APRA on the 21st July 2021 provided an update to industry based on the proposed bank capital reforms off the back of the consultation paper released in December 2020 and subsequent responses received from industry and other stakeholders made to APRA in April 2021.
APRA have invited ADIs and interested stakeholders to provide further feedback on these policy settings by 20th August 2021 along with conducting a further quantitative impact study (QIS) on a best-effort basis, with responses also due on the 20th August 2021. APRA have emphasised that the full suite of policy settings is not yet final, and there may be further revisions to these and other issues with the aim of releasing the final prudential standards in November 2021.
Here's a brief summary of key changes announced by APRA in the latest update.
Unquestionable Strong Benchmarks and Enhanced Competition
APRA have reinforced their views of improving the flexibility of the framework and maintain unquestionably strong capital benchmarks. Along with enhancing competition through requiring higher capital buffer requirements for larger banks and ensuring a floor on Internal Ratings Based (IRB) risk weights that limit benefits compared to smaller banks on the standardised approach.
Capital Buffers are likely to remain unchanged
APRA intends to maintain the buffers as outlined below and as explained in the consultation paper in December 2020.
The base level for the countercyclical capital buffer (CCyB) of 1.0 per cent of RWA for all ADIs remains.
The capital conservation buffer (CCB) of 4.0 per cent in total of RWA for IRB ADIs. The CCB for ADIs on the standardised approach remains at 2.5%. The Domestic Significant Banks (D-SIB) that applies to ANZ, CBA, NAB and WBC remains.
Residential Mortgages : What has changed?
Interest Only
The main change introduced by APRA was the narrowing of the definition of non-standard loans for higher risk residential mortgages. The criteria applied to Interest- only loans has the following criteria applied.
interest only period of greater than five year is based on contractual length, and
excludes loans with a loan to value ratio of less than or equal to 80% (i.e. LVR ≤ 80%)
This replaces the requirement to aggregate the interest only five year period (which included prior periods).
The other key change is there is now no requirement to track the interest only period of six months on conversion from interest only to principal and interest repayments. Although APRA indicated during this period that loans are subject to higher risk; this will simplify the implementation of the new APS 112.
The remainder of the rules around lower risk residential mortgages risk weights and Lenders Mortgage Insurance (LMI) 20 per cent benefit and credit conversion factors (CCF) for undrawn exposures remain the same. Along with the specific IRB requirements for RWA multipliers and the mortgage risk-weight floor for the IRB approach being set at 5 per cent limiting the difference in capital between the standardised and IRB approaches.
Mixed property collateral
A loan secured by both residential and commercial property and the predominant security is residential property. APRA will allow ADIs to,
use commercial property in the LVR calculation for mixed collateral exposures
subject to a 40 per cent haircut on the value of the collateral
This approach recognises the commercial property and the haircut reflecting the higher risk of commercial property as collateral whilst alleviating concerns of excluding commercial property for business lending. The LVR including the haircut on the commercial property will be used to determine the risk weight for exposures.
Other APS 112 changes proposed?
SME Definition
Allow ADIs to include corporate exposure as SME where its consolidated annual revenue of $75m cannot be determined but exposure size is less than $5 million.
Revise the SME revenue threshold to “less than $75 million” across both IRB and Standardised Approaches going forward.
Margin Lending
If an ADI does not adjust the credit limit before a drawdown in response to a decline in security value, then the ADI must use the original amount in the loan contract that is independent of the security value.
Subordinated Debt
Definition of subordinated debt broadened to include economic subordination. Economic subordination could potentially arise when lending to a holding company with revenue generating operating subsidiaries, or when the ADIs facility is ranked behind other creditors.
Off-Balance Sheet Exposures
Conditions precedent: APRA considers that exposures with conditions precedent be treated as commitments, given these may involve circumstances outside the control of the lender and result in a credit exposure arising at any point in time.
Master agreements: APRA considers an arrangement that does not advise of a lending limit, and only stipulates the terms and conditions of future trades and limit establishment, does not generally constitute a commitment.
Mortgage CCFs: APRA confirmed that loan approved not advanced (LANA) therefore certain of drawdown the CCF of 100 per cent would apply; while for mortgages loans that allow redraws and has been paid down by the borrower ahead of schedule, or an equity line of credit the CCF of 40% would apply for the off balance sheet portion.
Conclusion
With the implementation due date just over 18 months away - ADI's must be well-progressed in their project planning and design phase.
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