Australian Tightening of Property Loan Standards Mostly Over

(Bloomberg) -- A three-year project to improve Australian mortgage lending standards is almost complete, the results of a stress test are reassuring, and loan rules won’t be tightened much more, the banking regulator said Wednesday.

The test, which included modeling for a 35 percent fall in property prices, provides “general reassurance” that the banking system is sound, Australian Prudential Regulation Authority Chairman Wayne Byres said in a speech in Sydney. Introduction of centralized credit reporting this year is expected to help lenders limit loan sizes based on existing debt-to-income ratios rather than just income.

“While there is more ‘good housekeeping’ to do, the heavy lifting on lending standards has largely been done,” Byres said. “Any tightening from here on is expected to be at the margin as banks seek to get a better handle on borrower expenses, and better visibility of borrower debt commitments.”

Alarmed that a fight for market share was eroding lending standards, APRA has progressively ramped-up lending curbs since late 2014. Restrictions on riskier loans, such as interest-only mortgages, and an increasing focus on expense and existing debt verification has contributed to a notably cooling market. Prices have fallen for nine straight months, with the biggest drops in expensive markets like Sydney where affordability is most stretched and investors no longer see good prospects for capital gains.

While APRA remains alert to slippage, overall it has seen “clear improvements and moves to better practice,” Byres said.

Stress Test

A stress test conducted in 2017, the results of which were published for the first time Wednesday, suggests lenders could withstand a severe economic downturn with house price declines of 35 percent without breaching minimum capital requirements, Byres said. The projected credit loss rate was “slightly lower” than APRA’s 2014 test, which partly reflects recent improvements in asset quality, he said.

The regulator modeled a scenario where a downturn in China led to the collapse of commodity prices and Australian gross domestic product fell 4 percent. The nation’s unemployment doubled and house prices fell 35 percent over three years amid a temporary closure of offshore funding markets. It also added operational risk losses from a misconduct and mis-selling of mortgages.

Overall banks projected credit losses of around A$40 billion ($30 billion) on their residential mortgage books, which Byres said was “broadly consistent” with loss rates seen in the U.K. 1990s downturn, though lower than seen in Ireland or the U.S. in the financial crisis.

Despite the severity of the crisis, no bank reported a tier one capital ratio below 5 percent at the lowest point and most maintained liquidity coverage ratios, Byres said. In normal times, APRA expects the nation’s biggest banks to operate with capital ratios of above 10.5 percent. Unlike in other countries, Australia does not publish the performance of individual banks in stress tests.

©2018 Bloomberg L.P.