Home' MFAA Prosper : Prosper April 2016 Contents REFINING THE MODEL
While APRA is required to implement at
least the minimum standards of the Basel
framework, in many areas it chooses to
go further and take a more conservative
approach to regulation.
One example is the approach to the rules
for the internal ratings-based model for
risk assessment used by the big four and
Macquarie. While it was amended last year
and looks set to be further amended, it is
already a conservative and robust measure,
says banking regulation expert Kevin Nixon.
Under the model, all of the banks’ data
on mortgages is compiled. “ The two key
numbers you calculate are the probability
of default (whether someone defaults on
their mortgage), and how many of your
mortgages will go into default,” s ays Nixon.
The second number is the ‘loss given the
default’ or LGD, which is the amount the
bank would lose if a borrower defaulted.
“T hat takes into account if you foreclose
on the property, sell it on the market, don’t
recover all the interest,” s ays Nixon.
“T he banks model those numbers, along
with their histories of foreclosures. The
percentage of the value of the loan they
would lose on average when they foreclose
on a property in Australia, is probably in the
“ But in Australia we have an LGD floor
of 20 per cent. No other country has this,
so it’s another case where APRA is more
conservative than the Basel standard. It
means that despite whatever the banks’
models are telling them about how little they
could lose in a foreclosure, they can’t go
below 20 per cent,” Nixon says.
VOLUME 3 | ISSUE 1 | 2016
THE ESSENTIAL RESOURCE
be based on two risk drivers: the loan to value ratio and the borrower’s level of
There would be a drop in risk weights for loa n-to-value ratios (0-60 per cent)
and LVRs above 80 per cent. But there’s no change for LVRs between 60 and 80
percent, says Yanotti, who points out that Australia’s average LVR is 64 per cent.
Nonetheless, with the banks able to reduce the amount of capital they
hold against low LVR and high LVR loans, there may be an improvement
in profitability a nd competitiveness that could have f low-on effects for
shareholders, borrowers a nd brokers. It could, for exa mple, mea n lower rates,
higher dividends or changes to broker commission str uct ures.
Ba nk of Queensland public disclosures on its loa n book suggest 60 per cent of
its home loans would benefit from risk-weight reductions under the proposals,
according to a recent Austra lia n Fina ncial Review report. But there a re never
winners without losers, says Yanotti. “There may be increasing costs of funds
and some people may find it a little harder to get loans than before.”
Investors could be a mong the biggest losers under the new rules. In fact,
the rules for investment loans are “the smoking gun” of Basel IV, says Michael
Cunningham. Nixon agrees, saying the rules deserve “a lot more attention”.
Under Basel IV, loa ns that a re ‘materially dependent ’ on cash f lows generated
by the property would attract higher risk weights – almost triple those for
ow ner-occupier loans.
For example an owner-occupier loan with an LVR above 80 per cent will
attract a risk weight of 45 per cent. But the risk loading for an 80 per cent LVR
loan that’s materially dependent on cash flows generated by the property will be
120 per cent.
Just how the term materially dependent will be defined is being debated, says
Cunningham. “ We don’t know at this stage how that’s going to play out. But it’s a
rea lly big issue because if you’re talking about people who a re negative gearing
a nd that ’s a significant propor tion of residential mortgage portfolios – then
there’s a rea l ex posure here.”
The va riation in rates for investors a nd the definition question a re issues that
haven’t received enough coverage, says Nixon. The pricing of investment loa ns
could be “significantly altered”, he says, because banks’ return on equity for
investor loa ns w ill be about a third of the equivalent loan to a n owner-occupier.
“It’s going to cause challenges,” says Nixon.Interest-only loans are also ex pected
to be caught by the higher risk weights.
Why the severe treatment for investor loans? Nixon sees it as a way of saying
they’re more like a business loan. “It’s treating an investment property more like a
business venture. If you’re investing in a piece of property, there’s a cost of running
the property, a nd there’s income from that property, and if you’re
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