In his address to the Customer Owned Banking Association (COBA) 2021 CEO and directors’ forum, Australian Prudential Regulation Authority (APRA) deputy chair John Lonsdale said that for the mutual banks sector, the proportion of new housing loans with a loan-to-value ratio (LVR) of greater than or equal to 90 per cent had risen from 11 per cent in March 2019 to 17 per cent in December 2020.
Mr Lonsdale said that this is a “notable” increase.
Commenting further, he said: “While LVR is only one of a number of metrics that need to be considered, it does raise the question of whether the mutual sector is taking on more risk in pursuit of market share, and how sustainable that is.
“As I mentioned at the outset, it’s critical in the current environment of heightened risk that boards remain highly attuned to shifts in the composition of their lending book. APRA is aware of the cost pressures faced by the sector and is doing what it can to reduce regulatory burden for mutuals. This will continue to be a focus.”
However, Mr Lonsdale said that managing costs does not depend solely on adjustments to regulatory requirements, adding that it is the responsibility of the boards to design strategies that enable their business to sustain into the future.
He said: “This means close monitoring of risk, making investments that are manageable and provide an adequate return, and a realistic assessment of the prospect of ongoing profitability. This may require members of COBA to work more closely together, including considering the possibility of mergers where that makes sense.”
“Perhaps of most importance is ensuring that your customers continue to value what you’re offering. As specialised players in a highly commoditised market with large, well-resourced competitors, having the unique business model that mutuals offer and providing a distinctive customer experience are key to remaining relevant to your community of customers.”
ADIs warned against relaxing risk appetite
Mr Lonsdale also addressed the housing market and the environment of rising house prices, high household indebtedness and record-low interest rates, and warned authorised deposit-taking institutions (ADI) to exercise caution around relaxing risk appetite limits and lending standards in the current environment.
He noted that the regulator is not currently seeing a return to higher risk lending such as investor and interest-only loans, areas which have prompted it to intervene in the past.
“However, it is important that standards are maintained, monitored and tested. Recently, we wrote to the 14 largest ADIs requesting more detailed data on their lending portfolios, and seeking assurances from boards regarding lending standards,” Mr Lonsdale said.
“All boards should be closely monitoring their lending standards, comfortable with their risk appetite and testing whether serviceability policies used to assess borrowers remain prudent in an environment of extremely low interest rates.”
He added that while the majority of COBA members have not been sent this letter and data requests to minimise regulatory burden, he flagged that smaller ADIs would also be expected to be “rigorous” in monitoring and testing their own risk appetite and lending standards, rather than waiting to be prompted by APRA.
Capital framework aims to allow growth, consolidation
Commenting on the consultation for revisions to the ADI capital framework released in December 2020, Mr Lonsdale said that the simplified framework for smaller ADIs is designed to reduce regulatory burden.
He added that in the consultation, APRA has proposed to lift the threshold for an ADI to be able to operate on a simplified framework from $15 billion to $20 billion in assets, adding that this is aimed at capturing the entire mutual sector while allowing for future growth and consolidation.
“The proposed framework also seeks to improve comparability between ADIs using internal ratings-based (IRB) and standardised approaches to calculating regulatory capital, by requiring IRB banks to also report capital ratios using the standardised approach,” Mr Lonsdale said.
“A mortgage risk-weight floor is proposed for IRB banks, which is intended to support smaller ADIs’ ability to compete for low-risk mortgages.”
Mr Lonsdale clarified that APRA is still targeting 1 January 2023 as the implementation date of the proposed ADI capital framework.
APRA proposed “improvements” to the framework to enhance the ability of the framework to respond “flexibly to future stress events”, improve the “transparency of ADI capital strength”, and embed “unquestionably strong” levels of capital.
Banks may have to hold a large share of their required capital as “buffers” under the proposed revisions.
COBA recently lodged a submission to APRA on its consultation, calling on APRA to ensure that the standardised capital framework is a “genuine competitive alternative” to the internal IRB framework used by the major banks.