APRA spooked by declining lending standards

Regular readers will know that MB has been arguing for new macroprudential rules – that is, hard and fast controls on lending such as LVRs – to be used in monetary policy management. The reason why is to ensure that as this business cycle develops banks do not return to their old dodgy lending practices. Moreover, such rules break the hard link between interest rates and currencies as they enable low interest rates without a corresponding takeoff in credit.

The interesting thing is that this idea is nowhere near as revolutionary as it appears. In fact, it already exists, but not in the form of transparent rules for all to see. Rather it is extant in the form of the shadowy regulator called the Australian Prudential Regulatory Authority (APRA) which polices bank lending standards but does so behind closed doors and on a discretionary basis.

Since the GFC, APRA has done  a pretty good job. Lending standards are much tighter than they were pre-GFC and APRA is widely thought to insist that new aggregate lending is funded through accumulated deposits rather than increased offshore borrowing by the banks. If maintained, this is an institutional bound that will prevent credit growth from accelerating much from its current level and certainly nothing like the levels of yesteryear.

We could argue over whether or not this is tight enough but it’s certainly a large improvement. As anyone who has refinanced in recent times will tell you, the banks will not lend anything like they used to.

But there are several very large problems with this approach. The first is a lack of transparency. We are all trading in an uninformed market with respect to what the parameters of lending standards are at any given time. This badly compromises price discovery in any number areas vis-a-vis house prices, bank values etc and pretty much rules out accountability for APRA itself.

Second and related, over time the culture of regulators can change or be changed. Regulatory capture is always a danger from both private and public interests. For instance, Joe Hockey is on the record recently insisting that he will defend APRA’s right to discretionary decisions making and that he should have a veto over the appointment of the APRA Chairman which comes up prior to the election. Somehow I don’t think Joe Hockey has tightening lending standards on his mind.

So, when APRA announces, like it did last night, that it is concerned that lending standards are already slipping, I think it right that we all react with a push to see APRA’s rules brought into the light of day. From The Australian:

The banking regulator has warned it will take action against any moves to relax credit standards, amid concern that banks are compromising on the quality of new business loans to generate volume growth in a flat economy.

…”We have been talking very often and noisily with our institutions about credit standards,” Dr Laker said after addressing an Australian British Chamber of Commerce lunch in Melbourne. “When things are going slowly, which is not in the experience of a lot of lending officers, one of the dangers is a temptation to compete on the basis of lower credit standards.

“If there’s been a re-thinking of (last year’s) conservatism, we’d certainly be taking that up with the institutions.”

Chairman Dr John Laker also indicated APRA would increase board scrutiny:

“Supervisory agencies want to better understand the actual workings of the board…They want to see the collective skills and experience of the board in action, independence of mind and spirit — not just form — contributed by directors, and the quality of board deliberations…Gaining this understanding will involve more frequent meetings with boards, chairs of board committees and other key directors, analysis of board papers and minutes, and reviews of board minutes, and reviews of board self-assessments of performance…It was a sign of the strength of Australia through the financial crisis. We had, generally speaking, very good boards, but there’s no perfection in this game.”

Laker also said that:

“We remain cautious — very cautious — at APRA”.

Let’s hope so, before and after the election, because hope is all we have.

Full speech below.

John Laker – Importance of Good Governance-ABCC Melbourne 27 Feb 2013-SC Single Spacing

David Llewellyn-Smith

Comments

  1. More talk in our press this morn. But at least it’s got people talking! “The (NZ) Government is considering restricting bank lending along with other tools to control credit growth. Real Estate Institute CEO Helen O’Sullivan is wondering how those loan-to-value ratio proposals will be implemented. She says there’d be concern if all types of buyers are treated the same. …. it would be wrong to apply the same approach to a first home buyer as to someone who’d been in the market a long time.”

    • And which way round did she mean the right approach is? Tighter or looser for the first home buyer? These days there is so little common sense around, that I would not know.

