Corporate regulator APRA has warned banks about the importance of vigilant credit assessments, after the outcomes of a hypothetical borrower survey were “a little disconcerting in places”.
Speaking at the COBA CEO & Director Forum in Sydney this week, APRA chairman Wayne Byres reinforced the significance of sound lending practices, as the proportion of home loan lending has increased over the past decade from an already dominant 55% to a little under 65%.
Specifically, he spoke about the room for improvement when it comes to lenders’ credit assessments, following the results of a recent hypothetical borrower survey where the regulator asked a number of the larger housing lenders to provide their serviceability assessments for four hypothetical borrowers – two owner-occupiers and two investors.
“The outcomes for these hypothetical borrowers helped to put the spotlight on differences in credit assessments and lending standards. The outcomes were quite enlightening for us – and, to be frank, a little disconcerting in places,” Byres said.
“…The first surprising result from our review was the very wide range of loan amounts that, hypothetically, were offered to our borrowers. It was not uncommon to find the most generous ADI was prepared to lend in the order of 50% more than the most conservative ADI.”
One significant factor behind differences in serviceability assessments, particularly for owner occupiers, was how lenders measured the borrower’s living expenses.
“As a regulator, it is hard to understand the rationale for large differences in what should be a relatively objective, and extremely critical, metric,” Byres said.
Of major concern, according to APRA, were the few lenders who opted to base their credit assessment on a lower level of living expenses than that declared by the borrower.
“That is obviously a practice that should not continue, and ADIs should be making reasonable inquiries about a borrower’s living expenses. In fact, best practice (and intuition) would be to apply minimum living expense assumptions that increase with borrower incomes; this was a practice adopted by only a minority of ADIs in our survey.”
Another area of interest were the differences in the treatment of interest only loans in the hypothetical test, which included one borrower seeking a 30-year loan, with the first 5 years on an interest-only basis.
“Only a minority of surveyed ADIs calculated the ability to service principal and interest (P&I) repayments over the residual 25 year term. Despite the contractual terms, the majority assumed P&I repayments over the full 30-year term, and hence were able to inflate the hypothetical borrower’s apparent surplus income by, in our particular example, around 5%.”
Whilst Byres admitted Australian lenders are "well away" from the types of subprime lending that have caused so many problems elsewhere, the overall conclusion from the hypothetical borrower exercise was that there were “clearly examples of practice that were less than prudent”.