APRA's article "Loan serviceability standards in housing lending" (in Insight Issue Two 2013) identifies areas in housing loan approval standards where improvements are needed. Some of these reflect the National Credit Act responsible lending requirements.
The article summarises a review of ADIs that focussed on the income tests that ADIs use to assess whether borrowers can afford the interest and principal repayments on their loans. A total of 27 ADIs participated in the review, including major banks, regional banks, credit unions and building societies. Together, these ADIs represented around 97 per cent of total ADI housing loans as at March 2013.
According to APRA:
A strong focus on debt serviceability is critical in a low interest rate environment. In particular, low interest rates can mask debt serviceability assessments, creating opportunities for borrowers to increase their leverage. The resulting growth in demand for housing loans can also put pressure on housing lending standards as ADIs compete to maintain or increase their market share. ADIs need to carefully monitor the debt servicing capacity of their borrowers over the duration of housing loans, not just at origination, to ensure that borrowers are able to manage the transition to higher interest rates, when that inevitably occurs.
APRA identified the following as forming a prudent approach to debt serviceability:
- Clearly documented policies and procedures for evaluating loan serviceability, subject to effective governance arrangements and board oversight.
- A set of consistent serviceability criteria across all of an ADI’s mortgage products.
- Application of an interest rate buffer to stress new and existing loan commitments, which is regularly reviewed in relation to the interest rate cycle and key economic indicators.
- Inclusion of an interest rate floor in serviceability assessments, based on the average mortgage interest rate over an appropriately long time period, being at least one cycle in interest rates.
- Use of a borrower’s declared living expenses as a more representative measure of their actual living expenses than the Household Expenditure Measure (HEM) or the Henderson Poverty Index (HPI) indices.
- Where the HEM or HPI indices are used, the addition of a margin to the relevant index linked to a borrower’s income, and regular updating of these indices.
- Formal procedures to verify a potential borrower’s existing debt commitments and to identify possible undeclared debt commitments.
- A framework that clearly defines overrides/exceptions and includes the documentary requirements for override/exception decisions and how overrides/exceptions are to be identified, reported and monitored.
- Regular override/exception reporting to the appropriate level of management and to the board.
APRA identified hindsight reviews (or independent reviews of compliance with serviceability policy) of housing loan portfolios as good practice
The review also identified that, in a minority of ADIs, the mortgage documentation supporting the serviceability assessment was incomplete and that there were inaccuracies in the income verification process.
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Posted 12th September 2013 by David Jacobson in responsible lending