Big Banks Feeling the Pinch
Australia’s big four, namely; Westpac, Commonwealth Bank, ANZ and NAB are set to face stronger competition from second tier banks once changes to key lending criteria have been made.
The Australian Prudential Regulation Authority (APRA) is the regulator of financial institutions. Their regulatory scope has them oversee banks, general insurance, health insurance and superannuation firms among others. As opposed to the market regulator ASIC, APRA’s ensures that institutions with an obligation to members remain financially sound and capable of meeting redemptions. This is done primarily through prudential and reporting standards, and systematic supervision. Perhaps buoyed by the ailing mortgage market, APRA is intending to implement a series of changes to help both banks and homebuyers.
7% serviceability buffer to be scrapped
Back in 2014, APRA forced Authorised Deposit-taking Institutions (ADI’s) to enforce safer lending practices. This took the form of the prudential standard for residential mortgage lending APG223, which stipulated among other things that ADI’s needed to incorporate a buffer of above 2% and a minimum floor rate of 7%. These standards were set in place to ensure that mortgagers could continue to service their debts in the event of a rise in interest rate. Back when excessive lending and high household debt was the norm, APG223 served to stricken bank lending practices. These standards were somewhat unwarranted given that the RBA continued to cut the cash rate to the low level today (1.5%).
APRA subsequently plans to scrap the 7% serviceability floor rate, and will increase the buffer from 2% to 2.5%. It is expected that these changes will provide greater flexibility for banks to implement their own metrics, and help more homebuyers meet their lending criteria. Bendigo and Adelaide Bank has backed APRA’s plan to loosen lending standards, and agrees that the present market and economic conditions warrant such changes.
Changes to risk weightings, and more
APRA is set to announce the removal of a two-tiered risk weighting system which has previously benefited bigger banks. The concept of risk weightings is important to how banks are regulated.
In a simplified example, a typical bank might see mortgages make up its assets from which it derives interest revenue. To fund these mortgages, the bank may use debt type instruments such as customer deposits, or go to equity capital instead. For a number of reasons, banks typically like to use debt instruments to fund their debts, yet this increases the risk of insolvency and bankruptcy – a somewhat recent example can be found in the global financial crisis incident.
Regulators such as APRA have to intervene so that banks hold enough capital to be deemed sufficiently safe. The amount of capital depends on their on balance and off balance sheet items, and is outlined in their APS112 prudential standard. For example, cash held by a bank represents no risk and attracts a 0% risk weighting, while loans given to overseas counterparties is subject to default risk and might attract a risk weighting of up to 150%. That is, to grant a loan of $100000, the bank must hold $150000 in equity capital.
Guidelines in force from 2016 have stipulated that for a typical mortgage with LVR below 80%, a risk weighting of 25% is applied by larger banks while 35% is applied by smaller banks. The unfair restrictions placed by this two tiered system has drawn the ire of smaller banks. In 2018, APRA suggested that smaller banks apply a sliding scale of risk weightings to loans to give them capital relief on loans with smaller LVR. A recent announcement will now narrow the 10% difference and level the playing field; more news is expected to come in June. It is expected that such changes will expand the financial capacity of smaller banks and increase the supply of credit in the market.
The decision to change risk weightings will be followed by two other announcements, as revealed earlier at the Australian Financial Review Banking & Wealth Summit. APRA chairman Wayne Byres has expressed that the current share of executive pay driven by shareholder returns should be reduced to below 25%, and that management should focus instead on serving customers. In the wake of the Royal Banking Commission’s revelation of poor conduct within the industry, Byres recommended that a cap be placed on cash and share bonuses. The other announcement relates to loss absorbing capital buffers for bigger banks.
The market reaction to the news has been mixed. ANZ was down 0.2%, CBA up 2%, NAB up 0.3% and Westpac down 0.7%. Smaller banks were also mixed, as BOQ gained 0.1% and Bendigo Bank 0.7%, while Suncorp dropped 1.5%. There is significant uncertainty in the market stemming from the trade war, as well as the upcoming RBA interest rate decision. What is certain however is that these reforms are a step forward in revitalising the housing market.
By Oliver Ju
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