Banks will have to hold more capital against risky mortgages

APRA's new framework to tighten mortgage capital requirements

Banks will have to hold more capital against risky mortgages

Banks will have to hold more capital against risky mortgages and change their reporting of key buffers starting in 2023 under the prudential regulator’s new capital framework.

On Monday, the Australian Prudential Regulation Authority released its new capital framework for Australia’s banks, to align with international Basel III requirements, according to a report by The Australian. While the framework raises capital requirements for riskier home loans, it loosens capital rules for loans to small businesses.

The changes are likely to spur more pricing differences between the kinds of loans borrowers choose to reflect lenders’ risk, The Australian reported. Banks will also more carefully consider the size of a deposit for a new loan.

APRA will provide a consultation period on the changes, but only for the guidance material on capital requirements. The new framework will take effect in January 2023 – a move that may incense parts of the banking industry that were lobbying for a longer implementation period to update their systems and investor reporting.

In Europe, similar changes have been delayed until 2025 by the European Commission.

Regal Fund Management’s Mark Nathan told The Australian that APRA’s new framework would impact each bank differently.

“In terms of the winners and losers, there will be subtle differences between all the banks,” Nathan said. “Banks exposed to high [loan-to-value ratio] or interest-only lending will see their capital requirements increased, while SME lenders will see capital reductions. There are also a number of initiatives that will help with the comparability between banks. For example, APRA will now require the major banks to also publish their capital position as calculated on a standardised basis.”

Commonwealth Bank is the nation’s largest mortgage lender, while National Australia Bank is the biggest lender to small businesses, The Australian reported. Westpac has been reducing its exposure to mortgage categories such as interest-only in anticipation of APRA’s new framework.

Under the new regime, the average common equity tier-one capital of the major banks will remain the same at $50 billion, but the composition of the funds will change, The Australian reported. For example, the amount of capital required to be set aside for riskier mortgages will spike by about 25%. That means banks will be required to hold a higher level of capital against interest-only and investor mortgages, compared to home loans where borrowers are paying principal and interest.

There will be a decline in capital set aside against lower-risk mortgages, according to The Australian.

APRA Chairman Wayne Byres said the new framework would give the banking system stability and protect depositors in periods of financial stress.

“Although Australia’s banking sector is already strongly capitalised by international standards, the new capital framework will help ensure it stays that way,” Byres said. “The fact that Australian banks already have the capital needed to meet the Basel standards, without the need for lengthy transitional periods and phase-in arrangements that will be needed in many other countries, is evidence of the underlying strength.”

The regulator also announced simpler capital requirements for smaller banks – those with less than $20 billion in assets – after criticisms from the smaller institutions of a tilted playing field.

“The development of a simplified approach for smaller banks avoids unnecessary regulatory burden without jeopardising prudential safety,” Byres said. “It has been designed to benefit a large number of institutions – about three-quarters of domestic banks will be able to take advantage of the simplified approach.”