Background
The Australian Prudential Regulation Authority (APRA) released its revised APS 112 Capital Adequacy: Standardised Approach to Credit along with a discussion paper and response to submissions on a more flexible and resilient capital framework for ADIs on 8th December 2020.
APRA have outlined that their focus is to improve risk sensitivity, transparency, and comparability along with enhancing competition.
At the centre of the revised APS 112 is the significant change to Property Exposures in comparison to current standards. We can see increased segmentation between Residential Property; Commercial Property and Land Acquisition, Development and Construction (ADC) along with additional criteria on what is being captured for a “standard” and “non-standard” loan. This is combined with risk sensitivities applying to more granular risk criteria and specific products.
RegCentric has recently hosted industry roundtables and webinars. A recording of Basel IV - a practical approach to APRA's QIS and Basel Readiness is available for viewing on demand here.
The implications of the proposed changes in APS 112 for property exposures are far reaching not only in terms of the capital impacts but also the end-to-end business and operational models that result from the revised regulatory standard.
APS 112 Standardised Approach to Credit Risk: Property Exposures
Basel IV – Property not just a regulatory change Standard vs Non-Standard
The criteria for a Standard Loan have expanded and will become stricter under the revised APS 112. For exposures to be classified as a Standard Loan will require all the criteria for enforceability, serviceability and valuation to be evidenced with accurate documentation and be readily accessible.
The above criteria will come into effect post 1st January 2023, while loans originated prior to this date - provided there is no material change to loan terms and conditions - do not need to satisfy the criteria of serviceability to be classified as Standard Loans.
The criteria of Standard vs Non-Standard is considered across the three main segmentation types.
Property Exposure Segmentation and Risk
Under the property segments of Residential; Commercial and ADC, APRA has broken down into sub-segments to align the risk weights according to the sub-segments relative risk. The following table summarises the categories into lower vs higher risk:
APRA are rewarding ADIs by providing lower risk weights in residential mortgages where there are principal and interest payments; lower LVR’s; LMI and the loan purpose is deemed less risky for example owner occupied vs investment. In Commercial Property where there is no reliance on the property cash flows and counterparties (rated) are a higher quality there are also risk weight benefits whilst for ADC strong policies and adherence to managing qualifying development costs and qualifying pre-sales as a percentage of total debt will also result in lower a risk weight.
What Strategy will ADIs adopt as a consequence of new APS 112
ADI's - by understanding the impact of the property exposure reforms - can take the opportunity to build better processes, products and policies along with improving the allocation of capital. In doing so, there will be transformation that is achieved from the front office to the back office of the Bank. The changes proposed by APRA should not be viewed as just a change in regulatory reporting and the risk weights that are applied to standardised asset classes. A complete review across all functions of how an ADI will manage property exposures and risk vs reward is warranted.
1) Impact on Operations & Frontline
Operations and Frontline will require new processes and policies to ensure a favourable capital outcome. Ensure that asset classes are booked correctly for example Owner Occupied vs Investment and tracking interest only periods on loans. Banks also need to define appropriate property valuation policies at origination that will improve LVR calculations.
2) Impact on Property Loan Portfolio
Property is a key element of most ADIs balance sheets. ADIs need to continually evaluate LVR movements over the lifetime of the loans assessing the trade-off between growth rate of the loan portfolio and taking on more risk. Understanding the impact of the new APS 112 on the loan portfolio for example the impact of undrawn commitments included in LVR calculations.
3) Impact on Products and Pricing
APRA - by introducing a more granular risk sensitive approach for RW - will impact product pricing, policing and development. There is an opportunity to review pricing of home loans based on LVR ranges and the types of products based on their perceived risk to be aligned with the new risk weights and assess return on capital. Some market participants are already pricing on LVR risk.
4) Impact on Data, Technology and Models
APRAs introduction of new property asset classes and rules associated with managing these will require new data elements. Data capture, system processing, modelling and reporting are key to doing detailed analysis and enabling better business insights. ADIs should consider alignment with models used for other purposes like AASB9 and stress testing.
The above is not an exhaustive list of areas to be considered in addressing the new Property Exposures rules under APS 112. Other considerations may include the capture of whether loans that did not meet the serviceability criteria have been performing for at least 36 months before being moved from Non-Standard to Standard or an interest only loan performing on an amortised basis for 6 months post moving off interest only.
It is important for ADIs to start collecting new data points and perform analysis now as to do a proper assessment and gain an appropriate understanding of the impacts of APS 112 on property exposures. Proper planning now will allow for better opportunities to lead the market in competition on price and the management of the end to end processes associated with managing property exposures.
How we can help
The Basel reform can act as a catalyst for a strategic review of your capital, credit risk and data governance, processes, technology and people capabilities. When implemented correctly, your Basel IV project will deliver efficient, cost-effective and sustainable compliance with APRA prudential and reporting standards; together with improved portfolio and customer analytics, optimised capital allocation for improved business performance and stakeholder value. RegCentric can assist you in turning your regulatory challenges into strategic opportunities.
With our team of APRA and technology experts, RegCentric offers cost-effective, flexible and scalable services and solutions to address your unique needs. We can supplement your existing teams and capabilities or we can take the lead on part of your end-to-end Basel program.
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