Basel III Mortgages: Australia - Key Themes and Strategic Approach

BASEL III
MORTGAGES:
AUSTRALIA
Point of View
April 2018
KEY THEMES AND
STRATEGIC APPROACH

Copyright © 2018 Accenture. All rights reserved. 2
OVERVIEW
How we got here?
On February 14, 2018, the
Australian Prudential
Regulation Authority (APRA)
released the Basel III
discussion paper,
canvassing how it proposes
to introduce the new
finalised Basel requirements
issued by the Bank of
International Settlements
into the Australian context.
2014 2017 2020 2021 20222018
Financial
System Inquiry
final report
published (Dec)
APRA released
strengthening of
capital rations
paper (July)
APRA released
discussion paper
& QIS (Feb)
Final Basel III
Standards to be
released (Jan)
Basel III to be
in effect (Jan)
Fundamental Review
of the Trading Book
(FRTB) to be
implemented (Jan)
While largely following the
Basel III reforms published
in December 2017, APRA
has focused on two key
policy initiatives aligned
with the 2014 Financial
System Inquiry (FSI)
recommendations. This
will further strengthen the
domestic regulatory
framework.
It endorsed the benefits
of a strong and well-
capitalised banking
system to set regulatory
capital requirements as
unquestionably strong
for the banking sector.
APRA’s ‘Unquestionably
Strong’ capital benchmark
It addressed the structural
weaknesses in the residential
mortgage sector, encouraging
competitive neutrality by
raising the average Internal
Ratings Based (IRB) mortgage
risk weights and reducing the
difference between the
standardised measures.
Align Capital with Risk
(e.g. Mortgages)
Figure 1: Implementation Timeline

NEW REQUIREMENT
STRATEGIC APPROACH TO BASEL III MORTGAGES
APRA focuses on the localised Australian retail mortgage book in addition to achieving strong
capital (CET1) and a revised RWA framework
1
ACHIEVING
STRONG CAPITAL
REQUIREMENTS
Raising the minimum
capital benchmark
requirements of Common
Equity Tier 1 (CET1) by:
• Increasing 150 bps for
ADI’s using the IRB
approaches.
• 50 bps for standardised
banks under the existing
Basel II approach.
STRENGTHENING
THE RISK WEIGHTING
FRAMEWORK2
Placing constraints on
modelling and providing a
floor based on the
standardised approach.
• 50 percent of standardised
RWA on January 1, 2022.
• Incrementally increasing
each year up to 72.5% until
January 1, 2027.
RISK SEGMENTATION
IN THE MORTGAGE
BOOK3
Segmenting Australia’s
residential mortgage book
into two distinct categories:
• Owner-occupied loans
• Investment property &
interest only loans
FACILITATING
SERVICEABILITY
OF LOANS4
Highlighting serviceability
requirements for
approval of loans:
• Encouraging compliant
standard origination
and underwriting.
• Ensuring a minimum 7
percent interest rate
floor to approve the
loan.
CET1, Jan 20 RWA, Jan 22 Retail, Jan 22 Loans, Jan 22
Strengthen the sector to
better handle future
adversity & periods of
financial stress
Standardised floor
imposed at 72.5%
More granular risk weights
using Loan to Value Ratio
(LVR) categories
Interest rate approval
floor assessment at 7
percent.
Source: APRA. “Feb 2018 Revisions to the capital framework for ADIs.” Page 67

Source: APRA, ‘Revisions to the capital framework for authorised deposit taking institutions’, Discussion Paper, 2018
CAPITAL BENCHMARK REQUIREMENTS OF CET1
TO RISE TO 150 BASIS POINTS BY 2020
NEW REGULATORY COMMON
EQUITY TIER 1 MINIMUMS
ACHIEVING UNQUESTIONABLY
STRONG CAPITAL REQUIREMENTS
• APRA reaffirmed its mandate of achieving
unquestionably strong capital ratios
published in July 2017, which drew on
international comparisons to increase the
quality and quantum of capital for the
domestic sector.
• In this paper, APRA concluded that it is
necessary to raise the minimum capital
benchmark requirements of Common
Equity Tier 1 (CET1) by 150 basis points for
ADI’s adopting the IRB approaches and 50
basis points for standardised banks as per
the existing Basel II approach.
• APRA requires that ADI’s meet these new
capital benchmarks by January 1, 2020 at
the latest.
Assumes normalised
capital surplus
Current surplus includes a margin in
anticipation of unquestionably strong
This is illustrative of
the effective impact
of future changes in
risk-weights & other
framework changes
8% 8%
9.5%
Dec 16 Jan 20 Jan 21
9.5%
>10.5% >10.5%
Minimum regulatory requirements
Capital surplus

