APRA warns banks on granting interest rate buffer exemptions to borrowers

With interest rates soaring the financial watchdog APRA has fired a warning to banks on the risks of granting loan serviceability exemptions to borrowers.

The Australian financial watchdog has fired a warning shot at the banking sector of the importance of maintaining interest rate buffers for borrowers in a climate of soaring loan costs and high inflation.

The Australian Prudential Regulation Authority letter to the banks follows recent changes by some banks to their processes for granting exceptions to support borrowers experiencing challenges and who don’t meet minimum home loan serviceability criteria, such as the 3 per cent buffer. APRA said that any changes to the criteria must be implemented prudently.

In the letter APRA chairman John Lonsdale said that with the potential for interest rates to rise further and with inflation still high and the possibility of weaker labour market outcomes, the buffer was an important risk mitigation.

“The serviceability buffer provides a contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower’s income or expenses,” he said.

“In the current environment, some borrowers who are seeking to refinance with another lender may no longer meet standard loan criteria.

“The reasons behind this are varied: some borrowers may not pass the serviceability buffer requirement, given higher interest rates and cost of living pressures; other borrowers may have less equity in their property following declines in housing prices; and some borrowers may have experienced changes to their personal circumstances.

“It is important that these loans are assessed on a case-by-case basis.”

Under APRA’s prudential framework, banks can use exceptions to policy if these are managed prudently and limited.

This approach allows banks to take into account additional indicators of repayment capacity beyond those captured in the standard serviceability test. For a borrower seeking to refinance, this could include past repayment behaviour.

Loans written as exceptions must be regularly reported to the relevant internal governance bodies of the bank and monitored against risk appetite limits.

APRA has fired a warning to the banking sector over loan serviceability exemptions.

APRA said it will be monitoring exceptions trends closely and may request additional information to assess how banks are managing risks. Banks reporting large volumes of policy exceptions will be subject to heightened supervisory attention.

Under APRA’s prudential framework, banks can use exceptions to policy if these are managed prudently and limited.

This approach allows banks to take into account additional indicators of repayment capacity beyond those captured in the standard serviceability test. For a borrower seeking to refinance, this could include past repayment behaviour.

Mr Lonsdale’s letter said APRA requires banks to have prudent policies and processes for dealing with exceptions to policy.

“Large volumes of exceptions can create risks by weakening banks’ risk profiles and increasing the vulnerability of their loan books to future shocks,” he said.

“Historically, serviceability policy exceptions have accounted for a small share of banks’ total housing lending, at between 2 and 3 per cent.

“It is important that exceptions are used in a prudent and limited manner, so as not to undermine the intent of the core policy.

“In using exceptions, APRA expects banks to make a prudent assessment of repayment capacity so that there is a good outcome for borrowers and the financial system.”

Australian Banking Association chief executive Anna Bligh said said buffers will continue to be an important part of good lending practice.

“However, APRA along with banks recognise that sometimes exceptions are necessary,” she said.

“Exceptions to adjust the buffer can occur when they are limited and managed prudently.”