Mortgage curbs earn banks $500m annuity from taxpayers

In its draft report, released following its review into competition in the Australian financial system, the Productivity Commission (PC) has suggested that macro-prudential measures introduced to reduce interest-only (IO) lending were “blunt interventions” and have cost taxpayers an estimated $500 million a year.

“We estimated that the cost borne by taxpayers as a result of changes in home loan investor rates following APRA’s intervention on interest-only loans in 2017 was up to $500 million per year,” the PC report reads.

The PC claimed that the regulator’s measures “boosted lender’s profits”, reduced market competitiveness and hiked interest rates. 

“APRA’s actions to slow new lending in what it determined are higher-risk areas resulted in higher interest rates on both new and existing investment loans, boosted lenders’ profit on home loans and saw a decline in competition from some smaller lenders in the home loan market.”

Further, the PC asserted that most of the banks’ supposed increased profit was paid for by taxpayers through negative gearing arrangements.

“Up to half of the increase in lenders’ profit was in effect paid for by taxpayers, as interest on investment loans is tax deductible.”

Call for a review into risk weights

In Draft Recommendation 16.1, the PC called for APRA to “commence and complete” a review the standardised risk weights set for residential mortgages by June 2020.

The PC noted that the review should be focused on “finely calibrating the risk weights to better reflect the risk inherent in individual mortgages”, with particular focus on home loans with a loan-to-variable rate (LVR) less than 80 per cent.

“In particular, consideration should be given to replacing the single risk weight that applies to standard eligible residential mortgages with a loan-to-valuation ratio below 80 per cent with risk weights defined in more narrow bands,” the recommendation reads.

Competition

Moreover, in Draft Finding 2.2 of the report, the PC stated that regulatory efforts to promote stability in the market should not undermine the “essential role” of competition in the sector.

“It is important to ensure that the essential role of competition in economic growth is not eroded further by having stability as the default regulatory position.”

The PC believes that APRA’s lending curbs inhibited competition in the banking sector by stifling the profitability of smaller lenders.

The Customer Owned Banking Association (COBA) has welcomed the PC’s findings, and it claimed that the report is a “wake-up call” regarding the state of competition in the banking sector. 

“The draft report is a very welcome wake-up call about the state of the retail banking market and the need to take action to promote competition,” COBA CEO Mike Lawrence said.

“COBA welcomes the report’s endorsement of key points made in our submission including the finding that the major banks have substantial market power and unfair advantages delivered by the regulatory framework and that competition has suffered.

“The PC finds that the major banks have the ability to pass on cost increases and set prices that maintain high levels of profitability — without losing market share.”

[Related: CFO optimism holding despite fears over further regulation]