July 30, 2015
The Australian Prudential Regulation Authority (APRA) last week announced that it will require the four major banks and Macquarie Bank to increase the amount of capital required against residential mortgage exposures. Currently these five institutions are allowed to set their own mortgage risk weights, but from 1 July, 2016 it will be mandatory to apply the APRA sanctioned internal ratings-based (IRB) approach to credit risk. The change will mean that, for these major lenders the average risk weight on residential mortgage exposures will increase from approximately 16% to at least 25%. All other APRA regulated lenders use a standard 35% risk weight on residential mortgages, thus the major institutions will still maintain a healthy cost advantage over smaller competitors.
The residential mortgage portfolio is the largest credit portfolio for the major banks and by increasing the capital adequacy requirement for mortgage exposures, APRA is enhancing the strength of the major banks and the wider financial system. APRA research indicates that the introduction of an IRB risk weight floor of 25% will necessitate the major banks raising their overall capital by $12 billion (80 basis points). This adjustment to capital requirements is the first step towards meeting APRA’s judgement that an additional $30 billion (200 basis points) is needed to ensure Australia’s banks are in the world’s top quartile for safety and stability.
Authorities have for some time expressed concerns with the level of speculation and lending in the property sector, and with major banks now holding less capital against their mortgage books than prior to the GFC, the announcement was widely expected. The impact of the change will vary from bank to bank, depending on the size and nature of their lending portfolio. The initial response by the major banks would suggest that shareholders and customers will both bear the cost of holding additional capital, with banks announcing earnings dilutive issues and the sale of non-core assets and interest rates on residential investor loans were hiked almost immediately.