        • Note that everywhere there is an affordability problem, all the political pressure is in the direction of “making credit easier”.

          Of course this does not solve the problem with the decline of “home ownership”, especially if we actually dare to define “home ownership” as having one’s mortgage paid off.

          http://finance.townhall.com/columnists/markcalabria/2013/02/12/the-long-run-decline-in-actual-homeownership-n1510358?utm

          “…..It would be far more accurate to label U.S. federal homeownership policy, U.S. mortgage policy. For the primary means of “extending” homeownership, via federal policy, has been the massive increase in mortgage debt. Sadly the actual trend increase in homeownership has been close to nothing since 1960.
          If the ultimate intent of housing policy is to help build wealth and enable families to have something to pass along to future generations, then the right measure should be home equity. Even better measure would be the percent of homeowners who own their homes free and clear, that is without any mortgage. As long as there is any mortgage, even a small one, the bank has some ability to foreclose if you are in default……it’s hard to say you really “own” it unless it’s all yours.

          Currently the percentage of homeowners that own without any mortgage is just under 30 percent. Prior to 1960, an actual majority of owners held their homes with no mortgage at all. For most of American history, the typical homeowner did not have any mortgage, not having to answer to a bank and also having some wealth to pass along to future generations.

          The primary impact of US homeownership policy has not been to increase homeownership, but to increase debt along with driving up house prices. Not a bad outcome if you’re a mortgage banker or a real estate agent. But not exactly a good deal for home buyers. Yes this has also helped increase the average size of homes, but helping everyone live in a McMansion hardly seems like a compelling public policy goal. And yes, reducing our reliance on debt for purchasing a home would result in lower prices, a huge win for renters….”

          • It is politically unpalatable to address price.

            Therefore they must address debt serviceability.

            In doing so, creating a generation of debt slaves.

          • “As long as there is any mortgage, even a small one, the bank has some ability to foreclose if you are in default……it’s hard to say you really “own” it unless it’s all yours.”

            Technically you don’t even have to be in default for a bank to demand repayment of the loan.

        • AND everywhere there is an affordability problem, and there is a widespread belief that rising house prices will always cover a lender’s equity, “ground zero” for dodgy mortgage lending practices in the private sector will be found.

          Note that in Atlanta, Georgia, the dodgy lending practices in the presence of already-extremely-affordable housing (due to a flexible housing supply regime) were all forced by government mandates. So you had solo mums living on a benefit getting $60,000 mortgages they couldn’t service.

  2. Sounds like a possible action group may be required ‘Macro Prudential Watch’ as relying on MP to allow a very low interest strategy will be an ongoing struggle to get between borrowers and manipulated cheap money.

    Needless to say we know which side the banks and our short termists pollies will be on.

    ” Moreover, such rules break the hard link between interest rates and currencies as they enable low interest rates without a corresponding takeoff in credit.”

    Perhaps breaking a link between our willingness to save and the interest rates charged to borrow is not such a great idea.

    While relying on cheap T-Shirts and TVs from mercantalist foreigners has a place ( but also limits) more care is perhaps needed when it comes to cheap savings from foreigners.

  3. TBH lending standards are pretty damn good. It’s much tighter that the pre-gfc days when it was still better than it was in other countries.

    Most of the changes that have been introduced are working well. I assume that APRA are playing to the gallery on this one.

    • Pre GFC lending standards in Australia didn’t exist. Banks and mortgage dealers could give any amount to anyone they want. LowDoc, NoDoc, 10x income, 105% LVR, … you name it

      now is just slightly better but people can still get 95%+ LVR, some LowDoc, NoDoc, and 10x income loans

      • Standards exist but they are within banks and variable.

        Every bank has lending parameters, portfolio management, industry exposure limits, client exposure limits, etc etc etc. as well as restrictions imposed through capital adequacy, risk weightings etc.

        They all have comprehensive credit manuals which explain the bank’s procedures and standards.

