Basel Risk Weights and Your Mortgage

Key takeaways

• Capital required = exposure x risk weight x capital ratio.
• APRA implements Basel standards through its prudential standards, including APS 112 and APS 113.
• Risk weights for residential mortgages vary by LVR, occupancy and repayment type.
• Lower risk weight is a cost advantage the lender can pass through as price.

How does a risk weight turn into a rate?

Capital rules do not tell a bank how much money to hold in total; they tell it how much equity to hold relative to risk-weighted assets. A $500,000 mortgage with a 35% risk weight becomes $175,000 of risk-weighted assets, and the bank holds its required capital ratio against that.

Equity is the most expensive money a bank has - shareholders require a return well above the cost of deposits. So a loan that consumes more capital must earn a higher margin to produce the same return on equity.

That is the entire chain: risk weight, capital, cost of equity, price. It runs quietly underneath every rate card in the market.

What drives the risk weight on a mortgage?

Under APRA's standardised approach in APS 112, residential mortgage risk weights depend on the loan-to-valuation ratio, whether the property is owner-occupied or an investment, whether repayments are principal and interest or interest only, and whether the loan is covered by eligible mortgage insurance. Weights rise as LVR rises, and investment and interest-only lending attracts higher weights than standard owner-occupier principal and interest.

The exact percentages are set out in APRA's prudential standards and are revised periodically, so check the current version of APS 112 rather than relying on a figure quoted in an article.

Why do big banks sometimes price sharper?

Because there are two ways to determine risk weights. Most lenders use the standardised approach, where APRA specifies the weights. The largest banks have accreditation to use the internal ratings-based approach under APS 113, where their own validated models produce the weights, subject to floors.

Historically IRB banks calculated materially lower mortgage risk weights than the standardised numbers, giving them a structural capital advantage on prime lending. APRA has narrowed that gap through capital floors and by adjusting the standardised weights, partly to address competitive neutrality between large and smaller lenders.

The gap has narrowed but the mechanism remains. It is one of several structural reasons a major bank can compete hardest on exactly the loans that are cheapest to capitalise - low-LVR owner-occupier principal and interest - and shows less appetite elsewhere.

Frequently asked questions

What is a risk weight?

A percentage applied to an exposure to calculate risk-weighted assets, against which a bank must hold regulatory capital. A lower risk weight means less capital is required for the same loan amount.

Why do investment loans cost more than owner-occupier loans?

Several reasons compound, and capital is one of them: investment and interest-only lending attract higher risk weights under APRA's standards, so they consume more capital and must earn more to deliver the same return.

What is the difference between standardised and IRB?

Under the standardised approach APRA specifies risk weights. Under the internal ratings-based approach, accredited banks use their own validated models subject to floors and supervisory approval. IRB has historically produced lower mortgage risk weights, though APRA has narrowed the gap.

Does lenders mortgage insurance reduce a bank's capital requirement?

Eligible mortgage insurance can reduce the risk weight on high-LVR residential lending under APRA's standards, which is part of why LMI makes high-LVR lending viable for the lender as well as protecting it against loss.

Related reading

• Bank Capital Requirements for Borrowers
• Expected Loss vs Unexpected Loss
• LMI in 2026: What It Costs by Deposit Size

Sources

• Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk — APRA
• Prudential Standard APS 113 Capital Adequacy: Internal Ratings-based Approach — APRA