Banking regulator suggests mortgage lenders must address risk management strategies

The regulator that oversees Australian banks and other deposit-taking institutions has released for consultation a draft guide to sound risk management practices for residential mortgage lending.

The paper comes amid warnings that banks’ bad debts are at “unsustainably low levels” and are likely to rise when interest rates are lifted.

The Australian Prudential Regulation Authority’s (APRA) draft prudential practice guide notes that while Australian lenders have experienced low default and loss rates on home mortgages, the strong economy, low interest rates and rising house prices could lead to complacency among lenders.

Residential mortgages account for about half of the assets of the four major banks, the Reserve Bank of Australia estimated in its submission to the Financial Services Inquiry in March.

Each of the major banks reported low levels of bad debts during the recent reporting season.

Morningstar head of Australian banking research David Ellis said the big four banks had been performing strongly and could continue to do so through to the 2015-16 financial year. However, he warned the banks’ bad debts were at “unsustainably low levels”.

“I can’t see that bad debt level declining much further ... it can only go up from here,” he told Property Observer.

Rising interest rates would be the catalyst for increasing default levels in lenders’ mortgage books, Ellis said.

APRA’s draft guide suggests residential mortgage lenders should have policies in place that address their risk appetite and risk management strategies for loans.

It says they should ensure they can identify and control risks in their residential mortgage lending portfolios. It also sets out suggestions for managing loan origination, including assessing the borrower’s capacity to service the debt, verifying income, living expenses and other debt commitments.

The paper outlines good practices for remunerating mortgage brokers that would allow the lender to end or claw back commissions where there were high levels of delinquency. It also suggested lenders should set up systems to prevent brokers from pursuing loans with inadequate or false verification, marginal serviceability, excessive leverage or unsuitable terms for the borrower.

Ellis said that while rising mortgage rates would increase bad debts to banks, it was unlikely that their businesses would harmed overall.

“Higher interest rates mean a stronger economy and a stronger economy means more banking activity which means more profit [for the banks],” Ellis said. “While bad debts will increase, headline profits will also improve.”

Many borrowers are ahead on their mortgage repayments at present. Commonwealth Bank reported recently that 78% of its loan customers had paid in advance by an average of seven months, while Westpac reported around 70% of its loan customers were ahead of their required payment schedules.

APRA has called for comment on its draft guide by July 21, 2014.