APRA has released APG223, which provides useful commentary on the use of brokers by ADIs and other aspects of residential mortgage lending.
Lending secured by mortgages over residential property constitutes the largest credit exposure in the Australian banking system, and for many ADIs, represents over half their total credit exposures. This concentration of exposure warrants ADIs paying particular attention to residential mortgage lending practices.
APRA’s Prudential Practice Guides (PPGs) provide guidance on APRA’s view of sound practice in particular areas, but do not themselves create enforceable requirements. PPGs for Authorised Deposit Taking Institutions are called APGs.
APRA regulated institutions have the flexibility to manage residential mortgage lending in a manner that is best suited to achieving the institution’s business objectives. This means that not all of the practices outlined in APG223 will be relevant to every institution. Rather, the application of practices will depend on the particular institution’s size, complexity and risk profile.
ADIs dealing with brokers
APG223 draws upon APRA’s Cross Industrial Prudential Standards (CPS).
CPS 510 requires an ADI’s remuneration policy to be aligned with prudent risk taking. This should include remuneration of third parties, particularly mortgage broker firms, when they are responsible for origination of a material proportion of the residential mortgage loan portfolio. Alternatively the ADI may address such remuneration arrangements within its risk management framework with appropriate senior management or board oversight.
An ADI should ensure that any commission based remuneration does not create adverse incentives by ensuring that contracts with third parties include provisions dealing with clawback provisions and ensuring that incentive arrangements discourage conflicts of interest and inappropriate behaviour. Where an ADI relies on brokers to originate a material proportion of its residential mortgage portfolio, the ADI should closely monitor the performance of the broker firm and its employees. Where loans originated by a particular broker or broker firm have an unexpectedly elevated level of loan defaults, or materially deficient loan documentation and processing, a prudent ADI would take measures to address such matters including restricting or terminating such relationships.
Good practice would be for an ADI, rather than a third party, to perform income verification. However, if an ADI delegates this role to a third party, the ADI would be expected to maintain appropriate oversight of the third party’s processes and procedures.
Consistent with CPS 231, a prudent ADI would ensure that its arrangements with third party residential mortgage loan originators allow for timely cessation of such arrangements should the ADI form the view that it is no longer able to place reliance on the third party.
Relying on benchmarks
Industry benchmarks and indexes (such as the HPI) may not be representative of a borrower’s actual living expenses, which may be considerably higher. APRA therefore expects ADIs to use a borrower’s declared living expenses for the purposes of assessment and states that where a benchmark is used, a prudent ADI should apply a margin linked to the borrower’s income to the relevant index.
Note however that ASIC requires a higher standard of enquiry and verification for regulated loans.
Foreign currency loans
In APRA’s view, it is not prudent to extend foreign currency denominated loans against domestic currency income streams or against domestic currency collateral.
In reverse mortgage loans, lenders should caution borrowers against waiving independent legal and financial advice.
Imposing a minimum genuine savings requirement as part of the initial deposit is considered an important means of reducing default risk. A prudent ADI would have limited appetite for taking into account non‑genuine savings such as gifts from a family member.