Bankers knock new capital plans

The Reserve Bank believes borrowers with high LVR loans are more vulnerable to an economic downturn. Photo / Thinkstock

Reserve Bank proposal would mean big increase in amount banks need to carry against their housing loans.

The Bankers Association is critical of Reserve Bank proposals to increase the amount of capital banks have to hold against home loans with a high loan-to-value ratio (LVR).

The proposal, released yesterday, aims to get the baseline right before the Reserve Bank adopts new "macro-economic" regulatory tools which would allow it to raise and lower over the course of an economic cycle the amount of capital banks need to hold.

Some lending, particularly residential mortgages, is considered to involve a smaller risk of default, so less capital is required.

The specific issue is whether the formula used to risk-weight housing loans underestimates in the case of high LVR loans the importance of systemic risks - those associated with general economic conditions - as distinct from risks associated with the particular circumstances of the individual borrower.

The Reserve Bank believes borrowers with high LVR loans are more vulnerable to an economic downturn and that the losses on such loans are more highly correlated than other loans, that is, if some such loans are in default it is more likely that others will be.

"If economic conditions change for the worse, and in view of the current state of the housing market, there is a risk that borrowers most exposed to adverse changes in general economic conditions could all come under pressure at the same time, with a corresponding impact on the quality of banks' housing loan portfolios," the bank says.

It has analysed data on banks' loss rates between 2008 and 2012 - a period which it says included a "mild" downturn.

It found that loss rates on high LVR loans generally increased more, in some cases substantially more, than loss rates on lower LVR loans.

But Bankers Association chief executive Kirk Hope said the banks would like to see much more evidence than that sweeping observation to back up the Reserve Bank's conviction that high LVR borrowers are at greater systemic risk, as opposed to those risks particular to the borrower which will have been taken into account when the loan was made.

Hope said that it was wrong to assume all high LVR borrowers were on comparatively low incomes; it might reflect a relatively high income and capacity to service the loan.

He is critical of the short period the banks have been given to run their own models and prepare a response to the Reserve Bank proposals - three weeks, including the Easter break.

The proposal would have a material effect on the amount of capital the banks need to carry against their housing loans, which are the lion's share of their business, increasing the capital required by anything from 14 to 23 per cent.

And that is before any further temporary increase which might be imposed under the new macro-prudential regime the Reserve Bank is keen to add to its regulatory toolbox.

But the bank points out that under the old one-size-fits-all Basel I capital adequacy regime, replaced in 2008, a 50 per cent risk weighting was attached to all residential mortgages. The current regime, which is intended to allow a more fine-grained approach to weighting the risks of default, has lowered the risk weighting for home loans to the 25 to 31 per cent range.