INTRODUCTION OF A CAPITAL FLOOR BASED ON THE
STANDARDISED APPROACH BY 2022
OUTPUT FLOOR APPLICATIONSTRENGTHENING THE RISK
WEIGHTING FRAMEWORK
• The objective is to reduce the flexibility
and competitive advantage of IRB
institutions by promoting greater
consistency across firms in the industry.
• Align capital requirements to risk
exposures and risk weighting between
the standardised and IRB approaches to
minimise the amount of capital benefit
that can be obtained.
• APRA will impose the floor consistent
with the Basel III framework. This is
proposed to commence at 50% of
standardised RWA on January 1, 2022,
incrementally increasing each year to
72.5% until January 1, 2027.
Output Floor is applied to each major risk category.
As per the output floor framework, the banks’ risk-weighted assets must be
computed as:
CR CCR CVA SEC Op. RiskMarket Risk
𝑹𝑾𝑨𝒔 = 𝐦𝐚𝐱 𝑹𝑾𝑨𝒔 𝑰𝑴 𝒐𝒓 𝑺𝑨 ; 𝒇 ∗ 𝑹𝑾𝑨 𝑺𝑨
RWA determined using
the approach that the
bank has supervisory
approval to use in
accordance with the
Basel capital framework
RWA
computed
using the
standardised
approach to
be used
Floor will be
implemented
during the
phase-in (2022-
2027) according
to the following
scale:
1January
2022: 50%
2023: 55%
2024: 60%
2025: 65%
2026: 70%
2027: 72.5%
EFFECTS
Introducing risk-based
measures which limit
the extent to which
banks reduce their
capital requirements.
Increasing comparability
between banks using
internal models and
standardised approaches.
Reinforcing the
credibility of banks’
internal risk-
weighted
calculations.

Risk segmentation in the mortgage book
COMPLIANCE & SEGMENTATION OF MORTGAGE BOOK
REQUIRES EXTENSIVE DATA CAPTURE AND ANALYSIS
NEW REQUIREMENTS FOR OWNER-
OCCUPIED AND INVESTOR LOANS
• APRA proposes to continue applying the risk
weighting banding associated with the LVR
profile of the loan similar to the current APS 112
treatment and consider LMI as investor loans will
attract a higher risk weight and capital impost.
• APRA proposes to address the structural
concentration of systemic risks within Australia’s
residential retail book by segmenting the
portfolio into two distinct categories:
• Owner-occupied loans which are deemed as
lower risk segments due to the lower historical
characteristic losses and
• Higher risk loans defined as investment
property, interest only loans (investor loans)
and loans to Small Medium Enterprises (SME)
secured by residential properties, which are
materially dependent on the cashflow profile of
the secured property.
RISK WEIGHTINGS FOR RESIDENTIAL MORTGAGE
EXPOSURES AS PER STANDARDISED APPROACH
Risk weighting
Type ≤50 ≤60 ≤80 ≤90 ≤100 ≤100
Standard:
Owner-occupied
20% 25% 30% 40% 50% 70%
Other residential
mortgages (high risk
and SME)
30% 35% 45% 60% 75% 85%
Non standard 100%

• APRA proposes to update its criteria for
standard residential mortgages to align with the
Basel III reforms and serviceability parameters
outlined in Prudential Practice Guide APG
Residential Mortgage Lending (APG 223).
• Banks need to ensure that their standard
origination and underwriting practices meet
serviceability and operational requirements.
• Mortgages that don’t meet the criteria will be
deemed non-standard mortgages and attract
an additional capital impost incurring a risk
weight of 100% due to higher operational risk
caused by greater susceptibility to market
changes.
New operational serviceability requirements
ENCOURAGING SERVICEABILITY & OPERATIONAL
REQUIREMENTS
ServiceabilityValuation
Marketability

