APRA Issues Letter on Capital Treatment of Residential Mortgages
APRA published a response letter on the consultation on adjusted capital requirements for residential mortgages covered by the First Home Loan Deposit Scheme (FHLDS). The scheme aims to improve home ownership by first home buyers through a government guarantee of eligible mortgage loans for up to 15% of the property purchase price. Recognizing the government guarantee as a valuable form of credit risk mitigation, APRA has proposed to reflect this in the capital framework by applying a lower capital requirement to eligible loans. APRA will shortly provide the standardized authorized deposit-taking institutions that have been included on the National Housing Finance and Investment Corporation’s panel of lenders with formal written approval to apply the adjusted capital treatment, as set out in this letter.
In its consultation, APRA had proposed adjusting the residential mortgage capital requirements detailed in the prudential standard APS 112 that addresses capital adequacy in context of the standardized approach to credit risk. The proposed adjustments involved allowing the eligible First Home Loan Deposit Scheme loans to be treated in a comparable manner to mortgages with a loan-to-valuation (LVR) ratio of 80%. This would allow the eligible First Home Loan Deposit Scheme loans to be risk-weighted at 35% under the current capital requirements of APRA. Once the government guarantee ceases to apply to eligible loans, the authorized deposit-taking institutions would revert to applying the relevant risk-weights set out in APS 112.
APRA received 10 submissions in response to its consultation. Respondents were generally supportive of the proposed capital treatment but sought confirmation about whether the same capital treatment would apply to the eligible First Home Loan Deposit Scheme loans under the revised authorized deposit-taking institutions capital framework, which is commencing from January 01, 2022. After considering all feedback, APRA is proceeding with the capital treatment as initially outlined in the consultation letter. APRA considers that this approach is simple to implement, appropriately reflects the value of the government guarantee as a form of credit risk mitigation, and will improve competition for the provision of these mortgages. APRA will apply the same approach under the revised APS 112; however, the risk-weight may differ from the currently applicable 35%, depending on the calibration of the final mortgage risk-weights.
At this time, APRA is not proposing adjustments to the internal ratings-based capital requirements for First Home Loan Deposit Scheme mortgages. It also did not propose changes to regulatory reporting requirements as part of the adjusted capital requirements. For regulatory reporting purposes, banks should report First Home Loan Deposit Scheme mortgages as having an 80% LVR only under Reporting Standard ARS 112.1 (Standardized Credit Risk – On Balance Sheet Assets). For all other regulatory reporting forms, banks must report the First Home Loan Deposit Scheme mortgages according to their actual LVR. Similarly, for setting internal limits on high LVR lending, APRA expects that the First Home Loan Deposit Scheme mortgages would still be included based on their actual LVR. Irrespective of the presence of the government guarantee, banks should still be setting prudent limits on the amount of this type of lending that they will offer, consistent with their risk appetite.
Keywords: Asia Pacific, Banking, Capital Adequacy Framework, Credit Risk, Standardized Approach, APS 112, Responses to Consultation, Residential Mortgage, Reporting, ARS 112.1, Basel III, APRA
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