Following consultation with industry over planned changes to ADI capital rules, the Australian Prudential Regulation Authority has decided to stick with its approach to capital buffers, but it has given some ground on capital requirements for higher risk mortgage lending.
APRA released a consultation paper in December last year and took submissions up to April. Yesterday it released a letter to ADIs updating them on its planned policy settings for the changes, which take effect in 2023.
The purpose of the changes is to embed an “unquestionably strong” level of capital and enhance competition in the industry.
APRA said it will maintain the approach to capital buffers above minimum capital requirements set out in the consultation paper, including a base level of 1 per cent of risk-weighted assets for the counter-cyclical buffer.
The capital conservation buffer will increase from 2.5 to 4 per cent of RWA for internal ratings-based ADIs and remain at 2.5 per cent for ADIs using the standardised approach to credit risk.
APRA rejected arguments from some IRB ADIs that the base level of the countercyclical buffer be set higher and the capital conservation buffer be lowered.
APRA will modify the proposed capital requirements for higher risk residential mortgage lending. Its December 2020 proposal was that residential mortgages with an interest-only period of more than five years would be categorised as “non-standard”, with a risk weight of 100 per cent.
In response to feedback, APRA said it would narrow the scope of the non-standard definition so that: the interest-only period would be based on contractual length rather than an aggregation that includes prior periods; and exposures with a loan-to-value ratio of less than or equal to 80 per cent would be excluded.
APRA said it would maintain the following proposals from the December 2020 consultation: lower risk residential mortgages will be defined as lending to owner occupiers on a principal and interest basis, with all other residential mortgages categorised at higher risk; lenders mortgage insurance will be recognised as a 20 per cent benefit, reducing capital requirements; and the mortgage risk weight floor for the IRB approach to be set at 5 per cent, limiting the difference in capital between the standardised and IRB approaches.
It said the higher capital buffer requirements for larger banks using the IRB approach and the new 5 per cent floor would enhance competition by narrowing the gap in capital requirements between the IRB and standardised approaches.
It rejected an argument in some submissions that capital requirements for lower risk mortgages should be reduced on the standardised approach to further enhance competition.
APRA said it is likely to retain eligibility for classification as “SME retail lending” at a maximum of A$1.5 million.
And it has softened its stance on recognition of commercial property collateral as security in cases where the predominant security is residential property. It intends to allow ADIs to use commercial property in the LVR calculation for mixed collateral exposures, subject to a 40 per cent haircut.