While the 25-page ‘information paper’ was a response to the Productivity Commission’s call last year for APRA to be more transparent about its decision-making, the regulator used it to rebuff the PC’s harsh critique, which described APRA’s policies as a ‘”blunt intervention with detrimental effects on market competition”.
The prudential regulator rejected any suggestion it had not been properly explaining its actions, arguing it specifically considered the impacts of its actions on competition – but considered competition was destablising the banking system and it wanted to “reduce banks’ ability to compete for customers through easier credit standards”.
APRA said that but for its action, the system would have been exposed to even larger risks down the track, as risky lending to property investors – many of which were using interest-only loans to inflate a property bubble – would have continued.
“The share of potentially speculative lending for property investment has been significantly reduced, as has the proportion ofinterest-only mortgages, which could otherwise have led to a further build-up of systemic risk,” APRA said.
“Had APRA not taken these actions, it is likely that higher risk forms of mortgage lending would have continued to outpace more traditional mortgage borrowing as well as household income growth.
“This concentration would have left the banking sector increasingly vulnerable to future adverse developments, and would have allowed imbalances in the housing market to escalate.”
With banking analysts skittish ahead of the release of the final report of the Hayne royal commission next Monday afternoon, APRA sought to assuage concerns that its actions had restricted credit, saying “the overall rate of credit growth for housing remained broadly stable” indicating its measures “have not had an undue impact on credit availability”.
It and the Reserve Bank – whose interest rate cuts helped inflate the housing bubble APRA was forced to respond to – closely monitored the impact of the investor benchmark on total credit growth, and the aggregate trend had remained broadly unchanged, APRA said. Total housing credit grew at between 6 to 7 per cent both before and after introduction of the investor benchmark and remained at this level until relatively recently.
APRA’s paper also pre-empted the royal commission final report’s expected questioning of whether banks are conducting sufficient assessments of borrowers, to satisfy their duties under credit laws. Banks are “now obtaining and analysing more comprehensive data on their borrowers to reduce the risk that they cannot repay their loans, and have improved controls to more consistently meet prudential and responsible lending obligations,” APRA said.
These tighter mortgage assessments provided comfort to keep the ‘countercyclical capital buffer’ at zero, but APRA flagged the prospect of higher capital requirements for the major banks, saying in a separate paper on Tuesday it is “considering setting the [countercyclical capital] buffer at a non-zero default rate as part of its ongoing review of the ADI capital framework”.
The ‘countercyclical capital buffer’ allows APRA to force banks to hold additional capital at riskier times in the economic cycle, to provide a bigger buffer to strengthen the resilience of the sector.
With both the ACCC and Productivity Commission suggesting in their reports last year that APRA’s interventions delivered a profit windfall to the major banks – who lifted interest rates to get under the caps – APRA said this had not been part of their planning when the measures were first discussed with the banks, and the pricing action came about because the banks had “difficulty implementing processes that would allow them to maintain a particular rate of lending”.
It also suggested the ACCC’s analysis on pricing was simplistic, saying its criticism of the banks for lifting rates on interest-only loans on their entire book, when the caps only applied to new loans, failed to appreciate “the other factors at play, such as the potential for higher capital requirements for these types of lending, which would apply to the entire portfolio.”
APRA also defended itself against the Productivity Commission, noting smaller banks had “increased their market share slightly” during the four years the caps were in place, and APRA’s had approach “provided more flexibility for smaller [banks]”.
In ascathing assessment, the PC in its report last year into competition in the financial systemcalled on APRA to “use targeted interventions to the risks it identifies…rather than imposing blanket rules across all institutions and geographic regions”.
But APRA said on Tuesday this would have been shortsighted. “APRA’s view was that sound lending standards were appropriate across all regions. Regionally based constraints would also have been extremely difficult to calibrate.”
It did consider various “trade-offs”, including industry competitive dynamics and the repricing of higher-risk mortgages, and said it was aware the caps tended to preclude significant shifts in market share. However, “given concerns about potential impacts on competition, APRA took a more flexible approach in implementing the investor benchmark with the smaller [banks], particularly with respect to timing.”
In light of the impacts on competition, APRA considered applying the benchmarks only to the largest banks, but said “it is likely that this would have resulted in higher risk lending simply spilling over to the smaller [banks], leading to a concentration of risk in smaller entities less equipped to manage it.”
APRA also rejected the PC’s assertion that it’s approach lacked transparency. “In light of the somewhat innovative nature of the interventions, APRA officials provided regular ongoing public commentary about the rationale for and impact of its actions in the mortgage lending sector, including through speeches, publications and regular appearances before parliament.”
Yet the publication of the information paper itself reflects a desire within APRA to improve the way it communicates about its policies and decisions.
With both sides of politics set to consider responses to the royal commission’s final report next week and withTreasurer John Frydenberg flagging a measured approach to the report to minimise adverse impacts on the economy, APRA chairman Wayne Byres said he hoped his focus on improving lending standards would have a permanent impact on the market.
“Importantly, while the temporary lending benchmarks are being removed, the changes we have made to lift lending standards are designed to be permanent, continuing to support the resilience of the banking system and ultimately the protection of bank deposits,” Mr Byres said in a statement.
In conjunction with the Council of Financial Regulators, APRA said it will continue to closely monitor economic conditions, and adjust the countercyclical capital buffer “if future circumstances warrant it.”
“Many of the underlying structural risks associated with high household debt remain and will do so for some time.”