Delivering his keynote address at the AFR Banking and Wealth Summit in Sydney on Tuesday, APRA chairman Wayne Byres said that while APRA’s measures to strengthen the mortgage lending market have had a positive impact, at the same time the risk environment “certainly hasn’t moderated”.
He emphasised that house prices remain high, household income growth remains subdued, the high ratio of household to income has increased, the already low official cash rate has lowered further, and competitive pressures haven’t diminished.
In response to these market conditions, Mr Byres revealed that the prudential regulator is developing a more strategic response that recognises that housing lending risks and capital adequacy are “far from independent issues” in the Australian banking system.
Mr Byres highlighted that the Financial System Inquiry recommended in 2014 that APRA should set capital standards such that the capital ratios of Australian deposit-takers are ‘unquestionably strong’.
“In making this recommendation, the FSI did not dispute that the Australian banking system was in good shape, but simply that some further strengthening was a worthwhile investment for the Australian community,” Mr Byres noted.
“In thinking how to put the recommendation into practice, we have been mindful that the international bank capital regime is still undergoing further fine-tuning. We therefore chose to hold off implementing the ‘unquestionably strong’ recommendation until the work in Basel was completed. We thought it made sense to tackle both issues together, on the basis that implementing one set of changes rather than two was likely to be more efficient and provide greater certainty for everyone.
“However, without clarity as to a deadline for an agreement in Basel, we have decided it does not make sense to wait any longer to deal with the question of ‘unquestionably strong’.”
Following on from its announcement last week, Mr Byres said that APRA will now engage in a review of the relative and absolute capital requirements for housing exposures.
“That should not be taken to imply that there will be a dramatic increase in capital requirements for housing lending: APRA has always imposed capital requirements for housing exposures that are well above international minimum standards, so we do not start with glaring deficiencies.
“By anyone’s standard, however, we have a banking system that has a notable concentration in housing. It is therefore important we give that issue particular attention as we think about how to put the concept of ‘unquestionably strong’ into practice.”
Moving forward, Mr Byres said that APRA will be taking a closer look at many components of the nation’s capital adequacy framework.
Given its position as the dominant asset on the balance sheet of the banking system, Mr Byres explained that the adequacy of capital requirements for housing-related risks will be a critical part of the assessment of the framework.
“Beyond the recently-announced tactical responses to current conditions in the housing market, making sure the system is on a sound footing for the longer term is even more important,” he elaborated.
“Put simply, the capital adequacy framework needs to address the concentration in housing lending that has built up in the banking system over time: if we are going to put an increasing number of eggs into a single basket, we’d better make sure that basket is a (unquestionably) strong one.”
APRA’s plan is to issue an information paper around the middle of the year, which will set out how the regulator views the banking system, the extent of further strengthening requirements, and the timeframe over which they will be achieved.
‘Additional moderation’ was needed for I/O loans
Referring to APRA’s announcement last week regarding interest-only mortgages, Mr Byres explained that the regulator focused on this area of lending to complement its earlier measures.
“Although there are perfectly legitimate reasons why individual borrowers might prefer an interest-only loan, in aggregate the level of interest-only lending creates additional vulnerabilities and we came to the view some additional moderation in this area was warranted,” he clarified.
Further, Mr Byres noted that APRA chose not to lower the investor lending growth benchmark at this point in time, given the need to accommodate the increasing supply of housing in the construction pipeline.
Although the 12-month annual growth rate for investor lending is currently below the 10 per cent benchmark, Mr Byres stressed that the run rate in more recent months has been closer to – if not a little above – 10 per cent on an annualised basis.
“Therefore, even with the benchmark unchanged, lenders are still likely to have to tighten their lending practices and slow lending from that in recent months to ensure they remain comfortably below the desired level,” he said.
“This latest step is a tactical response to current market conditions – we can and will do more (or less) as conditions evolve.”