APRA has announced an increase in the amount of capital required to be held by lenders against residential mortgage lending, which will foster greater competition and level the playing field in the mortgage market.
This change will mean that for authorised deposit-taking institutions (ADIs) accredited to use the internal ratings-based (IRB) approach – i.e. the major banks – the average risk weight on Australian residential mortgage exposures will increase from approximately 16% to at least 25%.
The increase in IRB mortgage risk weights addresses a recommendation of the Financial System Inquiry (FSI) to narrow the difference between average mortgage risk weights for ADIs using IRB risk weight models and those using standardised risk weights – i.e. many non-major banks.
This was something which was heavily campaigned for by many non-major and regional lenders. Suncorp Bank
argued in its second submission to the FSI that the rules around risk weights and capital adequacy created an “entrenched disadvantage” for the non-majors.
“As a regional bank, Suncorp Bank is required to hold up to three times the level of capital of the major banks against equivalent portfolios with the same underlying risk. This makes clear the competitive differential driven by the regulatory settings. It also highlights the barriers to entry in banking created by the onerous capital and regulatory environment for non-major banks,” the non-major said.
The increased IRB risk weights announced today by APRA will apply to all Australian residential mortgages, other than lending to small businesses secured by residential mortgage. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI.
In order to provide these ADIs sufficient time to prepare for the change, the higher risk weights will come into effect from 1 July 2016.
According to the regulator, the residential mortgage portfolio is the largest credit portfolio for ADIs and, in aggregate, IRB accredited ADIs hold the material share of these exposures. Therefore, strengthening the capital adequacy requirement for residential mortgage exposures under the IRB approach will enhance the resilience of IRB-accredited ADIs and the broader financial system.
However, the increase in IRB mortgage risk weights announced today is an interim measure. It is not possible to settle on the final calibration between the IRB and standardised mortgage risk weights until changes arising from the Basel Committee’s broader review of this framework are complete.
Further changes to IRB mortgage risk weights will be considered over the medium term in the context of these broader international developments.