New paper addresses how APRA ensures that capital requirements for housing lending are strong enough to withstand losses
The Australian Prudential Regulation Authority (APRA) has published an information paper, detailing the credit risk capital requirements for housing loans and providing insight into the mechanisms that underpin capital adequacy rules for housing lending.
The document specifically addresses how APRA ensures that capital requirements for housing lending are robust enough to withstand losses over various economic cycles, and how it maintains the balance between internal ratings-based (IRB) and standardised capital requirements to limit impacts on competition within the Australian banking sector.
APRA said its approach to capital requirements for housing lending is influenced by the internationally agreed framework developed by the Basel Committee on Banking Supervision. However, due to the significant presence of housing loans in Australian banks’ portfolios, APRA has opted to reinforce the national framework beyond the minimum Basel guidelines.
Noteworthy adjustments include the increase of the loss given default (LGD) input floor for housing lending from 10% to 20% in 2008, enhancements to IRB risk-weights in 2016, the enforcement of “unquestionably strong” capital ratio requirements in 2020, and further revisions to the broader capital framework that came into effect at the start of 2023. These revisions, APRA noted, aim to strengthen the housing lending framework.
In the information paper, the prudential regulator assured that it has taken steps to ensure that the differences between the IRB and standardised capital requirements do not undermine fairness in the banking sector.
These measures include making the IRB approach accessible to all banks capable of meeting APRA’s modelling standards, introducing a capital floor to limit IRB benefits, and enforcing rigorous approval and validation processes for IRB banks. Comprehensive disclosure requirements are also set for IRB banks to foster transparency and market discipline.
Read more: APRA keeps eye on factors affecting financial system stability
Despite the apparent gap in the average headline risk-weight for housing lending between the IRB (22%) and standardised approaches (36%), APRA emphasises that the real difference in capital requirements is narrower when considering other factors such as capital ratio requirements, expected loss adjustments, and operational costs.
The authority suggests that after adjusting for these and other key differences, the gap in risk-weights between the IRB and standardised approaches is significantly reduced, highlighting APRA’s commitment to maintaining a balanced and competitive banking system in Australia.
Read more: Banks’ capital levels remain robust – APRA
“APRA ensures that capital requirements for housing lending under both the IRB and standardised approaches are sufficient to withstand losses across the cycle through the implementation of a robust regulatory framework and rigorous ongoing supervision,” said Anthony Coleman, head of credit risk analytics at APRA’s financial risk specialist teams.
“There are differences between IRB and standardised requirements, reflecting the expectation of more sophisticated risk management by larger, complex institutions. The differences also seek to provide an incentive for banks to invest in advanced modelling capabilities, improve risk management frameworks and better align capital with risk.
“APRA has robust mechanisms in place to prevent excessive divergence between IRB and standardised capital requirements and limit any detrimental effect on competition. We conclude that the current capital framework delivers on the goals of robust and equitable capital adequacy rules for Australian banks.”
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