In a discussion paper released today, the Australian Prudential Regulation Authority (APRA) proposes the introduction of more detailed criteria for authorised deposit-taking institutions (ADIs) to qualify for the concessional risk-weighting of residential mortgage lending for capital adequacy purposes.

APRA’s proposal follows its earlier survey of the experience of ADIs with “low doc” loans, which are written with considerably less documentation and verification of income and serviceability than “conventional” mortgage lending, and which ADIs themselves consider carry a higher risk of loss. APRA has also noted that, in some cases, ADIs are offering loans originated via mortgage brokers and other third-party channels, without independently verifying relevant information about the borrowers.

Most loans made by ADIs have a 100 per cent risk-weight for capital adequacy purposes. However, a concessional risk-weight of 50 per cent applies to loans that are fully secured by registered mortgage over a residential property, provided certain criteria are satisfied. This concession reflects the very low loss rates historically associated with mortgage lending in Australia. It also reflects the fact that conventional mortgage lending by ADIs has involved them undertaking a comprehensive assessment of the ability of the borrower to service the loan, as well as ensuring that the property is appropriately valued.

APRA’s Chairman, Dr John Laker, said that APRA’s concern is that applying this concessional risk-weight to loans where the borrower’s servicing ability is not verified by ADIs may not adequately reflect the likelihood of increased risk.

“The changes proposed reinforce the importance of prudent lending practices in the housing market, which APRA has been emphasising to ADIs over the past twelve months,” he said.

APRA’s proposed criteria are:

• an ADI must have documented procedures in place to assess the ability of potential borrowers to meet repayment obligations;
• an ADI must have established verification procedures to substantiate critical data provided by potential borrowers;
• where an ADI does not use a formal valuation, its lending procedures must detail the criteria used to justify the purchase price, or other means of valuation, as an indication of the value of the residential property;
• where an ADI requires a formal valuation for a home loan, all residential properties securing the loan must be subjected to an independent valuation;
• loans will only be eligible for the concessional risk-weighting if they are secured against properties zoned residential or where the ADI can demonstrate the marketability of the property would be of a similar nature to properties with such zoning;
• a 100 per cent risk-weight will be assigned to loans that do not fulfil the criteria set out above unless (1) the loan-to-valuation ratio (LVR) at origination is 60 per cent or less or (2) the loan is fully mortgage insured with a mortgage insurer rated at least A, in which case the risk-weight will be 50 per cent; and
• where an ADI outsources any part of the credit process to a third party, the arrangement must comply with APRA’s prudential standard APS 231 Outsourcing, and the ADI’s lending criteria must be met at all times.

A full copy of the discussion paper is available on APRA’s website at http://www.apra.gov.au/adi/ADI-Publications.cfm

ADIs and other interested parties have the opportunity to comment on the proposed changes before they are finalised. The consultation period will end on 30 January 2004. The intended date for implementing the proposed changes is 1 July 2004. 

The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, friendly societies, and most members of the superannuation industry. APRA is funded largely by the industries that it supervises. It was established on 1 July 1998. APRA currently supervises institutions holding approximately $1.7 trillion in assets for 20 million Australian depositors, policyholders and superannuation fund members.

Media and industry inquiries only:	Sue Morey Head of Public Affairs Australian Prudential Regulation Authority Telephone: 02 9210 3384 Mobile: 0438 124 524
All other inquiries:	APRA Contact Centre 1300 131 060