Investor loans could face major capital increase

The Basel Committee on Banking Supervision issued its second consultation paper on the standardised approach for credit risk in December.

CoreLogic RP Data’s executive general manager of commercial Craig Mackenzie said the paper is “extremely important” as it effectively sets out the minimum international expectations of the Basel Committee with respect to the capital treatment of a range of asset classes.

“Of particular relevance to the Australian market is the proposed new capital treatment for residential mortgages,” Mr Mackenzie said.

The proposal could affect all Australian banks other than the big four and Macquarie, who use an IRB approach to determine regulatory capital.

“The most controversial aspect of the consultation paper is the Basel Committee’s proposal to levy higher capital on a subset of investment loans,” he said. “Not just marginally higher. Two to three times higher than for a like for like owner-occupied loan.”

Mr Mackenzie explained that the Basel Committee has defined these loans as one where "repayment is materially dependent on cash flow generated by the property”. However, the paper does not define what this phrase means in any further detail.

“Currently in Australia lending institutions use, on average, 80 per cent of the estimated rent from the investment property towards serviceability,” he said.

“It is likely many investment loan applications in Australia wouldn’t pass servicing without at least some portion of the rental amount having to be relied upon.”

The threshold question for APRA, Mr McKenzie said, will be to determine whether or not it wishes to adopt the Basel Committee’s proposed approach to imposing higher capital on investment loans, like the Reserve Bank of New Zealand did earlier this year.

Mr Mackenzie expects it will be difficult for APRA not to follow the international agenda and adopt some form of differentiated capital treatment for investment loans, particularly as APRA will not wish to be inconsistent with, and less conservative than, the international benchmark.

“If that is the case, then APRA will need to carefully think through its approach and the flow on market impact in terms of the availability of credit and pricing for investment loans,” he said.

“If APRA forms the view that it wishes to go down this path, then it will need to engage in some spirited debate with industry participants throughout the course of 2016 to provide greater clarity around the meaning of the term "materially dependent", particularly given the proposed material difference in capital treatment between an owner-occupied loan and an investment loan.”

The Consultation Paper closes for comment in March 2016.

[Related: Big four banks will continue to raise capital 'for some time']