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Should APRA review its buffers?

Oksana Patron9 August 2022
Money beyond reach

After the Bank of England has recently relaxed the requirement for borrowers to be assessed for a potential three percentage points increase in mortgage rates, some expect that the Australian Prudential Regulation Authority (APRA) may follow suit.

With Australia’s cash rate target already having been lifted from 10 basis points to 1.85% and being set to rise to 2.35% next month according to most market analysts, the equivalent stress test in place in Australia should also come under scrutiny next month, according to chief executive of BuyersBuyers, a network of buyer’s agents, Doron Peleg.

He stressed that in early October 2021, APRA introduced a requirement for a lending assessment buffer of at least 300 basis points, which was deemed prudent at the time to address rising systemic risks, and reflective of evolving market pricing for the trajectory of interest rates.

“But with the cash rate set to rise to 2.35% next month, such a stringent stress test would no longer makes sense, especially with the banking system so well capitalised, and with the regulator confirming that sound lending standards continue to be applied overall,” he said.

“Australia’s three-year government bond yield is now trading at well under 3%, and the terminal cash rate for this cycle is also expected to be somewhere around that level.

“A buffer of, say, two percentage points would be far more appropriate now, not least because the current rules make it far too difficult for many borrowers to switch lenders, often leaving them trapped on unattractive mortgage rates and poor terms.”

Additionally, making changes to lending standards was frequently challenging because of how amendments were negatively perceived in media reporting, the firm said.

According to BuyersBuyers co-founder Pete Wargent, it was sometimes difficult for regulators to communicate the reasoning behind changes, which were often “ether misunderstood or misreported by non-financial media outlets or ‘shock jock’ websites”.

“Many of our clients and other borrowers are finding it impossibly difficult to refinance when lending standards are so tight, leaving them stuck with unattractive mortgage rates or on challenging repayment terms. This is actually a net negative for financial stability risks, of course, though sadly media reporting rarely reflects this accurately,” he said.

The Bank of England first introduced the stress test in 2014, and amended it in 2017, to assess borrowers for whether they could comfortably service a mortgage in the event of interest rates being increased by 300 basis points.

“In the event, the base rate only lifted by a maximum of 0.50 percentage points between 2017 and 2021, and it was concluded that the stress test was far too stringent,” the firm said.

“From this month the UK stress test rules have now been eased, so that lenders only need to assess for a minimum stress buffer of one percentage point, although rising power bills will also still need to be factored in.”

 

 

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