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Table of Contents
Executive Summary.........................................................................................................................2
1.0

Differences between bank credit risk and bank capital risk.................................................3

2. Differences between lending to individual via residential home mortgage to other type of
consumer lending.............................................................................................................................4
3.0 Comparison between Australian Bank and UK Banks..............................................................5
3.1 Residential Mortgage loans to Gross loans (Percentage)......................................................5
.....................................................................................................................................................5
3.2 Non Performing Loans (percentage).....................................................................................6
3.3 Major changes in residential loan over Year 2007 to Year 2014...........................................7
3.4 Australian Banks Vs U.K Banks credit quality (from non-performing loan ratio)................8
4.0 Impact of introducing comprehensive credit reporting (CCR) in Australia............................10
Conclusions....................................................................................................................................11
References......................................................................................................................................12
Appendix........................................................................................................................................14

Executive Summary
This reports aims to interpret Australian Banks (which includes National Australia Bank limited,
Commonwealth Bank of Australia, Australia and New Zealand Banking and Westpac Banking
Corporation) and United Kingdom Bank credit quality. The report will first distinguishes the
differences between bank credit risk and bank capital risk. In the second part of the report, it will
distinguishes the difference between lending to individual borrower via a residential home
mortgage compare to others type of consumer lending from lenders perspective.
In order to portrait a clearly view in comparison of Australian Bank and United Kingdom Bank,
five banks were chosen and divided into two groups. Banks included in Australia banks are
National Australia Bank limited, Commonwealth Bank of Australia, Australia and New Zealand
Banking and Westpac Banking Corporation while United Kingdom bank include Barclays Bank.
Two ratio are being analyze from Australian Bank and UK bank which are residential loan as a
percentage of total loans and non-performing loan ratios. A data from Year 2007 to 2014 were
taken as data. All the data for these five banks are generate from Bankscope.

As Australia is introducing comprehensive credit reporting (CCR), the impacts of CCR are
discussed in the last part of this report.

1.0 Differences between bank credit risk and bank

capital risk
Bank credit risk is the potential loss bank would faces or suffers if bank borrower which also
known as counterparty fails to meet its obligations by paying interest on the loan and repay the
amount borrowed (the principles amount) in accordance with agreed terms. (GARP , 2014)
Credit risk also refers as default risk. (Varatto, 2011). It is the single largest risk that most of the
bank face and arises from the possibility that loans or bonds held by bank will not be repaid
partially or fully. (Saunders, 1994) The Basel Committee on banking division reports (Basel
Committee on Banking Supervision, 1999) that credit risks equal to a measure of unexpected
credit lossthe difference between the expected value and an extreme loss value of the
probability distribution of a credit portfolios potential future value. (Kupiec, 2002)

Bank capital risk is the potential risk shareholders, creditors and depositors of bank faces in
terms of bank insolvency by having insufficient capital and reserves to buffers and supports its
financial risk, operational risk and environmental risk. Shareholders have an interest in return on
the capital they invest in bank hence bank capital risk should be low; while for creditors and
society it is important that bank maintains sufficient buffer or risk capital to cover potential
losses. (Swedbank, 2014). Higher bank capital risk happen when capital in the bank cannot cover
losses; bridge cash flow and pay off creditors. (Maisel, 1983). The measurement of bank capital
is Capital Adequacy Ratio (CAR) which also known as Capital to Risk (Weighted) Assets
Ratio (CRAR) which set minimum requirement on the size of buffer based on how much risk
bank assume (Fatima, 2014). Capital Adequacy Ratio is expressed as a percentage of a bank's
risk weighted credit exposures.

2. Differences between lending to individual via

residential home mortgage to other type of consumer
lending
In the bank perspectives lending to individual via residential home mortgage is considered as
secured loan as compare to other type of consumer lending. (Gitman, Joehk, & Billingsley,
2013). As residential home mortgage is secure with residential property, the said property serves
as collateral for the mortgage loan and can repossessed by lender should the buyer fail to make
payment; other type of consumer lending are considered either secured or unsecured loan as
some of the consumer lending are tie with collateral like auto loan while personal loan are
approve with no collateral. Residential mortgage loan amount are corresponds to a well-defined
proportion of the total investment being made.

