The Australian Prudential Regulation Authoritys (APRAs) latest move may reduce bank risk for home lending, but it will increase home loan rates for borrowers. This surprise move by APRA may affect all Australians who are buying property, not just investors.
Early in August 2015, APRA announced that it would increase the capital requirement for authorised deposit-taking institutions (ADIs) to reduce their financial risk in relation to Australian residential mortgage exposure. This ruling applies to lenders who are approved to use the internal ratings based (IRB) approach to credit risk. At present, this change applies to Australias four major banks, the ANZ, NAB, CBA and Westpac, and the Macquarie Bank, which is currently well over APRA’s guideline of a 10 percent growth per annum in investment home loan lending.
This now means that the average risk weight of residential mortgage exposure in Australia will increase from around 16 percent to 25 percent for lenders who use the IRB approach. The increase in mortgage risk weights for the lenders allows them to adhere to the recommendations made by the Financial System Inquiry (FSI) that APRA increase IRB mortgage risk weight so that the differences between average mortgage risk weights for ADIs using IRB risk and those using the standardised risk weights were reduced.
The increase in IRB risk weights apply to all Australian Residential home loans apart from small business lending that is secured by a residential mortgage. The higher risk weights will come into effect on July 1 2016. This will allow these five lending institutions or ADIs time to prepare for the change.
Will All Lenders Make the Change?
At this stage, only the four major Australian banks and the Macquarie Bank will have to make the change. All other lenders who are regulated by APRA use the standard 35 per cent risk weight model for residential mortgages. Therefore, financial experts expect that these lenders will have an advantage in the mortgage market once the four major banks, and the Macquarie Bank raise their rates, as the lenders that use the standard risk weight will be able to offer residential borrowers lower interest rates.
Why Have These Changes Been Made?
Apart from reducing credit risk for the major Australian banks and the Macquarie Bank, these changes have been made as the residential home loan portfolio is the biggest credit portfolio for ADI’s and these lenders hold the largest share of exposure for this market.
Thus, APRA state, by increasing the capital adequacy of ADI’s who use the IRB approach the resilience of these lenders to financial changes in the market will also increase. This, in turn, will also strengthen the Australian financial system as a whole. Undoubtedly, these changes will affect the major banks, but how remains to be seen. It is also expected that each bank will be affected differently depending on how they elect to deal with the anticipated change.
How Will this Change Affect Residential Home Loans?
It is anticipated that the ANZ, NAB, CBA, Westpac and the Macquarie Bank will have to raise their interest rates further. The ANZ and CBA raised property investor interest rates by 0.27 percent in early August 2015 in response to APRA changes. The other major lenders and Macquarie Bank are expected to follow suit, despite these banks having already removed investor loan discounts and tightening lending eligibility.
The move by the ANZ and CBA banks to raise investor interest rates has been a surprise move. This is attributed to the fact that banks, in the past, have typically been restricted from making interest rate adjustments outside of the official cash rate moves made by the Reserve Bank of Australia (RBA). This has largely been political based, where some politicians are quick to chastise the greed of banks for an out of cycle profit grab.
But, the playing field has now changed. Banks are now able to reprice with limited risk, and for borrowers this means rate rises are expected to continue. Economists are now even suggesting that all residential home loans that are offered by the major Australian banks and Macquarie Bank will rise between 0.55 and 0.65 percent. This will allow these banks to maintain a return on equity that may otherwise be lost as a result of APRAs decision to increase risk weights to a 25 percent minimum from July next year.
The move by the ANZ and CBA to raise interest rates has been applauded by shareholders and the RBA, who believe that repricing home loans will help profit margins, slow loan growth and possibly allow the RBA to further reduce the official cash rate, without fears of over-inflating an already growing housing bubble, especially in Sydney and Melbourne.
Are you looking to refinance your home with another lender before rates rise? Then contact eChoice, we can help you.
Written by eChoice
Since 1998, eChoice has helped more than 50,000 Australians secure a home loan through its network of over 25 lenders and hundreds of loans. Best of all our service is cost and obligation free!