The final report of David Murray’s Financial Systems Inquiry (FSI) has urged APRA to adjust the requirements for calculating risk weights for housing loans, to narrow the difference between average IRB and standardised risk weights.
The average mortgage risk weight for an ADI using the standardised model is currently 39% — more than twice the size of the average mortgage risk weight for banks using IRB models, which is 18%. However, the Inquiry notes that the principle of holding capital relative to risk should apply, not only within an institution, but also across institutions.
“In the Inquiry’s view, the relative riskiness of mortgages between IRB and standardised banks does not justify one type of institution being required to hold twice as much capital for mortgages than another. This conclusion is supported by the findings of APRA’s recent stress test, which found regulatory capital for housing was more sufficient for standardised banks than IRB banks.”
The report notes that the competitive disadvantages that arise due to the current risk-weighting arrangements pose a threat to the Australian financial system.
“Given that mortgages make up a significant portion of the assets of almost all Australian ADIs, competitive distortions in this area could have a large effect on their relative competitiveness. This may include inducing smaller ADIs to focus on higher-risk borrowers. Restricting the relative competitiveness of smaller ADIs will harm competition in the long run.”
The Inquiry considered two options to narrow the difference between standardised and IRB mortgage risk weights: raising average IRB mortgage risk weights or lowering standardised mortgage risk weights – concluding that raising IRB risk weights would be more effective.
“The Inquiry judges the option of lowering standardised mortgage risk weights to be substantially inferior to the recommended option of raising IRB mortgage risk weights.”
While non-major and customer-owned banks – who have been very vocal about levelling the playing field – will be welcoming this recommendation, the Property Council of Australia says it will push the cost up for new borrowers in 2015.
“Capital holding recommendations have the effect of adding weight to loans and costs to borrowers, which could hurt already low first home buyer rates, effect new housing starts and challenge seniors who are looking to downsize,” Nick Proud, Executive Director of the Residential Development Council said.
“This added cost could dampen the current housing upturn response to pent up demand and reduce activity in emerging markets outside of Sydney and Melbourne.”