APRA sets new borrowing rule for banks as New Zealand raises interest rates

Did you hear? Australian Banks have been given new borrowing rules on the same day New Zealand’s Reserve Bank lifts interest rates, as an attempt to tackle property prices and inflation.  

On Wednesday, The Reserve Bank of New Zealand lifted the country’s cash rate for the first time in seven years by a quarter of a percentage point to 0.5%. This hike puts New Zealand amongst a handful of developed economies that have raised borrowing costs in recent weeks. 

Over on this side of the ditch, The Australian Prudential Regulation Authority (APRA) is making a case for tougher serviceability tests for home loans. In its letter to banks on Wednesday, APRA has announced the increased minimum interest rate buffer on home loan applications from 2.5 to 3 percentage points. 

"The buffer provides an important contingency for rises in interest rates over the life of the loan, as well as for any unforeseen changes in a borrower's income or expenses. - said the APRA in the letter. 

How did they come to this decision?

The banking regulator has consulted with the Australian Competition and Consumer Commission before going with this course of action. 

This move was aimed at helping curb the house prices and large mortgage debt, which soared in recent months. Most prominently, more than one in five new loans approved in the June quarter  were at more than six times the borrower’s income. It means people are overstretching themselves and taking on risky levels of debt. 

Increasing the buffer rate is probably the gentlest way to let down a no-hoper borrower who is borrowing at their capacity. Mortgage interest rates will not be impacted. 

“In taking action, APRA is focused on ensuring the financial system remains safe, and that banks are lending to borrowers who can afford the level of debt they are taking on – both today and into the future,” Apra’s chair, Wayne Byres said in a statement on Wednesday.

"While the banking system is well capitalised and lending standards overall have held up, increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building," he noted.

What does it mean?

From November, banks will have to test whether new borrowers can go so far to afford higher mortgage repayments with home loan interest rates at 3 percentage points above their current rate. If they cannot approach this serviceability buffer with confidence, their application would be rejected. 

For home loan applicants, the new serviceability test means the maximum amount they can borrow relative to their income and expenses will be lower than it was. It’s estimated that households will see their maximum borrowing capacity drop by 5%. 

Under the new rules, the average family with one adult working full time and the other part time and two dependent children will be able to borrow $35,025 less. 

Further steps may be necessary in the coming months

So far, the big banks have welcomed this change. 

"We believe that APRA's announcement to increase the serviceability floor is a sensible and appropriate step to help take some of the heat out of the housing market," the Commonwealth Bank's chief executive Matt Comyn said in a statement.

“In the context of the current strength of the housing market this is a modest change,” said ANZ’s head of Australian economics, David Plank.

The APRA will continue to monitor risks in residential mortgage lending and might introduce further tightening measures in the future if necessary. 

"With an information paper covering other macropru options set to be released in a few months' time, we expect that APRA is currently hard at work on the logistics of implementing further measures." said Su-Lin Ong, Managing Director of RBC Capital Markets. 

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