Five comments from APRA about lending standards

Yesterday, APRA stated that they had sent letters to all authorised deposit taking institutions (ADIs) outlining the steps they intend to take to enforce residential lending practices.

APRA noted that they would be increasing supervisory oversight onto lending.

Here are five comments to note:

1. “Interest rates remain at historically low levels, household leverage remains high, and housing loans represent a large and increasing concentration on many ADI balance sheets. Strong competition in the housing market is also evident, which is accentuating pressure on lending standards. Against this backdrop, housing credit growth has accelerated, with lending to property investors particularly strong; the Reserve Bank of Australia (RBA) has noted that this could be funding additional speculative activity in the market.”
   
   
2. “There are a number of additional regulatory and supervisory tools that APRA can apply to address emerging risks, building on the enhanced monitoring and review of recent years. These include additional supervisory monitoring and oversight, supervisory actions involving Pillar 2 capital requirements for individual ADIs, and higher regulatory capital requirements at a system-wide level. Beyond this, there are also more direct controls such as regulatory limits on lending activities, as introduced in other jurisdictions to manage risks emerging in the housing market.”
   
   They do note that they do not propose increases in system-wide capital or to introduce new regulatory limits, but does say they will keep them “under active review”.
   
   
3. Higher risk lending includes, for example, a high proportion of lending at high loan to income ratios (LTI), lending at high loan to valuation ratios (LVRs), lending on an interest-only basis to owner-occupiers for lengthy periods and lending at very long terms. In the current environment, where an ADI is undertaking large volumes of lending in these categories, or increasing this higher risk lending as a proportion of new lending, this will be a trigger for the consideration of supervisory action.”
   
   
4. “Given the currently very strong growth in investor lending, supervisors will be particularly alert to plans for rapid growth in this part of the portfolio. For example, annual investor credit growth materially above a benchmark of 10 per cent will be an important risk indicator that supervisors will take into account when reviewing ADIs’ residential mortgage risk profile and considering supervisory actions. The benchmark is not intended as a hard limit, but ADIs should be mindful that investor loan growth materially above this rate will likely result in a supervisory response.”
   
   
5. “The serviceability buffer assumed by ADIs as part of this assessment accommodates not only future changes in interest rates but also unexpected changes in borrower income and expenses. Practice in setting the serviceability buffer varies across the industry, with some assessments allowing borrowers to take on debt at very high multiples of their income.”

APRA notes that a prudent serviceability buffer is at least 2% above the loan product rate, with a minimum floor assessment rate of 7%.

They do suggest that “good practice” is the maintain a buffer and floor rate above these levels rather than operating at the minimum expectation, and that those who do keep to the minimum will more likely face further supervision.