• 24/07/2024

DTI limits and buffers in APRA’s arsenal to manage credit risk

Annie Kane| Mortgage Business| 11 November 2021


Debt-to-income ratio limits and serviceability buffer changes are to be embedded into APRA’s standard for credit risk management.

The Australian Prudential Regulation Authority (APRA) has written to banks asking for feedback on proposed its proposal to ‘formalise and embed’ credit-based macroprudential policy measures within its prudential standard for credit risk.

The proposals include a set of credit-based macroprudential measures that could be used to address systemic risks, should they be needed. It would also require authorised deposit-taking institutions (ADIs) to “preposition in advance to address potential barriers to implementation, supporting a timely response to any emerging risks”.

The changes focus on “risks” in residential mortgage lending and commercial property lending, which account for more than 70 per cent of total credit extended in Australia, according to the regulator. 

The proposed credit-based macroprudential measures include:

  • Lending limits “applied at portfolio level”, that could be used to “moderate any excessive growth in higher-risk lending during periods of heightened systemic risks”
  • Minimum requirements for lending standards “applied at the individual loan level”, that include measures such as the serviceability buffer for residential mortgages

APRA will formalise and embed these credit-based macroprudential policy measures via an attachment to its Prudential Standard APS 220 Credit Risk Management (APS 220). 

It will require banks to

  • Ensure they have the ability to limit growth in particular forms of lending 
  • Moderate higher risk lending during periods of heightened systemic risk or meet particular lending standards, at levels determined by APRA
  • Ensure there would be adequate reporting in place to monitor against limits

Lending limit details

For residential mortgage lending, APRA said that banks should ensure that they have the ability to limit the extent of lending in the following loan types:

  1. Lending with a debt-to-income ratio greater than or equal to four times or six times
  2. Lending with a loan-to-valuation ratio greater than or equal to 80 per cent or 90 per cent
  3. Lending for the purposes of investment
  4. Lending on an interest-only basis
  5. Lending with a combination of any two of the types specified in (a) to (d)

Banks must also apply a buffer over a loan’s interest rate to assess the serviceability of a borrower of at least 3.0 per cent (as previously announced), but the regulator said it “may vary the minimum level of the buffer between 2.0 and 5.0 per cent”.

For commercial property lending, banks must ensure that it has the ability to limit the extent of lending in the following loan types:

  1. Lending for land acquisition, development and construction
  2. Lending for the purposes of investment

“APRA will notify ADIs of any decision to set a limit, including the limit level and the date from which it would apply, for the loan types specified in this attachment or other loan types as determined by APRA,” the regulator told ADIs in a letter on Thursday (11 November). 

It said that banks must also report to the board the level of lending against any limits specified by APRA on at least a monthly basis, for the period in which the limits apply.

APRA may also require ADIs to publicly disclose the level of lending against any limits specified by APRA, for the period in which the limits apply. 

As well as lending limits, APRA is also consulting on “a small change to the reporting definition of borrower income” for the purposes of calculating debt-to-income and loan-to-income ratios (as under Reporting Standard ARS 223 Residential Mortgage Lending) to “ensure alignment with the new attachment”.

It is proposing amending the definition of a borrower’s gross income to “borrower’s annual before tax income verified by an ADI, excluding any compulsory superannuation contributions and before any discounts or haircuts under the ADI’s serviceability assessment policy”.

‘Changing the way measures may be applied’

APRA chair Wayne Byres highlighted that while the proposed changes “do not change the potential macroprudential tools APRA may use, or provide APRA with additional powers”, they instead “change the way in which certain measures may be applied”.

He explained: “At present, APRA’s ability to implement macroprudential measures is somewhat indirect, with credit measures typically enforced through the potential imposition of higher capital requirements where needed. By defining certain credit measures within APS 220, APRA’s objective is to strengthen the transparency, implementation and enforceability of macroprudential policy.”

APRA said it may also broaden the focus of macroprudential measures contained in APS 220 if, over time, other portfolios “potentially grow in systemic importance”, or other risks emerge – and may also review, add or revise the loan types specified on a regular basis “to ensure that the range of measures remains up to date and appropriate to the risk environment”. 

However, any decisions by APRA to implement temporary limits for particular forms of lending or to set minimum requirements for lending standards would be publicly communicated and banks would be notified of any limits for the specified loan types ahead of the date from which they would apply, it said. 

While the standard changes mainly impact banks, APRA suggested that non-banks should also review the changes as “it is APRA’s expectation that any rules, if introduced for non-ADI lenders, would likely mirror those set out for ADIs” in the draft attachment to APS 220.  

“Should APRA determine that non-ADI lenders are materially contributing to risks of instability in the Australian financial system, the draft attachment to APS 220 sets out the main types of credit-based macroprudential measures that APRA would likely apply,” Mr Byres explained.

“As part of this consultation process, non-ADI lenders should consider the macroprudential measures set out in the draft attachment to APS 220. Any future rules introduced by APRA for non-ADI lenders would be legally binding and made under delegated legislation.”   

Next steps 

APRA is now calling for “specific feedback” on any implementation issues that could arise from using the definitions of higher-risk loans, as set out.

Written submissions on the proposals should be sent to [email protected] by 28 February 2022. 

From 1 January 2022, ADIs will be required to meet the previously finalised requirements of APS 220 Credit Risk Management.

The regulator expects to finalise its response to the consultation on the new attachment “in the first half of 2022”, with these new requirements coming into effect shortly thereafter. 

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