Outgoing APRA chair defends risk weighting framework

Speaking to the Financial Services Institute of Australasia (FINSIA) on Wednesday (19 October) for his last official speech, the outgoing chair of the prudential regulator, Wayne Byres, defended the regulator’s risk weighting framework.

In the eye of the beholder

After unpacking his thoughts on falling house prices and APRA’s work on lending standards, Mr Byres reflected that during his tenure, the regulator had “dealt with a long-standing debate about the impact on competition from differences in housing loan risk weights within the capital framework”.

He said: “Like beauty, the view on housing risk weights is usually in the eye of the beholder. 

“They are viewed as too low (driving the flow of credit into housing over other activities), too high (unnecessarily raising the cost of housing finance), and too differentiated (giving larger banks with internal models an advantage over smaller banks using the standardised approach).”

The APRA chair said the regulator had achieved “three key outcomes” with risk weights over the past few years.

These included:

• More capital allocation to home loan portfolios, “reflecting the heavy concentration of mortgages on the balance sheet of the banking system”
• Embedding differential pricing between owner-occupied and investor lending (and between amortising and interest-only lending, by setting differential capital requirements)
• Narrowing the gap between risk weights from internal models and “the APRA-prescribed standardised approach”

On the last point, Mr Byres suggested that “the complexity of the risk weighting framework sometimes masks the reality”.

He explained: “Headline risk weights are not directly comparable because of differing requirements in the way capital adequacy is calculated.

“We therefore need to assess differences on a more realistic, like-for-like basis,” he said, flagging that the average mortgage risk weight had been around 39 per cent for standardised banks versus an average of 18 per cent for banks prior to the Financial System Inquiry — but that this had now reduced to 38 per cent to 31 per cent on a like-for-like basis.

“The gap will narrow fractionally further under the new capital regime coming into force from 2023.”

The APRA chair also took the opportunity to hit back at critics, stating: “We still hear complaints from bankers that we have not addressed this issue. 

“I’d suggest they are not letting the facts get in the way of a good story.”

But the chair did reflect on competition in the financial space and how prudential levers interact with it.

“It is true that a prudential supervisor will lean towards promoting stability over promoting competition,” he said.

“After all, that is how Parliament has established our mandate. But that does not mean we do not think about competition. 

“Our approach has always been one of recognising that competition and financial stability can, with the right settings, be mutually reinforcing.”

He also flagged that “periods of instability are often bad for competition,” noting that — particularly in times of turbulence — consumers tend to flock to larger, traditional institutions (as they did during the global financial crisis when the major banks saw a dramatic recovery in market share for mortgages). 

However, he did acknowledge that some of the regulator’s housing interventions had impacted competition, and “deliberately so”.

Mr Byres concluded: “The idea that the pursuit of stability must come at the cost of competition is a furphy.”

As well as looking at capital risk weighting, Mr Byres also covered off some of the major themes and patterns that had dominated his eight years as chair, including house prices and APRA’s home loan interventions, capital, superannuation, and community expectations.

The outgoing APRA chair said his successor would likely continue to be busy focusing on the same key areas he had, as well as “newer issues” such as:

• Risk culture and incentives
• Digital finance and crypto assets
• Cyber security
• Climate risks

[Related: Falling house prices ‘not all downside’, says outgoing APRA chair]