APRA's Proposed Revision to RWA Computation Approach for Residential Property Exposures

APRA is in the process of finalising the Standardised Approach to Credit Risk standard under the finalised Basel III framework (often also referred to as "Basel IV"). APRA finalised its QIS in early April 2021 and will release the final standards in the second half of 2021, with the new standard coming into force on 1 January 2023.

In this post, we focus on the proposed revisions to Risk Weighting the Residential Property Exposures. We cover the key changes that will impact the bank’s policy-driven decision making and the additional data requirements to enable Risk Weighted Asset computations for the asset class.

To derive the prescribed risk-weights for residential property, similar to the existing standard, the residential property exposures are further segregated into Standard and Non-Standard loans. The majority of the conventional residential property mortgage loans fall under the Standard loan category with some exception being loans to SMSF, loans with interest only repayment period of over 5 years and some reverse mortgages/shared equity type loans. Any residential property loan that does not qualify for Standard Loan, must be assigned into Non-Standard Category.

Standard & Non-Standard Loans

The differentiators to segregate between Standard & Non-Standard loans have been expanded in the proposed revision to APS 112. The basic criteria for a standard loan still exists as the foundation i.e., before tagging a loan as Standard: At the time of loan origination, the bank should have conducted thorough assessment on repayment ability of the borrower as well as the marketability and fair value of the property being accepted as security.

However, APRA has also introduced additional conditions at a more granular level for the banks to classify their property exposures into the Standard & Non-Standard Category.

In this edition, we are primarily going to cover two major differentiation factors:

A. Loans Secured Against a Second Mortgage

B. Assessment of Borrowers’ Repayment Ability

A. Loans Secured Against a Second Mortgage

If a bank is exposed to a property as a second mortgagee then before classifying the loan into eligible standard loan category which attracts lesser quantum of risk weighting, the bank must ensure that:

- The ADI has written consent from the first mortgagee bank (before approving the loan) and has also received current outstanding balance for the first mortgage as the same needs to be added into total exposure amount for deriving LVR.

- The second mortgagee must also ensure that its rights are protected at all times; especially in the event of liquidation where sale of the property should not induce undue losses to the second mortgagee.

- Also, the second mortgagee bank should be able to sell off the property in the event of default without any interventions.

- Lastly, any additional loans disbursement against the property should be junior to second mortgagee bank’s claim.

B. Assessment of Borrowers’ Repayment Ability

APRA is also keen on ensuring the borrowers’ repayment ability has been subjected to various factors, stressed to adequate levels, to ensure that the borrower is able to repay the loan during high interest rate environments and through the periods when interest-only repayment arrangement comes to an end, and the loan enters into amortisation phase.

It is noteworthy that some of these criteria have already been incorporated in most of the banks’ credit decisioning policies yet, the rules have now been explicitly added into the standard, thus becoming part of the legislation.

Considering the stricter entry rule for standard loans category based on borrowers’ repayment ability; APRA has also proposed to exempt the loans originated prior to Jan 2023 from the assessment criteria provided the loans haven’t undergone material changes with regards to its terms & conditions ("grandfathering arrangement").