APRA lifts bar on home lending risks

The Australian Prudential Regulation Authority (APRA) has increased the minimum interest rate buffer for banks to use when assessing the serviceability of home loan applications.

In a letter to authorised deposit-taking institutions (ADIs), APRA told lenders they expect them to assess new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3.0 percentage points above the loan product rate. A buffer of 2.5 percentage points is commonly used by ADIs today.

APRA’s decision comes after growth in financial stability risks from ADIs’ residential mortgage lending, and it is supported by members of the Council of Financial Regulators (CFR), including the Reserve Bank of Australia, the Treasury and the Australian Securities and Investments Commission.

APRA Chair Wayne Byres said this action is intended to reinforce the stability of the financial system.

“In taking action, APRA is focused on ensuring the financial system remains safe, and that banks are lending to borrowers who can afford the level of debt they are taking on – both today and into the future,” he said.

“While the banking system is well capitalised and lending standards overall have held up, increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building.”

According to APRA, the current environment of very low interest rates and rapidly rising house prices means that pressures on household indebtedness are likely to remain heightened. This presents risks to future financial stability, as borrowers may be less resilient to shocks like rising interest rates or income reductions.

Byres said current trends in lending to highly indebted borrowers are high by both historical and international standards, and require action to prevent further increases.

“More than one in five new loans approved in the June quarter were at more than six times the borrowers’ income, and at an aggregate level the expectation is that housing credit growth will run ahead of household income growth in the period ahead,” he said.

“With the economy expected to bounce back as lockdowns begin to be lifted around the country, the balance of risks is such that stronger serviceability standards are warranted.”

APRA and other members of the CFR will be closely monitoring these risks in residential mortgage lending.