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Banks urged to ‘justify’ exceptions to lending guardrails

By Charbel Kadib
4 minute read

The prudential regulator has reinforced home loan serviceability standards as banks increasingly apply for exceptions amid fears borrowers have been locked into “mortgage prison”.

The Australian Prudential Regulation Authority (APRA) has issued a letter to licensed banking institutions aimed at stressing the importance of compliance with housing lending policy.

This follows moves by a number of banks to revise their policy exception processes to support borrowers experiencing mortgage stress but unable to pass serviceability assessments for refinancing applications.

Banks are currently required to apply a 3 per cent serviceability buffer on top of the advertised rate for a given home loan application.


“The serviceability buffer provides a contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower’s income or expenses,” APRA noted in its letter.

The regulator added the current economic environment — characterised by elevated inflation, rising interest rates, and deteriorating labour market conditions — warrants continued vigilance from banks when assessing a borrower’s long-term suitability for a loan.

“With the potential for interest rates to rise further, inflation still high and the possibility of weaker labour market outcomes, the buffer is an important risk mitigant,” the regulator stated.

However, APRA acknowledged some existing borrowers have encountered difficulty when looking to ease their repayment burden via refinancing applications.

“In the current environment, some borrowers who are seeking to refinance with another lender may no longer meet standard loan criteria,” APRA stated.

“The reasons behind this are varied: some borrowers may not pass the serviceability buffer requirement, given higher interest rates and cost-of-living pressures; other borrowers may have less equity in their property following declines in housing prices; and some borrowers may have experienced changes to their personal circumstances. It is important that these loans are assessed on a case-by-case basis.”

Given these challenges, APRA allows for exceptions to its standards, provided they are “managed prudently and limited”.

“This approach allows banks to take into account additional indicators of repayment capacity beyond those captured in the standard serviceability test,” the regulator noted.

“For a borrower seeking to refinance, this could include past repayment behaviour.”

But the prudential regulator warned that “large volumes of exceptions can create risks” — weakening the risk profiles and “increasing the vulnerability of their loan books to future shocks”.

Therefore, APRA has stressed banks should ensure these exceptions do not undermine the overall asset quality.

“Historically, serviceability policy exceptions have accounted for a small share of banks’ total housing lending, at between 2 and 3 per cent,” APRA observed.

“It is important that exceptions are used in a prudent and limited manner, so as not to undermine the intent of the core policy.

“In using exceptions, APRA expects banks to make a prudent assessment of repayment capacity so that there is a good outcome for borrowers and the financial system.”

The regulator said prudent banks should have “acceptable reasons and clear justifications” for loans written outside policy, and should consider responsible lending obligations set out by the Australian Securities and Investments Commission (ASIC).

“Loans written as exceptions must be regularly reported to the relevant internal governance bodies of the bank and monitored against risk appetite limits,” APRA added.

“Prudent boards would assess the impact of any proposed changes to exceptions processes on the bank’s risk profile and risk appetite.

“This includes understanding the types of loans that are being written outside policy, such as like-for-like refinancing.”

To ensure banks maintain prudent lending practices, APRA has requested regulated institutions notify supervisors ahead of “material changes to their exceptions process”.

“APRA will be monitoring exceptions trends closely and may request additional information to assess how banks are managing risks,” the letter stated.

“Banks reporting large volumes of policy exceptions will be subject to heightened supervisory attention.”