What homeowners need to know about mortgage lenders going bankrupt

Speaking simplistically, it's unlikely for an Australian bank to go bankrupt. What happened at the Silicon Valley Bank (SVB) isn't very likely to occur in Australia, thanks to the checks and balances put in place by regulatory authorities like the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). 

While the events at the Silicon Valley Bank sent ripples across the global financial industry, it's worth remembering that Australian banks work differently from how things unfolded at SVB. 

Banks in Australia typically do what they are supposed to do – lend depositors' money and earn interest on it to make a profit. SVB, on the other hand, had large amounts of deposits invested into government bonds. 

Even though government-backed securities are considered safe assets, they are vulnerable to interest rate movements. When interest rates started rising last year, the bonds quickly lost value, and SVB found itself sitting on huge losses. 

Soon enough, there was an exodus of withdrawal requests from customers, and the bank couldn't raise enough cash to meet the outflow. As most of the bank’s deposits came from the tech sector, they were well above the $250,000 deposit insurance limit, a major trigger for the mass withdrawals that took the bank under.

Unlike SVB, Australian banks are "mortgage focussed banks funded with retail deposits." Additionally, APRA requires all authorised deposit taking institutions (ADIs) to hold a minimum level of liquid assets as a security net against possible liquidity risk.

The regulatory authority upholds similar standards for all banks in Australia, irrespective of their size or scale. This is different in the US, where banks may choose their regulator. 

SVB was regulated by the California Department of Financial Protection and Innovation – which could mean it wasn't subject to the same liquidity standards imposed on the larger US banks by the Federal Reserve Board.

Overall, it may be safe to say that the major banks in Australia wouldn't go bust. Even RBA assistant governor Christopher Kent affirmed the strong position of Australian banks in a recent speech, despite the increasing volatility in markets.

"Australian banks are unquestionably strong - the banks' capital and liquidity positions are well above APRA's regulatory requirements,” Kent said.

However, it's important to remember that while a financial institution going bust in Australia is highly unlikely, assuming that such a situation is impossible isn't prudent. 

No economy is wholly insulated from the impact of the events taking place across the world. Still, one could say we're in a relatively stable position in Australia due to the strict regulations imposed on banking operations in the country.

Furthermore, even if we assume the worst were to happen, the Australian government would step in with the  Financial Claims Scheme (FCS) to make sure your money isn't lost. 

Before we answer that question, it's important to reiterate that it's unusual for Australian mortgage companies to go bankrupt. However, if your mortgage lender went bust and it was classified as an ADI, you needn't worry, as it's likely it would be taken on by another lender.

ADIs, otherwise known as Authorised Deposit-taking Institutions, refer to banks, building societies, credit unions and other financial institutions that are licensed to accept and hold deposits of money from the general public. Not every home loan lender is an ADI, so it's worth checking before you apply if this is something important in your mortgage comparison.

So, if a mortgage lender goes bankrupt and they are an ADI, your loan is covered by the FCS. The Australian government guarantees deposits up to $250,000 under ADIs. The same guarantee also protects your savings and deposits with banks up to a limit of $250,000.

Generally speaking, your home loan will most likely be transferred to a new bank that chooses to absorb the bankrupt mortgage lender. The net effect is that you get a new lender and continue making your mortgage repayments as before, albeit to the new lender.

It is also unlikely for the new lender to change the terms of the agreement. However, the interest rate could move up or down depending on the terms set by the new lender. You also have the option to refinance your home loan if you're not satisfied with the new rate on your home loan.

If you're worried about losing your home if your lender goes bankrupt, don't fret. Lenders cannot call up your loan or ask you to pay it down early unless you're in default.

However, regarding the bells and whistles on your home loan, you might find your redraw facility restricted or waived. While you won't lose out on the extra repayments you've made, the additional funds you paid into your loan could become inaccessible, at least for some time. On the other hand, if you've been using an offset account linked to your mortgage, you may be covered by the FCS as well.