Tighter regulation has made banks tweak lending practices, increase mortgage lending: RBA bulletin
In the aftermath of the GFC, a focus on more financial resilience has meant that Australian banks have had to increase capital requirements by strengthening their capital position, primarily through an increase in common equity.
This has impacted banks’ ROE, encouraging them to tweak their lending activities, according to the RBA’s latest bulletin.
“One of the most notable ways that banks have been able to reduce their average risk weight, and the effect of higher capital on ROE, has been through a continued shift towards housing lending,” it says.
In 2016, housing credit made up nearly two-thirds of the stock of banks’ domestic credit, up from a bit above half in 2008 and well above the level from a couple of decades ago (Graph 5).
According to the bulletin, this long-run trend has been underpinned by factors such as financial deregulation and competition in lending markets, a fall in inflation and an increase in the cost of housing relative to business assets over time. More recently, low interest rates have likely encouraged housing investment and demand for housing credit.
It said that one reason banks have accommodated the strong demand for housing credit may have been that housing lending has been able to generate higher ROE than other types of lending, because the lower risk weight applied to mortgages has not been fully offset by narrower credit spreads.
Some banks have also been scaling back lending activities that are more capital intensive but do not generate sufficient returns (for the amount of capital required).
Banks have also repriced their loans, mostly housing loans, in response to higher capital requirements.
“Since mid 2008, the cash rate has declined by 575 basis points while housing lending rates have declined by around 390 basis points (Graph 6). While part of the widening in this spread has been due to a rise in banks’ funding costs relative to the cash rate, the implied spread between banks’ mortgage lending rates and their funding costs has still increased by around 110 basis points.
“Part of this increase in spreads reflects efforts by banks to offset the costs associated with using more equity to fund lending as capital requirements have increased,” it said.
The remainder likely reflects banks’ efforts to offset the impact on their earnings from new regulations requiring them to hold a greater amount of HQLA, which typically have a yield that is less than the cost of funding (as discussed below).
More recently, banks have increased their lending rates on investor and interest-only loans, relative to those on amortising owner-occupier loans, in response to regulatory tightening.
Stronger capital and liquidity positions improve banks’ resilience against adverse shocks.
However, such changes can also affect their funding costs and key profitability metrics.
These changes have included a continued shift towards housing lending, a scaling-back of capital-intensive and lower-return lending, and a repricing of loans.