BIG IMPACT REQUIREMENTS
DATA AND SYSTEMS: THE FOCAL POINT
* Internal Model Method – Counterparty credit risk
Key impact to banks across departments from the new Basel III risk management framework
Who
What
Level
impact
Bank
departments
AuditRisk Mgmt.
Internal
Validation
Product
Control
Financial
Control
Accounting Organisation
Front
Office
IT
Data & System CapitalModels Organisation
Risk Mgmt. IT Risk
Mgmt.
Internal
Validation
Audit Risk Mgmt. Organisation Risk Mgmt.
Impacts include data quality,
Architecture, Taxonomy, Lineage and
Technological Systems.
This will also have flow through impacts
to management and regulatory
reporting including D2a and Pillar III
Disclosures.
Changes will impact capital usage and
allocation, product pricing, balance
sheet & limit management.
Banks should overlay impacts to their
strategy; capital forecasts; risk appetite
& risk strategy to understand portfolio,
product and business strategy
implications.
Impacting the internal measurement of
risk, Basel III provides an opportunity to
develop mature and accurate risk
based customer profiles and pricing
models.
This will allow banks to derive more
meaningful insights & analytics at the
portfolio and customer level.
Organisational impacts include internal
policies, processes & systems across the
value chain through imposing additional
serviceability and operational
obligations.
Banks should consider implications at
the customer and facility management
level to better originate, manufacture
and distribute their products.
High impact 20%-30% Low impact <20%Significant impact >30%

Basel III Reform Capital Framework          
Fundamental Review of the Trading Book          
Responsible Lending       
Residential Mortgage Lending Guidance 223       
Advanced Approach to Credit Risk Capital (APS 113)        
Prudential Standard APS 110       
Banking Executive Accountability Regime (BEAR)      
Modernised Economic and Financial Statistic (EFS)     
BCBS239 Risk Data Aggregation      
IFRS9 Financial Instruments       
Royal Commission Recommendations (Observations)      
DUE TO OVERLAPS IN DATA, BANKS SHOULD CONSIDER
A SYNERGISED REGULATORY CHANGE
Observations on implicit requirements for compliance
SYNERGICREGUATIONS
Expressly identified within standard

Banks need to answer
five key questions to
assess their readiness in
the wake of additional
regulatory obligations
ARE YOU
READY?
1. Are you capturing the right data?
Banks need to understand what data they
require to capture at origination to meet
new serviceability and operational
requirements which has flow on impacts
to management and regulatory reporting.
2. Do you have limitations in your
current systems and infrastructure?
Banks need to assess their technology
and infrastructure systems to understand
existing limitations and gaps which could
possibly hinder meeting these new
obligations. Basel III provides an
opportunity to strategically address these
limitations and use appropriate tools to
improve the processes.
3. Do you have the resources and
capability to meet these requirements
within the regulatory timeframe?
Basel III will demand developing new
models and reporting capabilities that
will impact multiple systems. The banks
need to know how they will respond and
adapt to these new changes considering
the competitive regulatory initiatives and
market priorities.
4. How will the changes impact your
incentive scheme and front office
conduct and behaviour?
Banks need to ensure that they
incentivise, capture and document
accurate information to meet these
new obligations and equip the business
units with the right tools and adequate
risk knowledge to leverage it optimally.
5. Do you have the right resources,
capabilities and understanding of data
commonalties across the regulatory
change agenda to best meet these
new requirements?
Banks need to approach these
regulatory changes adopting a
strategic approach in gathering
requirements across the customer
lifecycle and understand the cross-over
with other relevant regulations.

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TALES SIAN LOPES
Managing Director, Finance,
Risk and Compliance Australia
& New Zealand
tales.s.lopes@accenture.com
+61 419 163 178
CONTACT US
ANDREW ATTARD
Manager, Finance, Risk and
Compliance Australia & New
Zealand
andrew.attard@accenture.com
+61 418 668 424

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The views and opinions expressed in this document are meant to stimulate thought and
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Basel III Mortgages: Australia - Key Themes and Strategic Approach

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