        The issues are transparency, variability, auditing compliance, systems which don;t automatically aggregate exposures from various entities and operations (Westpac/BAC/PPL had this problem in the 80’s),ability to evade internal controls (particularly for FX dealers as NAB (and AWA) found out), rogue lenders, fraud, cyclical over-optimism, inability to deal with boom/bubble development and increased likelihood of downturn in values from excessively high levels/growth, unique project analysis (eg the FNQ space station).

        That is not to mention misjudgement, inadequate knowledge and training and the follow the crowd mentality and the desire to maintain market share in major markets.

        Selection of board and senior management is absolutely critical.

        In banking overall it takes say 30 years before you are only lending a customer his own money you have taken in profit, whereas in high fashion supply with a 4 times stock turn to boutiques it might only take 1 year. The credit decision in banking is far more critical not only because of gearing but also because of margin.

    • Nonsense IMO, and I am surprised at the assertion from HnH that standards are better than pre-GFC.

      I have recently bought and the bank would have loaned me 6x my income or 7.2x joint income. A friend who has just bought had a similar experience. This is madness and no way could I get a loan like this in either US or UK.

      • Yes, this is the fly in the ointment of the responsible lending claim: the total amount of debt we carry. If the lending was so responsible, how did we end up more as a percentage of our GDP than, say, the US?

        • Good point, it is the overall credit decision within a portfolio that matters. Neither LVR alone nor income multiple alone are the determinants of a good loan.

          You/your partner might have great prospects for advancement/promotion/payrise which means they might only be lending you 3 times likely combined income in 5 years and you might be in the most aggressive 1% of loans

          You might be in a great position for continuity of employment through a downturn compared to most other people.

          • How do they determine what my prospects for advancement are, can they share that with me 🙂 (we are 35-40 with decent jobs, but thats not unique…)

          • Banks have several lending channels, but for the sake of simplicity, lets just consider the two that people here might encounter.
            The commercial channel can indeed make judgements on what a business person might earn in the future based on cashflow projections etc, and they can land against those projected income.

            However for a consumer loan (salaried employee buying a house or car etc) they can only lend against a proven income – eg payslips, employment contract, letter from employer stating salary etc. they cannot lend based on what someone might earn at some point in the future, unless perhaps it was an immediate future and can be proven.

            APRA don’t actually lay down any nuts and bolts guidelines on that, they simply say that a bank must lend responsibly, so there is some differences between the various interpretations of that, and yes the banks do take that seriously, they are not spraying money all over the place.

            I couldn’t possibly comment on davels particular circumstances, but many of you may get an unpleasant surprise when you do get around to applying for a loan.

        • But what was the LVR? If there is sufficient headroom, the bank’s exposure is minimised.

          The house, or its “value”, isn’t going to service the loan. The borrower is going to be the one servicing the loan.

          What if the borrower’s job was sent offshore (the banks are doing that as part of their “cost cutting” exercise)? Then, no amount of cutting back on essentials and eating 2 minute noodles will help the borrower service the loan.

          “The loan is covered by the value of the house and prices only ever go up, so the exposure is minimal”. This is one of the biggest logical fallacies that led to the GFC.

          • If the loan was for only 60% of the current valuation, prices would have to drop 40% before the bank was faced with a loss.

          • Mav, correct but not a huge factor. Assume the interest rate is (say)5.5%, even after a year they would still not be facing a huge loss if they repossessed and sold. Probably still end up in the black.

          • The rule is the three S.

            Selectivity
            Servicing
            Security

            In that order.

            Home loans are cookie cutter processed, so those rules don’t strictly apply, but it is better to lend to someone who has the willingness and capacity to repay with perhaps a lesser offering of security, than it is to lend against a heap of security to someone without the willingness and capacity to repay.

            Whilst the first example might be viewed by many to be a higher risk of default, the history is that they are not.

        • LVR = 80% in both cases.

