Accounting standards & proposed changes to negative gearing to impact bank profitability

Banks need to be thoroughly prepared for AASB 9, with proposed changes to negative gearing set to have a material impact on loss provisioning and profitability, according to RiskWise Property Research.

Under the new financial instruments, accounting standard banks will need to make provisions under an ‘expected credit loss’ (ECL) model, rather than the incurred loss models used previously.

Where banks identified an increase in credit risk, a loss allowance must be recognised in respect of a residential mortgage before it became past due.

The ECL impairment model must incorporate detailed macro-economic modelling and consideration of multiple forward-looking scenarios.

For residential lending, mortgage books need to be better analysed and in more detail across each portfolio.

Changes in tax legislation to create further challenges.

Wargent Advisory CEO Pete Wargent highlighted the potential impact of changes to negative gearing and capital gains tax legislation, if the ALP succeeds at the next Federal election, as one possible challenge for loss provisioning. 

“Extensive RiskWise modelling shows that, nationally, dwelling prices would fall by 9 to 12 per cent should the proposed changes to tax legislation be voted through and, under AASB 9, banks will need to consider such forward-looking information in their models,” Mr Wargent said.

“This could soon become the base-case scenario as the Federal election approaches and banks need to prepare accordingly.

In addition to the obvious impact on each of the loan portfolios, banks will need to accurately assess the risks associated with future lending decisions.”

Regional modelling essential

Mr Wargent said although the proposed changes to tax legislation would be applied nationally, there would be meaningful variations in performance at the regional level. 

“RiskWise models show that, by SA4 region and dwelling type, there will be significantly different impacts, and banks must use similarly detailed models or risk failing to comply with the standard,” he said.

“Even at the regional level the findings were often markedly different for houses and units, with material impacts in certain areas of highly concentrated rental stock that isn’t family-appropriate.”

Weaker housing market conditions already reflected a deterioration in buyer sentiment.

Our models have also assessed potential impacts on the price of new dwellings and consequently loss provisioning for construction loans needs to be updated where the risk of default increases.

All these changes require lenders to manage this process in a thorough and timely manner to assess the impact on each of the SA4s regions.

External auditors will need to review ECL models and should work jointly with independent property research companies to ensure that bank models meet the requirements of AASB 9.

Due to the complexity and inherent uncertainties, the impacts should be reviewed regularly, potentially leading to significant adjustments.

Banks may not have adequate internal models for this complex scenario analysis.

If they don’t act now the impact could potentially be material to financial reporting and, in turn, to share prices.

About Doron Peleg is the CEO/Founder of RiseWise Property Review. He has more than 20 years’ experience in risk management including, Co-Founder of Peleg, Kessel & Co, an assurance and advisory accounting firm & Executive Manager at Westpac Banking Corporation in Sydney. www.riskwiseproperty.com.au/