Banks Need to build capital buffers to manage housing risks

Banks need to build capital buffers to manage housing risks:IMF

The International Monetary Fund has called on banks to further strengthen their capital positions to buffer the economy from potential housing related shocks, even as it praised Australian regulators for acting to mitigate the risks in the housing market. In its 18-monthly review of the Australian economy, the Washington based agency reaffirmed its concerns about a heated housing market, and a build up in household debt that “could still amplify the negative impact of large shocks”.

The IMF also weighed on the negative gearing debate, pointing out that “the macrofinancial resilience of the economy to housing market shocks could be enhanced through tax reform.”
Australia’s banks were urged to “further strengthen their capital position, which would increase their resilience to housing and other macro-financial shocks,” which is said would improve their ability to “withstand a significant housing market correction.”

It recommended APRA consider adjusting capital levels based on a bank’s exposure to risky housing segments and lending standards, or introduce higher minimum risk weights for certain housing related loans. “With expectations of lower profitability in the sector, it will be important for banks to remain in a position to continue to generate sufficient internal capital to finance the growth of their balance sheets and maintain unquestionably strong capital ratios.” The IMF pointed to Australia’s tax system as providing “households with incentives for leveraged real estate investment that likely amplifies housing cycle,” referencing so-called negative gearing policies.

The incentives, it said “arise from the combination of tax concessions on capital gains and the possibility to apply losses from negative gearing to income from other sources.”
“Reforms of capital gain tax concessions would need to be undertaken in a broader context, to avoid introducing new distortions in the taxation of different assets.”

Prudential measures were more a contingency for future risks, the IMF said, particularly as housing markets in mining related states were in the process of correcting. Tighter lending conditions in these areas risked delaying the recovery and hindering labour mobility it said.
But with upsides risks in housing, APRA should stand ready with “targeted prudential measures.”

It also recommended minimum amortisation requirements for new loans to further rein in interest only lending. Despite the warnings, the IMF praised Australian regulators for their efforts to mitigate the build up of risks in the housing market and improving anti-money laundering safeguards in the real estate sector. The risks with household leverage had diminished, it said. This was tighter lending standards had slowed mortgage credit growth, reduced the riskiness of new loans and moderated house price growth. Meanwhile the risks associated with property developers was being monitored while households continued to accumulate deposits in their offset accounts and did not use mortgage borrowings to finance consumption.

IMF directors encouraged authorities to remain “vigilant and continue to enhance the resilience of the banking system to shocks with macro-financial implications, including encouraging banks to strengthen their capital position.”

“Financial regulatory authorities would need to stand ready to intensify targeted prudential measures, if lending or housing growth were to re-accelerate, while advancing the implementation of the regulatory reform agenda.”

The IMF recognised that APRA was working towards enforcing higher capital ratios by ensuring the banks met the definition of “unquestionably strong” by sitting within the top quartile of capitalised banks in the world, in addition to meeting other regulatory requirements relating to leverage ratios and loss absorbing capital buffers.

Australia’s banks had already bolstered their capital ratios from 8.6 per cent of risk weighted assets in mid-2014 to 10 per cent at the end of 2015. In 2016, they were at the low end of the top quartile of banks internationally.

Article by Jonathan Shapiro, Australian Financial Review 10/2/2017