APRA issues updated credit standards framework

The Australian Prudential Regulation Authority (APRA) has released its final Prudential Practice Guide APG 220 Credit Risk Management along with a letter to authorised deposit-taking institutions (ADI) to assist them with making prudent lending decisions and meeting their requirements under the new prudential standard APS 220 Credit Risk Management (APS 220).

APG 220 has incorporated examples of better practices that APRA has identified in recent supervisory reviews.

In December 2020, APRA began consulting on changes to APS 220 in light of the incoming reforms to consumer credit laws.

While APRA finalised a new APS 220 standard in December 2019, which was due to be implemented from 1 January 2021, the new version was delayed by 12 months due to the coronavirus pandemic.

However, in the meantime, the federal government proposed a bill to reform consumer credit laws, including the repeal of responsible lending obligations (RLO) for ADIs, and new lending requirements for non-ADIs.

As such, APRA sought to amend its credit-related prudential standards and guidance to reflect the consumer credit reforms.

The government’s planned repeals to the responsible lending obligations in the National Consumer Credit Protection Bill are still before the Senate.

In his latest letter to ADIs, APRA deputy chair John Lonsdale said the consultation sought closer alignment between the implementation date of the government’s proposed consumer credit reforms and the new APS 220, if the reforms come into effect from 1 January 2022.

He said that APRA has remained committed to ensuring that there is appropriate alignment between the new ADI and non-ADI lenders’ regimes.

Furthermore, he stated that the new APS 220 will be implemented on 1 January 2022, or earlier if the federal government’s proposed reforms are passed as legislation, in which case, APRA will provide an update to ADIs at the time.

“APRA expects that prudent ADIs would already be meeting the requirements of the new APS 220. In particular, given APRA’s focus on reinforcing sound lending practices, and in light of the current risk outlook, APRA would be concerned if ADIs were not already meeting the core requirements for prudent loan origination standards,” Mr Lonsdale said.

In addition, Mr Lonsdale warned that in the current environment, APRA would expect ADI boards to have a strong focus on credit risk management, particularly for residential mortgage lending.

He said: “APG 220 sets out examples of better practice to assist ADIs in maintaining sound lending practices and managing their credit risk, including during periods of heightened risk.

“It would be prudent for ADIs to review closely the examples of better practice in APG 220 against their current credit risk management practices, and make changes where appropriate.”

The APG 220 has provided guidance on sound practice to support APS 220, and should be read in conjunction with other relevant prudential standards and prudential practical guides, including APG 223 Residential Mortgage Lending.

It has covered the lifecycle of lending, from credit origination to controls and monitoring, and it includes guidance on managing non-performing loans, restructured exposures and credit losses.

APS 220 has set out APRA’s requirements for an ADI to implement a credit risk management framework that is appropriate to its size, business mix and complexity. It has covered all types of lending undertaken by ADIs, including lending to households, small businesses and large corporates.

The APS 220 framework must include a credit risk appetite statement, credit risk management strategy, credit risk policies and processes, a credit risk management function, a management information system, and an independent review process.

Additionally, since ADIs may have credit exposures in different geographical locations within Australia and overseas, the guidance stated that good practice is for an ADI’s credit risk management framework to recognise the varying risks in different locations, and take into account local economic, social, climatic, political and other conditions that could impact risk profile.

Processes when using brokers

For loans sourced via third-party channels such as brokers or introducers, the guidance stated that ADIs must establish formal processes for approving or certifying third parties, in line with the objectives of the credit risk management strategy.

Under APS 220, ADIs must have prudent policies and processes to verify the accuracy and “completeness” of the borrower information provided by the third party, and the outcomes of these processes must be documented.

It said: “In some circumstances, an ADI may have direct exposure to credit risk through a third party, such as an online lending platform. Under these arrangements, requests from borrowers for loans are made and then matched against offers from the ADI to fund (partially or fully) the loans.

“The platform operator or other third party typically undertakes the credit assessment and approval of the underlying borrowers under its own credit risk policies and processes. This type of lending is often referred to as peer-to-peer or marketplace lending.

“For such lending, APRA expects ADIs to have undertaken a comprehensive assessment of the associated risks.

“Prior to entering into these arrangements, it is prudent for ADIs to conduct appropriate due diligence and implement appropriate controls. This could include, for example, establishing contract provisions that impose obligations on the third party to notify the ADI of, and seek the ADI’s consent to, any material changes to its credit risk policies.”

[Related: APRA consults on updates to credit standards]