Murray says act now on mortgage risk weights

Financial System Inquiry chairman David Murray has added his voice to the call for the government and the Australian Prudential Regulation Authority to act quickly to level up the playing field in the banking industry by narrowing the difference between the mortgage risk weights used for capital purposes by different classes of financial institutions.

Since the release of the Financial System Inquiry report last December there have been calls for the FSI's recommendation on mortgage risk weights to be implemented as a matter of priority. The issue was a hot topic again at yesterday's Financial Review Banking and Wealth Summit.

It was the Inquiry's main recommendation aimed at improving competition in the banking industry and a number of commentators have called on the Government to act without reference to Basel Committee developments.

In March the shadow treasurer Chris Bowen said the government should act on that recommendation soon and not wait to see how Basel deliberations might have an impact.

The FSI recommended that the prudential regulator narrow the difference between the mortgage risk weights used for capital purposes by lenders using the internal ratings-based methodology (the big banks) and lenders using standardised risk weights.

The objective is to improve the competitive neutrality of capital regulation by limiting distortions caused by the differential regulatory treatment of different classes of ADI.

Since IRB was introduced in 2008, the divergence in mortgage risk weights between the IRB and standardised approaches has widened. The average mortgage risk weight for an ADI using the standardised model is currently 39 per cent - more than twice the size of the average mortgage risk weight for banks using IRB models, which is 18 per cent.

Speaking on a panel at yesterday's conference, Westpac deputy chief executive Phil Coffey said: "It is appropriate to look at mortgage risk weights. If it is not justified on the basis of risk it should be looked at."

The FSI suggested that IRB risk weights could be raised to 25 per cent or 30 per cent to even things up.

Coffey rejected this idea. "If you are lending on a secured asset you have more than equity capital to fall back on. You have the asset," he said.

"If the loan-to-valuation ratio on an old loan is ten per cent you have a very secure asset. I don't think we should be forced to have a 25 per cent risk weight."

The issue is complicated by the fact that the Basel Committee has started revising the standardised approach for credit risk used to calculate regulatory capital.

In a discussion paper issued in December the Committee said bank exposures would no longer be risk-weighted by reference to the external credit rating of the bank.

Under consideration is a system where exposures secured by residential real estate would no longer receive a 35 per cent risk weight. Instead, risk weights would be determined according to a look-up table where risk weights range from 25 per cent to 100 per cent on the basis of two risk drivers: loan-to-value and debt-service coverage ratios.

Also speaking on the panel, Murray said it was up to the Australian Prudential Regulation Authority to advise the Government on whether this matter could be attended to before any Basel Committee decision.

Murray said: "When we looked at competition this one stuck out. What you can't do is allow a clear regulatory impediment to competition.

"I would be more inclined to move on it," Murray said.

Suncorp chief executive John Nesbitt said APRA should act on the issue.

Coffey disagreed, saying the Basel Committee was "talking about some fundamental changes that will affect all of us.

"If you want to avoid doing things twice don't run ahead of the global changes. We should not act in isolation.

"Benchmarks are changing. You don't know what the standardised risk weights will be."