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Banks warned over mortgage risks

Canberra Times logo Canberra Times 26/05/2014 Clancy Yeates
a © Getty Images/William West a

The financial regulator has warned banks not to become complacent about potential risks in the $1.3 trillion mortgage market, amid signs banks are increasingly engaging in higher-risk lending.

The Australian Prudential Regulation Authority released new draft guidelines setting out what it expects from banks in the home loan market, the banking sector's single biggest credit exposure.

With banks competing fiercely for new business in an environment of record low interest rates and rising house prices, chairman John Laker said there had been an increase in higher-risk lending and mortgages.

''In this environment, APRA is seeing increasing evidence of lending with higher risk characteristics and it does not want this trend to continue,'' Dr Laker said.

''The draft prudential practice guide reinforces the importance of maintaining prudent lending standards when competitive pressures may tempt otherwise," Dr Laker said.

Mortgages have proven highly profitable for banks in recent years due to low default rates, but APRA said that the boom time conditions could result in risks being overlooked.

''Historically, residential mortgage exposures have exhibited low default and loss rates. However, lengthy periods of economic growth combined with low interest rates and a sustained period of rising house prices can create a sense of complacency among residential mortgage lenders,'' it said.

Mortgage lending accounts for more than half the credit exposure of the Australian banking system.

APRA said this concentration meant lenders should pay particular attention to the segment.

To ensure lenders remained prudent, APRA published guidance on key aspects of mortgage lending, including: its expectations of boards, remuneration, banks' credit policies and stress testing.

The guidance, which is being released for consultation, comes as competition in the mortgage market remains fierce, as banks eye the big profits on offer in home lending.

Boards of authorised deposit-taking institutions (ADIs) should remain alert to the risks of rapid expansion in mortgage lender, APRA said, and directors should seek explanations when lenders were growing faster than their rivals.

''Rapid relative growth could be due to an unintended deterioration in the ADI's loan origination practices, in which case APRA expects that an ADI's risk management framework would facilitate rapid and effective measures to mitigate any consequences,'' the guide said.

The Commonwealth Bank, NAB and ANZ have all been expanding their home lending faster than the industry average over the past year, and Westpac is accelerating its growth.

One way in which banks have sought to increase their market share is by increasing incentives paid to mortgage brokers.

APRA said banks should make sure these do not lead to extra risk taking, noting that larger up-front commissions encouraged brokers to pay less attention to loan quality. ''Trailing commissions are more likely to provide incentives for brokers to retain and monitor customers,'' APRA said.

The guidance also touched on lending standards, saying it expected banks to closely monitor the share of new loans with high loan-to-valuation ratios (LVRs). While Australia has no caps on LVRs, it said those above 90 per cent clearly exposed banks to a higher risk of losses.

APRA is taking feedback from the industry on the policy until late July.

Lengthy periods of economic growth combined with low interest rates and a sustained period of rising house prices can create a sense of complacency among residential mortgage lenders.

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