In December 2015 the Basel Committee released its second consultation paper on the standardised approach to credit risk, proposing substantially higher capital requirements on investment loans.

If implemented by the Australian Prudential Regulation Authority (APRA), the proposal would affect all Australian banks other than the Big Four and Macquarie; skewing the level playing field called for by the Financial System Inquiry (FSI) again.  

APRA’s reaction will be important – it may follow New Zealand, which increased the lowest risk weighted asset from 35 per cent to 50 per cent to boost capital. It is expected that APRA will follow the international agenda and adopt some changes to capital treatment for investment loans.

In addition, the Committee has defined investment loans as those where the ‘repayment is materially dependent on cash flow generated by the property’. This means that exposures secured by either residential or commercial real estate would receive differing risk - weight treatments depending on whether the loan repayment was materially dependent on rental income from the investment property. The definition of investment loan this is likely to be open to substantial debate as this will drive the ultimate classification of loans between owner-occupied and investment. Changes like this could result in increased complexity for Authorised Deposit-taking (ADIs).

Further changes to risk weightings have been on the agenda for some time and the focus continues. The changes will place more pressure on small to mid-size banks and mutuals, and adds complexities to capital calculations.

In the interest of competition and promoting a level playing field, implementation of further changes is likely to attract significant debate, as it presents an unfair burden on the Australian banks not within the Big Four/Macquarie nexus.

We recommend that you familiarise yourself with the proposal, examine the potential impact of the proposal on your business and consider putting forward a submission by 11 March 2016.