Australian banks should 'prepare accordingly' for stricter accounting standards on risky home loans

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  • Australian banks need to prepare for changes in accounting standard AASB 9 – Financial Instruments, analysts say.
  • After the changes, banks will have to use modelling to calculate provisions for bad loans, rather than using losses already incurred.
  • If banks aren’t prepared for the changes it could lead to unexpected write-downs if house prices continue to fall.

In the context of the Australia’s property market, analysts are increasingly turning their attention to the prospect of a Labor victory at the next Federal election.

Specifically, the likelihood that Labor will enact its policy platform to remove tax breaks for property investors.

Changes to negative gearing and capital gains tax could lead to further price falls of 9% in the major east coast housing markets, according to RiskWise Property.

The prospect of additional declines doesn’t bode well for Australian banks, which are already facing a challenging transition as Australia’s 25-year mortgage bull market comes to an end.

Further complicating matters, the big banks will need to be “thoroughly prepared” to ensure compliance with changes to the Australian accounting standard for Financial Instruments (AASB 9).

The key change relates to how banks make provisions for credit losses on their financial statements.

Previously, the banks were able to base their provision estimates on losses which had already been incurred.

But the new standard will enforce an Expected Credit Loss (ECL) model, which requires banks to make a judgement on whether loans which haven’t yet fallen into arrears are still risky.

If Labor’s tax changes do exacerbate price falls, then Australian banks “will need to consider such forward-looking information in their models”, said Pete Wargent, CEO of property advisory firm Allen Wargent.

The next federal election must be held by no later than May, and “banks need to prepare accordingly”.

“In addition to the obvious impact on each of the loan portfolios, banks will need to accurately assess the risks associated with future lending decisions,” he said.

If banks deem that more loans are at risk of default or falling into arrears under the new standard, the recognition of those changes on the financial statements could further erode profit margins.

But ECL modelling will also need to be carried out with careful adjustments for specific regions and property types, said RiskWise CEO Doron Peleg.

For example, RiskWise said Labor’s tax changes could exacerbate house-price falls in Victoria to fall by 9%, while units will only fall by 6%. In Queensland, it’s 6% for houses and 7% for units.

Banks will also need to factor in other details, such as relative population growth across all 86 SA-4s — the statistical regions categorised by the ABS which cover the whole of Australia.

“All these changes require lenders to manage this process in a thorough and timely manner to assess the impact on each of the SA4s regions,” said Peleg.

Peleg said any new ECL models will then need to be signed off by auditors.

A failure by the big banks to ensure compliance with the new accounting standards could give rise to unexpected write-downs if property prices continue to slide.

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