Lending to individual borrower via residential home mortgage lender is facing longer repayment
period than any common type of consumer lending. Repayment period for residential home
mortgage is at least ten years and above whereas most of consumer loans are typically short term
and must be paid off within five years. (Honigman & Sotelino, 2015).Hence, lenders face greater
interest rate risk in with residential home mortgage which lend out at fixed interest rate; lenders
less interest rate risk with floating interest rate home mortgage compare to fixed rate. (Dorsey &
Rockwell, 2005)

In order to protect the lender or bank against potential loss from residential home mortgage,
lender or bank will requires individual borrower or home owner to maintain adequate property
insurance against storms, fire or other calamities. Most of the time, banks will collect insurance
premium of property insurance from homeowner to make sure its security is covered; while for
other consumer lending insurance is not required by the bank (Center for Financial Training,

2009).Residential home mortgage loan application process is much longer time and more
involved than other consumer loan. Bank or lender need to process mortgage loan application in
more detailed as the transfer of real property brings into play and more legal issues than a simple
contract in other consumer loans. (Ryan & Ryan, 2015)

3.0 Comparison between Australian Bank and UK Banks

3.1 Residential Mortgage loans to Gross loans (Percentage)

Residential Mortgage Loans/Gross Loans

Per cent
80.00

70.00

60.00

50.00

40.00

30.00

20.00

10.00

0.00
2007

2008

2009

2010

2011

Graph 1: Residential Mortgage Loans/ Gross Loans (Per Cent)

3.2 Non Performing Loans (percentage)

2012

2013

2014

Non-Performing Loan
Per cent
10.00
9.00
8.00
7.00
6.00
Per cent

5.00
4.00
3.00
2.00
1.00
0.00
2007

2008

2009

2010

2011

Graph 2: Non Preforming Loans to Gross Loans (Per cent)

3.3 Major changes in residential loan over Year 2007 to Year 2014

2012

2013

2014

Graph 1 of residential mortgage loans to gross loans from Year 2007 to Year 2014 clearly
indicates that both Australian Bank (includes National Australia Bank limited, Commonwealth
Bank of Australia, Australia and New Zealand Banking and Westpac Banking Corporation) and
United Kingdom Bank (Barclays Bank) shows that the general trend of residential mortgage
loans are moving upward and there is a significant changes in residential mortgage loan during
the year of 2008.

There a few factors contributes to the major changes in residential loans over the years. In the
beginning of Year 2007, there is strong growth in the housing sector, great competitions in
mortgage market and banks leads to higher approval of mortgage loan and loosen lending
practice among global banks. (Reserve Bank of Australia, 2007) Hence, the percentage of
residential loan in all these five banks appealing to be high in year 2007.

The major changes happen in year 2008 leads to major decline in residential mortgage loans.
United States Subprime mortgage crisis happen in December 2007 to June 2009 (The National
Bureau of Economic Research, 2015) was triggered by large decline in home price, high default
rate in housing loans and devaluation of housing related securities. It caused global crisis and
high household debt globally. (Mian & Sufi, 2014) In graph 1, it clearly shows that the
percentage of residential loans drops significantly in year 2008 in all the five banks compare to
2007 as the global crisis and challenging economy conditions, falls in household wealth,
declining lending standard and value of housing assets falls are discourage the overall housing
markets. (Reserve Bank of Australia , 2008).

After year 2008, the residential mortgage loans percentage for both Australia and United
Kingdom are trending upwards. In year 2009, fiscal and monetary stimulus are introduces in both
countries where central bank provided liquidity support to local banks, increase in consumer
confidence release some pressure on housing asset valuation. (Reserve Bank of Australia, 2009).
However, in Year 2009 to Year 2011 the higher unemployment rate still weight in housing market
and loan write off continue to increase.

There are more favorable macroeconomics conditions in Australia throughout the year of 2011 to
2013, as Australian bank strengthening their balance sheet having extra capital buffer, with lower
interest rate environment, housing price are increasing gradually, tighten lending standard are
weight in low non-performing loans which leads to higher residential loans percentage for
Australian banks like National Australia Bank limited, Commonwealth Bank of Australia, and
Westpac Banking Corporation. (Reserve Bank of Australia, 2012) Investor demands in Australia
continue to drive housing and mortgage market with low interest rate ad strong competition
among lenders are translating into robust growth in housing market. (Reserve Bank of Australia,
2015)

In the context of United Kingdom, global economy are intensify throughout the year of 2011 to
2013 and the graphs shows that Barclay Banks residential loan increase steadily over the years
from 2011 to 2013. However, the euro area problems are weight into United Kingdoms asset
performance are continue to deteriorate in year 2014 and hence residential loan percentage of
Barclay banks drops in year 2014. (Reserve Bank of Australia, 2014)

