The Australian Prudential Regulation Authority (APRA) has announced a significant increase in the capital adequacy requirements for residential mortgage exposures held by authorised deposit-taking institutions (ADIs) that use the internal ratings-based (IRB) approach. This move aims to bolster the resilience of the financial system and aligns with international regulatory trends.
Key Takeaways
- Average risk weights for Australian residential mortgages under the IRB approach will rise from approximately 16% to at least 25%.
- The change is effective from July 1, 2016.
- This measure is an interim step, with further adjustments possible following international reviews.
Strengthening Financial Resilience
APRA’s decision to increase capital requirements for residential mortgages under the IRB approach is a direct response to a recommendation from the Financial System Inquiry (FSI). The FSI proposed that APRA should raise the average IRB mortgage risk weight to reduce the disparity between risk weights used by ADIs employing IRB models and those using standardised approaches.
This adjustment is also in line with ongoing work by the Basel Committee on Banking Supervision (Basel Committee) concerning global capital adequacy frameworks for banks. By increasing the capital buffer for residential mortgage exposures, APRA seeks to enhance the overall stability and resilience of IRB-accredited ADIs and the broader Australian financial system.
Impact on ADIs and Implementation
The increased IRB risk weights will apply to all Australian residential mortgages, excluding those used as security for small business lending. The implementation involves an adjustment to the correlation factor within the IRB mortgage risk weight function for each affected ADI.
The five major Australian banks – Australia and New Zealand Banking Group, Commonwealth Bank of Australia, Macquarie Bank, National Australia Bank, and Westpac Banking Corporation – are the ADIs accredited to use the IRB approach and will be impacted by this change. These institutions collectively hold a substantial portion of the residential mortgage exposures.
Interim Measure and Future Considerations
APRA has clarified that the current increase in IRB mortgage risk weights is an interim measure. The final calibration of risk weights for both IRB and standardised approaches will depend on the outcomes of the Basel Committee’s comprehensive review of the global capital adequacy framework. APRA anticipates further consideration of IRB mortgage risk weights in the medium term, in light of these international developments.
The decision to target an average IRB risk weight of at least 25% reflects the interim nature of the measure and the ongoing uncertainty surrounding the Basel Committee’s review. APRA has indicated that the final calibration will be subject to further consideration as international developments become clearer.
Relation to Capital Ratio Targets
This change in mortgage risk weights is expected to contribute approximately 80 basis points towards the previously announced forecast need for the major banks to increase their capital ratios by 200 basis points. This increase is APRA’s assessment of what is required for the major banks to be comfortably positioned within the top quartile of international peers over the medium to long term. The precise impact will vary among ADIs based on the size and characteristics of their mortgage portfolios.