The Australian Prudential Regulation Authority yesterday provoked some disquiet among consumer advocates after it announced the retention of its existing macro-prudential policy settings.
In the last decade APRA has been using so-called macro-prudential measures in the residential mortgage market to enhance stability of the financial system.
Included in the current macroprudential settings is a requirement for borrowers to show they are able to continue servicing a mortgage debt if the interest rate was to increase by 3 per cent on the loan product rate.
APRA has decided to retain the serviceability buffer at 3 per cent on the grounds that borrowing costs are likely to increase further this year.
“There remain heightened risks to serviceability, including the potential for further increases in interest rates, continued high inflation and risks in the labour market,” APRA said on Monday.
“It is important that banks’ lending remains prudent at this point in the cycle.”
The regulator also tried to qualify its decision by pledging to monitor developments in the mortgage market to ensure that the setting for the serviceability buffer did not become “excessively conservative”.
However, APRA did not address a perverse consequence of its serviceability buffer.
The measure, in its current form, applies not only to new home borrowers but also to existing home owners looking to refinance loans.
Research published on Monday by comparison financial service Canstar shows that many existing borrowers will be prevented from refinancing to lower interest rates because of the serviceability buffer.
According to Canstar, the decision by APRA not to lower the buffer to 2.5 per cent will act as a “roadblock” on borrowers trying to escape mortgage prison and refinance to lower rates.
A real world effect of APRA’s buffer requirement is that many borrowers on average weekly earnings could lose eligibility to refinance a mortgage currently charging 5.92 per cent to one priced at 4.69 per cent.
Once APRA’s 3 per cent serviceability buffer is added to the cheaper loan rate, the prospective lender could be compelled to reject the refinancing application even though approval would likely improve the financial circumstances of the borrower trying to switch.
Canstar explains this Orwellian-like scenario in the following way:
“If the lender determines they are not able to service a loan at 7.69 per cent, this implies that the borrower can’t afford repayments for a rate of 4.69 per cent even though they are currently repaying their loan at a rate that is 1.23 per cent higher. The benefits of refinancing aren’t considered in the assessment.”
According to Canstar, the monthly cost to borrowers of not being able to refinance a A$500,000 loan in such a scenario is $382 a month.
Despite this weakness in the policy setting, APRA chair John Lonsdale said the buffer was appropriate.
“APRA closely monitors financial risks, and we see a high degree of uncertainty in the broader outlook, globally and domestically,” he said.
“On the one hand, there are signs of a deterioration in conditions, including falling asset prices and the potential for pockets of stress.
“On the other hand, lending standards are broadly sound, loan arrears remain low and the banking system is well capitalised.
“On that basis, we believe our current macroprudential policy settings remain appropriate.
“In particular APRA’s view is that the 3 per cent level remains prudent given the potential for further interest rate rises, high inflation and risks in the labour market.”
The regulator is likely to come under pressure to explain how the buffer requirement as it applies to refinancing borrowers optimises its financial stability objective.