Banks have reinvested the cost of funds tailwind to date through a lot more selective discounting procedures,” Mr Manning said.
“If the current rate of improvement in the cost of funds prevails, we can see that behaviour continuing,” he said.
“However if the FSI does look to increase capital levels and amend risk weights on housing, which will ultimately absorb that future benefit and we think will ultimately see mortgage discounts for those specific borrowers revert back to the average of the portfolio that we see today.”
While the FSI considers increasing capital requirements, J.P. Morgan has challenged the proposal by suggesting an alternative – to reduce the level of mortgage risk.
“Certainly interest rate buffers seem like the most appropriate way to do that,” Mr Manning said.
The Reserve Bank has until now been reluctant to introduce macroprudential measures like those in place in New Zealand and the UK.
However, using RBA Freedom of Information disclosures released in May this year, J.P. Morgan provides greater clarity on the RBA’s view.
“The result is a clear preference for interest rate buffers as opposed to LVR limits, given in part the latter may provide material headwinds to non-speculative FHB activity,” the report found.
The RBA noted: “More focus should probably be given to serviceability and amortisation than LVE or low-doc lending.”
The report noted the RBA’s growing concern over residential investment activity in Sydney and Melbourne.