There are two big problems with the home-lending standards by Australian banks, according to the Australian Prudential Regulation Authority (APRA).
APRA chief Wayne Byres is concerned banks are underestimating borrower’s living expenses and overall levels of indebtedness.
As borrowers typically struggle to accurately estimate their expenses, banks employ a benchmark Household Expenditure Measure (HEM) based on household income.
For example, at least 80% of loans issued for applicants earning between $40,000 and $200,000 are assessed using the HEM.
Given the extensive reliance on the benchmark, Byres questions its accuracy in determining loan applicability.
While speaking at the Australian Securitisation Forum in Sydney, he issued the following warning to banks: “We would like to see the industry devote more effort to the collection of realistic living expense estimates from borrowers and give greater thought to the appropriate use and construct of benchmarks in instances where those estimates are deemed insufficient,” Byres said.
The risks associated with loan applications were highlighted in August, when the UBS banking team released findings that indicated a material number of loan applications to the major banks contained factual inaccuracies.
Secondly, Byres said the use of loan-to-income (LTI) ratios remains prevalent among Australia lenders, but such a measure doesn’t take into account overall debt levels.
He said Australian lending standards in this area are lax by international standards. Many other countries enforcing the adoption of more detailed credit assessments, although Byres welcomed the Government’s decision to introduce stricter lending requirements.
From 2018, it will be mandatory for banks to use total debt to income (DTI) ratios in determining debt serviceability.
Byres said the regulator was keeping a close watch on existing loans with a high LTI ratio, and that almost 50% of mortgages have a loan-to-income ratio of at least four times:
“As a rule of thumb, an LTI of six times will require a borrower to commit 50 per cent of their net income to repayments if interest rates returned to their long term average of a little more than 7%,” Byres said.
“High LTI lending in Australia is well north of what has been permitted in other jurisdictions grappling with high house prices and low interest rates, such as the UK and Ireland.”
Byres also discussed APRA’s stance concerning the small number of lenders (less than 10%) who aren’t supervised by the regulator.
While APRA has the authority to intervene in the so-called shadow-banking sector, Byres said the regulator was wary about over-extending its regulatory reach.
“For those of you uncomfortable at the thought of APRA supervising non-authorised deposit-taking institutions (ADIs), let me assure you the feeling is mutual,” he said.
“We are not seeking to expand our supervisory remit and, beyond collecting information that allows us to track aggregate trends in lending activity, we will not be undertaking any supervision of individual lenders.”
Byres said measures introduced by APRA in April, which restricted interest-only lending to 30% of all new loans, have had a clear impact on the market.
“Having run at between 40-50% of new lending for some time, interest-only lending accounted for about 23% of total new lending for the quarter ended September,” Byres said.
He added that out-of-cycle rate increases by the major lenders on interest-only loans has seen borrowers switch into principal and interest repayments.
The switch in borrower behaviour has seen a $36 billion reduction in interest-only loans by APRA-regulated banks, which amounts to around 7% of all loans outstanding.