Since December 2014, the Australian Prudential Regulatory Authority (APRA) has been closely monitoring residential mortgage lending practices and encouraging continuous improvement to enhance the quality of loan underwriting.

In particular, investor lending and interest-only lending have been under the spotlight.

The focus of APRA’s recent update to the guidance on residential mortgage lending (PPG 223) is on the quantitative serviceability parameters as well as other qualitative measures for assessing borrowing capacity including responsible lending requirements and the treatment of self-managed superannuation funds (SMSFs).

Most ADIs will be well placed to address APRA’s requirements and consider the following updates to the guidance:

1. The risk of non- compliance with responsible lending is highlighted as a potentially significant risk to ADIs. APRA recommends that ADIs conduct periodic assessments of compliance with responsible lending conduct obligations to reduce the risk of financial loss.
2. External environmental factors should be considered in reviewing risk appetite as well as policies around serviceability to ensure that impact of any change in risk profile for new loans is reported appropriately within the risk governance framework.
3. APRA suggests good practice will include monitoring of the level of, and trends for, lending to borrowers with minimal income buffers.
4. ADI serviceability policies should incorporate an interest rate buffer of at least two percentage points (minimum floor rate of 7%).
5. Buffer and floor rates should be applied to the borrowers’ new and existing debt commitments.  
6. For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis. Refer to the recent ASIC Report and our update relating to REP 493 into interest-only home loans.
7. Discounts of at least 20% should be applied to non-salary income such as rental income or bonuses.
8. Reasonable estimates of housing costs should be included in serviceability assessments. Reliance solely on the poverty index does not meet APRA requirements for “sound risk management”.
9. Interest only loans are expected to be offered only for limited durations, particularly for owner-occupiers.
10. Where an ADI lends funds for property held in SMSFs, APRA expects the ADI to identify additional risks relevant to this type of lending and reflect this in the loan application processes.

Actions for ADIs

• Review your policies, procedures and processes to incorporate the key revisions to PPG 223. This is a key priority to ensure better practice and ongoing compliance
• Consider appropriateness of your risk appetite in respect of residential mortgage lending in the context of the enhanced guidance and areas of focus including interest only lending, serviceability assessments, and responsible lending
• Consider the need for additional trend analysis around performance of loans with minimal income buffers
• Challenge the appropriateness of the reporting of risk profile on loans to the risk governance forums