Opinion: The big questions APRA needs to answer

Listening to APRA chairman Wayne Byres deliver a speech in Sydney this week, it struck me just how much the fear of a recession or economic downturn drives the regulator’s activities.

APRA celebrates its 20th anniversary this year, which means Australia’s last recession predates the regulator’s existence.

Is this long run of uninterrupted economic growth to be celebrated, or are we trying to avoid the inevitable? It’s worth noting that Mr Byres did acknowledge that Australian banks have a “lack of experience” of significant distress.

In 2017, APRA conducted stress tests on Australian banks based on a scenario designed to be severe but plausible.

“The basic scenario was a severe economic stress in Australia and New Zealand, with a significant downturn in the housing market at the epicentre. This was triggered by a downturn in China and a collapse in demand for commodities. The subsequent downgrade in sovereign and bank debt ratings leads to a temporary closure of offshore funding markets, a sell-off in the Australian dollar and widening in credit spreads. Australian GDP falls by 4 per cent, unemployment doubles to 11 per cent and house prices decline by 35 per cent nationally over three years,” Mr Byres explained this week.

APRA then decided to add a twist. In addition to the sharp downturn in the economic environment, banks had to consider an operational risk loss event involving misconduct and mis-selling in the origination of residential mortgages. The additional operational risk element served as an amplifier of the stress, adding a further shock to bank balance sheets.

Overall, banks projected credit losses of around $40 billion on their residential mortgage books, which was equivalent to a little over a quarter of overall projected loan losses. As a loss rate, this would be broadly consistent with the experience in the UK in the early 1990s, but lower than the losses seen in Ireland or the US during the global financial crisis.

While these hypothetical scenarios have their place, the big questions APRA needs to address are rooted in reality: the impact that macro-prudential measures have had on the market and Australian borrowers.

The big banks have hiked rates in response to APRA’s regulatory measures. Their pricing decisions are now being investigated by the ACCC.

Given that APRA’s actions triggered the banks to pull the price lever, what exactly is the relationship between higher interest-only and investor mortgage repayments and a more resilient system?

Now that investor and interest-only caps have been removed, APRA is focused on debt-to-income levels, as it announced earlier in the year.

The response from banks has been to reduce the amount they are willing to lend and increase their scrutiny of living expenses. For some applicants, there is now a significant shortfall between what they can borrow and what they can buy. Does this not disadvantage prospective buyers? Particularly considering those with similar situations were able to borrow previously? What has really changed? Are borrowers riskier now than they were before APRA started tampering with the mortgage market?

Whatever happened to caveat emptor (buyer beware)?

“The community wants an innovative, competitive, dynamic financial system, but nobody has any appetite to lose a cent,” Mr Byres said in response to this question.

“We’ve been blessed for a very long period of time without a prudential type of failure. There are obviously losses that occur all the time in the financial system, but from a prudential perspective, a bank failure or insurance company failure, those things have been few and far between. Touch wood it stays that way.

“But it is important that the concept of caveat emptor remains in the system and people understand not just that they are exposed to risks but that regulators can’t solve every problem. This is an issue for APRA and for consumer-facing regulators. Things will go wrong and not everything will work perfectly. It’s important that consumers understand that.”

The government has told APRA that it is not meant to calibrate the prudential regime such to achieve a zero-failure state of the world, Mr Byres said.

“I’m not sure that the broader community really buys into that,” the APRA chairman said.

[Related: Banks ‘slow to respond’ to weak income growth: APRA]