Basel IV – property lending implications beyond regulatory numbers.

Updated: Feb 24


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