The detailed nature of the guidance given in the draft Prudential Practice Guide and the frequent use throughout the draft guide of directive expressions is indicative of APRA’s concerns. Expressions used frequently include:
… a prudent ADI would be expected to …
… it would be prudent for an ADI to …
… APRA expects that an ADI would …
… in APRA’s view, it is not prudent to …
For example, in the draft guide the word "prudent" is used 81 times and the expression "good practice" 24 times.
The draft guide indicates APRA will take a more robust approach to supervision in this area. The mortgage origination industry has expressed concern over comments in the draft guide about the increased riskiness of brokered loans and the comments about use of "clawbacks"
If the draft Prudential Practice Guide is eventually adopted, it will have a significant effect upon:
- The policies and procedures of ADIs relating to residential mortgage lending
- The type of loan products that will be able to be offered by ADIs in Australia.
The prescriptive nature of the draft Prudential Practice Guide is more understandable when viewed in the context of APRA’s concerns. In the press release, accompanying the draft, the following comments are made:
"APRA chairman Dr John Laker says credit standards and residential mortgage lending have been a major focus of APRA’s prudential supervision of ADIs, particularly, in the current environment of strong pricing pressures in some housing markets and very active competition between lenders.
In this environment, APRA has seen increasing evidence of lending with higher risk characteristics and it does not want this trend to continue. The draft Prudential Practice Guide reinforces the importance of maintaining prudential lending practice standards when competitive pressures may tempt otherwise, Dr Laker said."
In this update we do not attempt to summarise the draft Prudential Practice Guide – it is too detailed to attempt such a summary and do the draft guide justice. However, we note that the draft guide covers all relevant areas of residential mortgage lending including:
- Establishing a risk management framework and APRA’s expectations of an ADI board in relation to residential
- Determining an appropriate "risk appetite".
- Establishing and maintaining robust management information systems.
- Appropriate remuneration structures - guarding against reward for risk scenarios.
- Loan origination processes, including serviceability assessments, how to assess and verify information and integration of buffer arrangements.
- APRA’s expectations with regard to a loan origination by third parties and the suggestion that such processes may have a higher risk profile.
- Use of scorecards and their limitations.
- Analysis of risk profile of specific loan types, such as interest only loans, foreign currency loans, home equity loans, loans with non-standard/alternate documentation and reverse mortgages.
- Valuation of security issues, in particular valuation methodologies, loan to valuation ratios and use of guarantors.
- Detailed guidance in relation to hardship loans and collections, with particular emphasis on the change in risk profile for ADIs in this area.
- Stress testing generally.
- Issues relating to lender’s mortgage insurance, in particular guarding against over reliance upon mortgage insurance in circumstances where claims may be denied or reduced.
- Ensuring that robust procedures are introduced to ensure compliance with LMI policy terms to limit risk of claims being denied or reduced.
We strongly recommend that all organisations and individuals involved in the residential mortgage lending space read this new APRA draft Prudential Practice Guide and consider how it is likely to impact on their business if adopted in its present format. The consultation period is still open so submissions can be made by concerned parties.
Disclaimer: The information contained in this e-alert/update is not advice and should not be relied upon as legal advice. Hunt & Hunt recommends that if you have a matter that is legal, or has legal implications, you consult with your legal adviser.