The Australian Prudential Regulatory Authority (APRA) has appeared before the Standing Committee on Tax and Revenue, outlining its role in the financial regulatory system.
Noting their aim was to regulate residential mortgage lending and address potential financial stability risks, APRA’s Policy and Advice Division Executive Director, Renée Roberts stressed the regulatory authority does “not target house prices”.
Instead, Ms Roberts told the Standing Committee, APRA had two main aims:
- To supervise institutions across banking, insurance and superannuation, and set prudential requirements in a bid to protect the interests of depositors and promote financial system stability in Australia.
- To ensure banks and lending institutions make sound credit decisions.
“APRA’s prudential requirements, which are focused on lending practices, can influence the terms, amount and price at which banks extend housing finance,” Ms Roberts said.
“They do not target house prices or matters of affordability.”
Explaining APRA’s recent increase of the lending buffer from 2.5 per cent to 3 per cent, Ms Roberts said it was designed to address emerging risks to financial stability related to residential mortgage lending.
“Last month, we set an expectation that banks would assess new borrowers’ repayment capacity at lending rates that are at least three percentage points higher than those currently prevailing,” Ms Roberts said.
“APRA’s objective is to ensure the financial system remains safe, with banks lending to borrowers who can afford the level of debt they are taking on – both today and into the future.
“We expect the overall impact on aggregate housing credit growth flowing from this change to be fairly modest, since many borrowers do not borrow at their maximum capacity.”
APRA’s recent changes to lending criteria came into effect on November 1, but there is ongoing debate as to whether further lending restrictions will be introduced in the coming months.
In his letter to lending institutions outlining the changes on October 6, APRA Chair Wayne Byres
cautioned lenders about their risk appetite for lending at high debt-to-income ratios.
“While the use of a higher serviceability buffer will reduce risks for individual borrowers, growing portfolio concentrations of high debt-to-income loans also need to be monitored closely,” Mr Byres wrote.
“Should concentrations of this lending continue to rise, APRA would consider the need for further macroprudential measures.”
In the interim, APRA has now released an information paper outlining the key indicators they examine when determining lending policy.
“…APRA monitors a range of key indicators to determine whether risks to financial stability are heightened,” the report noted.
“This includes four main indicators that have been shown empirically to provide an indication of emerging systemic risks: credit growth and leverage; growth in asset prices; lending conditions; and financial resilience.”
APRA explained together these indicators helped inform their judgement on the economic outlook.
“For example, strong growth in asset prices alone could present limited risks to financial stability where lending standards remain prudent and the banking sector is strongly capitalised,” they said.
“In contrast, growth that is driven by weak lending standards or higher risk loans would likely be a strong indicator that risks to financial stability are rising.”
How APRA has applied lending criteria in the past
Highlighting how these key indicators had been applied in the past, APRA noted in 2015 and 2017, they introduced increased lending criteria to manage an upswing in the financial cycle.
“…the environment was characterised by high and rising housing prices and household indebtedness, subdued income growth and low interest rates,” APRA explained.
“APRA’s concern was that bank lending practices, in aggregate, were amplifying these risks, reflected in systemic weaknesses in serviceability assessments and strong growth in higher-risk lending.
“Throughout this period, APRA introduced measures which limited growth in banks’ lending to investors and the concentration of interest-only loans in new lending.
“While these temporary benchmarks were in place, APRA also strengthened the rigour of banks’ underlying serviceability assessment standards.”
In 2020, APRA then loosened restrictions to give banks and lenders additional flexibility during a financial downturn.
“… when economic conditions are deteriorating, there can be a tendency for banks and insurers to conserve capital by constraining credit or limiting the underwriting of new business to preserve capacity to absorb expected losses,” APRA explained.
“However, excessive risk aversion has the potential to worsen the impact of any initial stress by restricting activities critical for economic recovery.
“APRA announced temporary changes to expectations on bank capital benchmarks and bank and insurer capital distributions, in response to concerns over the impact of COVID-19 on economic activity.
“These changes provided additional flexibility for entities to use capital buffers to absorb losses, while continuing to lend and underwrite insurance to support the economy.”