APRA’S SUPERVISORY ACTIVITIES IN 2004/05
http://www.apra.gov.au/AboutAPRA/Publications/Documents/Activities-2005-Annual-Report.pdf
AUTHORISED DEPOSIT-TAKING INSTITUTIONS
Authorised deposit-taking institutions (ADIs) continued to enjoy good financial health, with strong earnings, impaired assets at historical lows and capital ratios increasing in most areas. This general picture has altered little over recent years, although the underlying credit environment has changed. In 2004/05, credit growth slowed overall and there was a significant shift in its composition away from housing lending, as housing markets cooled, in favour of business lending. In this environment, interest margins came under further downward pressure. Competition for quality assets intensified and discounting of mortgage interest rates became more widespread; credit spreads in businesslending appear to have narrowed as well. Competition for deposits also intensified with the introduction of a number of high-rate on-line deposit accounts. One indicator that APRA is closely monitoring is loans that are past due but not yet considered impaired; these ‘delinquent’ loans have begun to increase, though from a low base.
Credit standards
APRA’s supervision of ADIs over 2004/05 has focussed on the ADI sector’s response to the slowdown in housing credit growth and the more aggressive competition for lending and funding. APRA has cautioned that ADIs should be attuning their business strategies and risk appetite to the changed credit environment and should not be pursuing growth targets that require them to take on more risk, without robust risk management systems and appropriate pricing. In addition, APRA has cautioned that ADIs looking for potential revenue growth in areas outside their traditional housing lending franchise should not move in these directions without ensuring that they have the personnel, expertise and systems to do so prudently. APRA has also expressed its concerns, as has the Reserve Bank of Australia, about slippages in credit standards in housing lending. These slippages can take different forms. One is the failure to independently verify customer data, particularly debt servicing ability, where loans are originated via mortgage brokers and other third party channels. Another is the increase in the maximum permissible debt servicing ratio of borrowers based on new assessment procedures introduced by ADIs, which treat all incomes above a minimum cost of living estimate as potentially available for debt servicing. A third is the use of various informal means of property valuation for loans on which lenders would traditionally
require formal valuations — the subject of a separate survey by APRA (see below).
Property valuation practices
During 2004/05, APRA surveyed the property valuation practices used by ADIs and lenders mortgage insurers (LMIs) as part of their mortgage and insurance approval processes. The results were published in May 2005. The main conclusion was that there has been a movement away from the traditional reliance on a full valuation of a property (involving an internal inspection) in favour of more streamlined valuation methodologies, particularly by the larger ADIs. These methodologies include greater use of restricted (or kerbside) valuations, or the use of valuations based on information drawn from sources such as the contract of sale, Valuer-General’s records or desk-based electronic systems. APRA is conscious of the pressures on ADIs to reduce valuation expenses but has noted that the new valuation methodologies have not been tested in a major property market downturn and may expose lenders to increased credit risk if appropriate controls are not in place. Good practice, in APRA’s view, would see these new techniques appropriately researched and approved at senior levels before introduction, and limited in their application to lower risk lending.
Foreign currency options exposures
Following the announcement by the National Australia Bank (NAB) in January 2004 of losses from irregular foreign currency options trading, APRA undertook an investigation that revealed significant deficiencies in NAB’s risk management and governance framework. APRA’s report, which was subsequently made public by NAB in March 2004, outlined a range of remedial actions that NAB was required to implement to address these deficiencies. The actions covered front and back office operations, internal control systems and NAB’s risk culture and governance framework. Until APRA was satisfied that these actions had been completed, NAB’s target capital adequacy ratio was raised to ten per cent, NAB’s approval to use an internal model to determine market risk capital was withdrawn and NAB’s currency options desk was to remain closed to corporate business and proprietary trading. NAB made significant progress on its remedial program during 2004/05 and, as a consequence, APRA agreed to the re-opening of NAB’s currency options trading desk in May 2005. APRA is continuing to work closely with NAB to finalise the remedial program.