The big four and Macquarie are being incentivised by a capital disparity to ‘cherry-pick’ high LVR loans and charge a higher rate, rather than use lender's mortgage insurance.
Under Basel II the big four banks and Macquarie can waive lender's mortgage insurance (LMI) with no capital consequences, unlike smaller lenders that must hold additional capital.
Listed mortgage insurer Genworth argues the current system not only weakens mortgage competitiveness but will lead to an increase in systemic risk.
The LMI group has called for policy changes to be introduced that would discourage the big banks from being able to target the ‘better’ risks from high LVR loan segments.
“If the bigger banks do not receive any capital benefit from using LMI, this can lead to their ‘cherry-picking’ better risk borrowers and waiving LMI, typically charging a fee or a higher interest rate instead,” Genworth said in its second FSI submission.
“In doing so the overall system capital is reduced, as the major banks do not hold additional capital that would otherwise have been held by the LMI provider had LMI not been forgone,” the insurer said.
Genworth has recommended that high LVR be treated as a separate segment within major bank capital modelling with increased minimum risk weights and “explicit recognition” for LMI.
In addition, the company has called for a government-sponsored “catastrophic reinsurance pool” for LMI policyholders in the event of a major financial crises.
“We propose a government-sponsored reinsurance arrangement for LMI policyholders which would only trigger if the financial system fails due to an unexpected major catastrophe that would be more than a one in 200-year event,” Genworth said.
“Such a policy would help protect the system against catastrophic tail credit risks, making the system more stable and enhancing competition for all residential mortgage lenders, as they would share access to the pool,” it said.
The proposed program would effectively introduce government support for the Australian residential mortgage loan market in place of the implicit government support that exists today in respect of the ‘too big to fail’ banks.
Rather than a government guarantee, the proposed reinsurance program would be funded progressively by the LMI industry, with no burden on the government or taxpayers in an extreme stress scenario.