APRA warns banks about loan serviceability exceptions

Lenders’ risk profiles under scrutiny

APRA warns banks about loan serviceability exceptions



APRA has issued banks a warning to exercise prudence when offering exceptions to the 3% serviceability buffer for customers refinancing their home loans.

In a letter to banks today, APRA Chair John Lonsdale (pictured above) noted banks had recently announced changes to their exception processes to support borrowers that may be experiencing challenges refinancing.

“APRA is aware that some banks have recently made changes to their exceptions processes to support borrowers who may be facing challenges in refinancing with another lender,” Lonsdale said in the letter.

However, he warned banks that APRA requires them to have prudent policies and processes for dealing with instances of “exceptions to policy”, and that not having these could carry risks.

“Large volumes of exceptions can create risks by weakening banks’ risk profiles and increasing the vulnerability of their loan books to future shocks,” Lonsdale said. “It is important that exceptions are used in a prudent and limited manner, so as not to undermine the intent of the core policy.

Historically, serviceability policy exceptions have only accounted for a small share of banks’ total housing lending, estimated by APRA at between 2% and 3%.

The FBAA, led by managing director Peter White, has called on APRA to review its decision to maintain the 3% serviceability buffer because a growing number of borrowers are stuck in “mortgage prison” and unable to refinance to a better deal.

Brokers have mixed views on the buffer but a number have called for a common sense approach and adjustments to the buffer level where appropriate.

APRA said it expected banks to make a prudent assessment of repayment capacity so that there was a good outcome for borrowers and the financial system, and that prudent banks would have acceptable reasons and clear justifications for loans written outside policy.

“It is also important that banks have considered their Responsible Lending Obligations, which are administered by the Australian Securities and Investments Commission,” Lonsdale wrote.

Lonsdale noted that loans written as exceptions must be regularly reported to the relevant internal governance bodies of the bank and monitored against risk appetite limits.

“Prudent boards would assess the impact of any proposed changes to exceptions processes on the bank’s risk profile and risk appetite. This includes understanding the types of loans that are being written outside policy, such as like-for-like refinancing,” he said.

In the letter, APRA requested that banks “notify their supervisor” ahead of material changes to their exceptions process, and said APRA would be monitoring exceptions trends closely and might request additional information to assess how banks were managing risks.

“Banks reporting large volumes of policy exceptions will be subject to heightened supervisory attention,” Lonsdale said.

Reasons for serviceability buffer reinforced by APRA

APRA’s letter to banks reinforced the necessity of existing customer serviceability requirements.

“Under APRA’s prudential framework, banks must apply certain minimum criteria when assessing a borrower’s repayment capacity. This includes a 3% minimum serviceability buffer, to be applied above the housing loan interest rate,” Lonsdale said.

He said with the potential for interest rates to rise further, inflation still high and the possibility of weaker labour market outcomes, the buffer remained an important risk mitigant.

“The serviceability buffer provides a contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower’s income or expenses,” he said.

Lonsdale acknowledged that in the current environment, some borrowers who were seeking to refinance with another lender might no longer meet standard loan criteria.

He said reasons included higher interest rates and cost of living pressures, borrowers having less equity in their property following declines in housing prices, or changes to personal circumstances.

“It is important that these loans are assessed on a case-by-case basis,” Lonsdale said.

APRA said that an “exception to policy” occurred when a bank approved a loan that did not meet standard loan criteria, such as the serviceability buffer, and that APRA required banks to have prudent policies and processes for dealing with exceptions to policy.

“Under APRA’s prudential framework, banks can use exceptions to policy if these are managed prudently and limited. This approach allows banks to take into account additional indicators of repayment capacity beyond those captured in the standard serviceability test. For a borrower seeking to refinance, this could include past repayment behaviour,” Lonsdale said.

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