Distrusting the banks. Do you trust the banks — your bank?  Do you reckon the key regulators — the Reserve Bank and the Australian Prudential Regulation Authority — “trust” our banks, especially the big four, to handle the rising level of risk in the Australian financial system from the housing boom? Forget the poorly informed racket over Westpac’s mortgage rate con job rise last week — that’s not the reason for regulators’ growing concern about the banks (although it has added to the scepticism). In fact the regulators reckon the banks’ management of the home lending boom, especially to investors in Sydney and Melbourne, has been sub par in many cases and has added to the rising level of risk in the financial system.

There’s the clear inference the regulators, led by the RBA, reckon the banks have been lending blind (either deliberately or unknowingly) to some customers. This scepticism of the banks performance in the current (but fading) housing boom dominated last Friday’s second Financial Stability Review of 2015 from the RBA, which believes some (unnamed) lenders have been very naughty:

“Recent investigations by regulators have revealed that housing lending standards in recent years have been somewhat weaker than had originally been thought (though still better than in the years leading up to the global financial crisis). In some cases, practices have not met prudential expectations, potentially placing lenders at risk of breaching their responsible lending obligations under consumer protection laws. In particular, poor documentation and verification by lenders in many instances suggests that some borrowers may have been given interest-only loans that were not suitable for them. Serviceability assessments also seem to have been especially problematic: the common (and prudent) practice of applying a buffer to the interest rate used when calculating the allowable new loan size had in some cases been undermined by overly aggressive assumptions in other parts of the serviceability calculations. As a result, some borrowers have had less of a safety margin against unexpected falls in income, increases in expenses or increases in interest rates than it had appeared.“

— Glenn Dyer

But wait, there’s more. That’s a litany of errors, poor decision-making and an indictment of the banks for a lack of competence in some key areas of lending. Regulators don’t name names in these sorts of reports for fear of sparking concerns about the stability of these institutions, which is a pity. Thanks to the regulators, led by APRA, going through the home lending operations of the banks earlier this year, we have found out just what was going on (and saved some banks from reporting some embarrassing future losses). And judging from the Financial Stability Report, what APRA found wasn’t pretty. So it’s no wonder the RBA questions whether the banks are up to the task as risks rise from the home lending boom (and some commercial property loans). That raises the question: should regulators continue to trust the banks in the more fraught climate of rising risk here and in in their biggest offshore market, New Zealand? The FSR says:

“Risks to the Australian banking system have increased somewhat over the past six months from banks’ lending to other sectors. The outlook for some commercial property markets has deteriorated further, and banks will need to be especially vigilant in their commercial property risk appetite and the maintenance of sound lending practices in the period ahead. Another area to watch is the four major banks’ international exposures, especially housing and agricultural lending in New Zealand where the risks have continued to grow.”

— Glenn Dyer

Rubbery figures. In regulator-speak the last sentence is a direct warning to the banks to continue lifting their game, because what the regulators have seen so far hasn’t be impressed them. And then there’s another very touchy subject for the regulators — the lack of understanding in some banks about to whom they were lending billions of dollars, and what they were telling regulators. That in fact was a $50 billion lack of understanding. Twice in the past few months the Reserve Bank and APRA have had to change their housing loan data to reflect at least two banks misclassifying investor loans as home loans to owner occupiers. Media reports earlier in the year say $20 billion of home loans were reclassified at investor loans at the ANZ, with a further $30 billion at the National Australia Bank also recast as investor loans — not insignificant errors, alongside a more worrying slippage in lending decisions by banks.

“… recent investigations by regulators have revealed that standards were somewhat weaker than had originally been thought. As a result, some borrowers have had less of a safety margin against unexpected falls in income, increases in expenses or increases in interest rates. Despite the recent targeted adjustments, banks will need to remain vigilant in ensuring that their risk appetite and lending practices are appropriate: risks in residential property development and other commercial property markets continue to build, and this area of their lending has been a key source of bank loan losses in the past.”

The RBA repeats itself several times on the issue of the banks, their past practices and need for an improved performance in doing what should come naturally — lending money in a prudent manner. On the basis of the comments in the FSR the RBA believes they have been naughty bankers indeed. — Glenn Dyer

Peter Fray

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