3.4 Australian Banks Vs U.K Banks credit quality (from non-performing loan ratio)
In order to assess banks credit quality, the impairment charges play an important role as it is one
of the most volatile line items in banks income statement. Impairment charges is the net changes
by calculating in the way off: bank will add up all its bad loans, estimate loan provisions, and
then adjust the numbers by amount of actual loan write off and recoveries in the period. When
credit environment suddenly changed, impairment charges will swing around widely and
unpredictably. Key indicator of impairment charges is the level of Non-Performing Loan (NPL)
which calculate by Non-performing loans ratio. An increase in NPL ratio indicates that
impairment charges will rise; a fall of NPL ratio indicates that falling in impairment charges.
(Chen, 2013)

Credit quality metrics for all five banks are draw out in Graph 2 Non Performing loan ratio. Over
the eight years, all these five banks are facing rise in Non-Performing Loan Ratio. By observing
the graph, all these five banks are facing sudden spike in NPL ratio during Year 2008 to Year
2010 during the global financial crisis and after math of global financial crisis. Until Year 2014,
all of these five banks NPL ratio is still above pre crisis level of Year 2007.

All these 5 banks recorded low NPL ratio in Year 2007 before Global financial crises (which
occur 2008 to 2011) and default risk is still low. During the Global Financial Crisis in year 2008
to 2011 both Australian and United Kingdom bank registered extremely high NPL ratio and the
NPL ratio drops during the global economy recovery in Year 2012 onwards.

Graph 2 clearly shows that United Kingdoms bank (Barclay banks) has the highest ratio
compare to all other four Australians bank namely National Australia Bank limited,
Commonwealth Bank of Australia, Australia and New Zealand Banking and Westpac Banking
Corporation. Before Global Financial Crisis, Australia banks NPL ratio is below 1 but Barclays
bank registered more than 1 percent NPL ratio and it increase tremendously during Global
Financial Crisis which is five to six times more compare to Australian Bank. The Ratio reflects
that U.K banks are considerably risker than Australias bank and it has loose lending practices
and the findings is tally with World Bankss data which shows that U.Ks NPL ratio is always
higher than Australians Bank. (Refer Graph 3 in appendix).

All of the four Australian Bank is doing well pre crisis and during crisis. During crisis, Australia
NPLs ratio are increasing but not as severe as U.K bank. Out of the four banks, ANZ and NAB
banks possess a great improvement over its NPL ratios.

4.0 Impact of introducing comprehensive credit reporting

(CCR) in Australia
Australia comprehensive crediy reporting (CCR) introduce on March 2014 with the aims that to
allow credit provider such as banks and all other lenders to share negative-only information
about consumer through credit bureau.(Johnson, 2013). There are five new data to be shared by
credit providers which are date account open; credit limit ; type of credit; date account close and
repayment history.

The good impacts of introducing CCR are it will creates growth in lending; making lending
fairer; and helping lenders mitigate risk ( which lower NPL ratio further). By having details
repayment history of borrower; lender are more willing to lend out hence lending growth
increase. Other than that, bank will also have more accurate pricing of risk premiums to
individual by using CCR as source of credit analysis.

CCR reports will makes lending markets works efficiently as the better information allows
lenders to be more accurately measure borrower risk and set loan terms accordingly. Lender can
recognize high-risk borrowers and set appropriate higher interest rate and consequently lower
risk borrower can enjoy attractive rates and further stimulate the quantity of loans demanded.
(Baron & Staten, 2011). So, lender can be prepared and ready in estimating their lending risk of
customer base they are having.

CCR will also increase productivity in Australian economy as a recent report by Policy and
Economic Council (PERC) suggests that CCR will create growth in lending to private sector
making lending fairer. (Turner, Varghese, & Walker , 2015)

The negative impact of CCR is it encourages entry of new competitors, including non-bank
financial institutions, which has stimulated vigorous price competition and more convenient

products. For instance, larger bank which holds large client base that contribute full
comprehensive data to the CCR is actually handing over their client info to its competitors to
offer better rate and dilute their competitive advantage. (Bruhn, Farazi, & Kanz, 2013).

Conclusions
This report explains thoroughly bank credit risk are totally different with bank credit risks. It also
pointed out that the lending practice are differ between Australian Bank and UK bank. The
performance between Australian Bank and U.K Bank are judge by non-performing loan ratio and
it clearly indicates that Australian bank have tighter lending practice and hence lower risk. In the
implementing of comprehensive credit report it brings both good and bad impact to Australian
bank and its economy.

Words count: 2,069 words

References

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Appendix

Graph 3 : Banks Non Performing Ratio (worldwide)