S&P/ASX 200 Index (ASX: XJO) bank shares are having another rough day of it, as investors remain cautious ahead of tonight’s interest rate decision by the US Federal Reserve.

In late afternoon trading the ASX 200 is down 0.6%, with all but one of the ASX 200 bank shares trailing the benchmark.

Down 0.6%, the Commonwealth Bank of Australia (ASX: CBA) share price is the best performer among the big four banks at time of writing.

Meanwhile, the Australia and New Zealand Banking Group Ltd (ASX: ANZ) share price is down 1.3%; the National Australia Bank Ltd (ASX: NAB) share price is down 1.2%; and Westpac Banking Corp (ASX: WBC) shares are down 1.1%.

Why are ASX 200 bank shares underperforming?

The big banks can benefit from aspects of rising interest rates. Mainly, they’re able to increase their net interest margins as rates climb from historic lows.

However, rising rates can negatively impact the demand for new mortgage loans. And, crucially, higher rates could see a spike in the number of bad debts held by ASX 200 bank shares.

Today’s underperformance could be tied to the latter issues, as investors mull over the implications of a precautionary letter sent to the banks yesterday by Australian Prudential Regulation Authority (APRA) chair Wayne Byres.

What is APRA concerned about?

The financial regulator is concerned that rising interest rates could result in a rise in bad debts.

As the Australian Financial Review noted, APRA’s March quarter data indicated that 23.1% of new mortgages are considered risky, with debt-to-income ratios of at least six times. While that’s down from the 24.3% in the December quarter, it’s well above the 18.9% figures from March 2021.

According to APRA, the ASX 200 bank shares “need to have systems in place to limit growth in higher risk residential mortgage lending, such as loans at high debt-to-income multiples or high loan-to-valuation ratios”.

Byres continued:

In the current environment, with high household indebtedness and rising interest rates, it’s essential for banks to prudently and proactively manage risks in residential mortgage lending.

APRA expects lenders to closely monitor housing lending risks to ensure that aggregate portfolio risks remain within their risk appetite and that standards for new lending remain prudent.

With stricter lending standards, the ASX 200 bank shares’ lucrative home lending businesses could face some additional headwinds.

The post Why are ASX 200 bank shares having another day to forget? appeared first on The Motley Fool Australia.

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Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Westpac Banking Corporation. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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