Banks are trying to blame APRA for your higher home loan rate, but here's why they're wrong

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Today the NAB has joined the Commonwealth Bank and Westpac in raising the rate they charge borrowers for their home loan.

The NAB’s rise of 17 basis points draws a line between between Westpac’s 0.2% rise and the Commonwealth’s increase of 0.15% announced yesterday.

In its press release this morning the NAB, like Westpac and the CBA before it, referenced the recent moves by Australia’s banking regulator, APRA, to increase the level of capital the banks need to hold against their home loans.

“Regulatory changes on capital requirements also increase the cost associated with providing home loans,” the bank said.

The NAB also said “today’s decision has not been easy, but we believe this is (the) right decision for the long term. We know we have to balance the interests of our customers with the needs of more than 550,000 shareholders.

Now, of course the banks blame APRA, for increasing the capital they have to hold against their home loan mortgage books.

But what is not well appreciated for those outside the banks or the arcane world of bank capital management, risk-weighted assets and the internal ratings-based approach to calculating the capital banks need to hold, is that for years banks ran down their capital while running up their mortgage home loan books.

That in effect made them bigger and more profitable but also more leveraged and, by definition, more risky.

Graham Andersen, chairman of Morgij Analytics – a company which provides sophisticated credit risk technology, software solutions and services to mortgage markets, told Business Insider how this worked. He said it was possible because changes to the way banks calculated capital under global banking rules, which came into effect in Australia on January 1 2008, allowed the banks to set their own capital levels.

“Basel 2 allows banks to apply to their regulator to use Internal Risk Based models in determining capital,” Andersen told Business Insider.

The major banks IRB models, which are tuned by historical defaults and losses, enabled them to considerably reduce the risk weightings on residential mortgages from the standard weighting that all other banks or ADIs must comply with. This resulted in both a significant cost and risk advantage being enjoyed by the major banks in residential mortgage markets.

In simple terms, that means in recent years the banks, using their own internal based models of history to determine how risky they thought their loans are, were able to increase the amount of home loans they held for every dollar of capital.

That made home loans insanely profitable on a return on equity basis, a fact which has driven Australia’s four majors to the top of the pile in terms of RoE basis, as the RBA pointed out in its recent Financial Stability review.

But the other side of the reward coin is risk. And the increased leverage the banks took on by reducing capital levels relative to the size of the home loan books is something that APRA has taken a fresh look at.

That’s because its own analysis found risks inherent in the Australian housing market, international comparisons, and recommendations by the Murray inquiry that Australia’s banks’ capital positions be strengthened to put them in the top 25% of all global banks.

It’s certainly true that the banks’ need to raise capital comes with added costs. APRA chairman Wayne Byers told a parliamentary committee today that costs equate to between 10 and 15 points.

But, he added, “we are in an environment of heightened risk” and that APRA was “watching the lending standards of banks” which both the RBA and ASIC have told us in the last week has slipped so far that in some cases, some banks may have breached their responsible lending obligations.

So when the banks tell us they are raising rates because APRA is making them hold more capital, what they aren’t saying is that APRA is doing this because the banks made an active decision to ramp up the risk on their balance sheet and the regulator is saying enough is enough.

That’s fair given that, as Murray’s financial system inquiry put it, these big banks enjoy “an implicit guarantee” from the government and people of Australia.

What’s not fair is that with that government guarantee they feel they have a right to earn world leading returns on equity.

The decision to force more capital by APRA is one to protect the interests of the Australian people and its economy. But as the international comparison of RoE shows, the decision to increase home loan rates is a purely commercial decision.

It’s not about regulatory capital, it’s about shareholders.

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