          Understand about the limited exposure but what about the systemic risk of loading a large number of households with dangerous/unrealistic debt?

          • See Explorer’s point above: what matters is the exposure of the overall book. Also remember the banks are now using RMBS’s extensively.

          • Then davel you should have told your bank that you are a credit risk, if you don’t feel that you can repay the loan.

            You did have to sign a declaration that you were comfortable with your level of commitments, did you not?

          • Peter, you’re missing the point. They can make a judgement in my case that I can repay or not, and their risk is limited by the 80% LVR.

            However the systemic risk of doing this hundreds of thousands of times is a completely separate issue. These loans and risks are highly correlated. That’s what is not being appropriately managed.

          • I’d also like to add that the loan I actually took is 3.5x my earnings, 1/3 or so of what they would have lent me if I also threw in the wifes income. No need to take on stupid debt in this environment, thanks. Modest house will suffice.

            The max they would have lent me would have consumed 95& of my post-tax income, or ~ 60% of our joint.

          • davel the banks work on the household income, not on a single breadwinners salary.

            So 3.5 X your earnings would be about 2 X household income – is that correct?

            If you are concerned then ask for CC Insurance that covers any loss of your wages. If your bank can’t offer that, plenty of insurance companies can.

            Borrowers have a responsibility to manage their own loans and offset risk if they feel it might be too high.

            You seem to be an intelligent and reasonable man, so I’m sure that you will do whatever you feel is necessary to manage your responsibility well.

            All the best, I’m sure that it will work out well for you.

          • Peter, you are missing the point. Not sure if this is deliberate on your behalf.

            Yes, about 2x household is my loan.

            No I am not worried about not being able to pay it back.

          • I get the point, but each bank can only manage risk one loan at a time.

            I can’t see your income and commitment figures, so I can’t comment on the specifics of your case.

          • Can only manage risk one loan at a time??

            You’re not serious. What they offered me and others is ridiculous. It is based on their models, which are clearly not reflective of the actual systemic risk.

  4. “This badly compromises price discovery in any number [of] areas vis-a-vis house prices”

    And maybe this is deliberate, and all part of the grand plan to deflate the bubble slowly.

  5. Second and related, over time the culture of regulators can change or be changed. Regulatory capture is always a danger from both private and public interests.

    +1000. A bit of sunlight is always good to keep the likes of Obeids and the Svengalis from getting their hands into the taxpayer cookie jar.

    • Apologies, I forgot blockquote doesn’t work too well here. Try this:

      The first man I saw was of a meagre aspect, with sooty hands and face, his hair and beard long, ragged, and singed in several places. His clothes, shirt, and skin, were all of the same colour. He has been eight years upon a project for extracting sunbeams out of cucumbers, which were to be put in phials hermetically sealed, and let out to warm the air in raw inclement summers. He told me, he did not doubt, that, in eight years more, he should be able to supply the governor’s gardens with sunshine, at a reasonable rate: but he complained that his stock was low, and entreated me “to give him something as an encouragement to ingenuity, especially since this had been a very dear season for cucumbers.” I made him a small present, for my lord had furnished me with money on purpose, because he knew their practice of begging from all who go to see them.

      • In case anyone is wondering what that is all about, the intro to the original post read “Just so long as you don’t get your sunshine from cucumbers”. The quote is from Jonathan Swift.

  6. LVR controls are all very well, but alone don’t really achieve much. Remember that lenders effectively operate on both ends of each sale. As leverage helps push prices up, those prices then support increased leverage while showing the same LVR.

    What would really be interesting is introducing serviceability controls alongside LVR controls. While serviceability is generally assessed by lenders, this is not done transparently, and the information is not provided to investors or regulators, and there are no explicit controls around it. Serviceability places a far more meaningful (and less gameable) limit on leverage.

    Offshore regulators are now insisting this kind of information be provided to investors, and the RBA looks like demanding it for RMBS repo eligibility.