By Eric Johnston
THE bank regulator has urged lenders to keep their levels of capital topped up to cover their exposure to reverse mortgages, cautioning that these loans rank among some of the highest risk.
The recommendation that banks hold more capital is likely to further pressure the fledgling $2.7 billion reverse-mortgage market, which was caught out last month when the Royal Bank of Scotland decided to shut down its Australian reverse-mortgage business.
Reverse mortgages are mostly used by older home owners to tap equity in their properties while they continue to live in them.
When banks are required to set aside more capital to cover their exposure to a loan, it dampens profitability.
If the loan is not repaid early, the principal and any accumulated interest are repaid from the proceeds of the sale of the property when the borrower dies or sells the home - usually to move into a retirement village.
While reverse mortgages became more popular in the 1990s, they have accounted for less than 3 per cent per cent of outstanding housing loans.
A recent study by accountants Deloitte found the Australian reverse-mortgage market consisted of nearly 39,000 loans worth a total of $2.7 billion at the end of last year, a growth of 9 per cent over the year. This compares with a 22 per cent growth in 2008 and 33 per cent in 2007.
In a letter to bank executives, Australian Prudential Regulation Authority general manager Charles Littrell said reverse mortgages were among the most risky loans even though they were secured by properties.
''The management of a reverse-mortgage portfolio can present challenges due to the long and uncertain maturity profile of the assets,'' Mr Littrell said in the letter. ''There are also a number of unique operational, legal and reputational risks associated with reverse mortgages.''
When a reverse mortgage represented more than 60 per cent of the value of the property, banks were required to hold the maximum amount of capital to back the loan, he said.
This contrasts with a standard mortgage, where banks can set aside just a fraction of the value of the loan.
He also said that if the accumulated interest and outstanding principle of a reverse mortgage outstripped the value of the house, then the exposure had to be treated as an impaired loan.