Capital adequacy requirements level playing field for regional banks

Christopher Joye

Coolabah Capital

APRA very much backs (or “reinforces”) the FSI’s analysis that while the major banks might be “well capitalised” they are not “unquestionably strong”, which is an FSI recommendation that APRA has embraced.  Specifically, APRA finds that on an internationally comparable basis, the major banks' crucial “common equity tier one” (CET1) capital ratios are “are above the median, but not in the top (fourth) quartile” (more particularly, they are situated in the middle of the 50th and 75th percentiles). APRA also reveals that it will commence using the FSI’s recommended benchmark of keeping the major banks’ CET1 ratio in the 75th percentile (top quartile) of internationally active banks as a “sense check” (aka sanity test) of their capital ratios over time, although it will not calibrate the banks’ capital on the basis of this level. This avoids the need for the banks to change capital simply because the 75th percentile level has moved around, which can happen for a variety of reasons that may or may not be relevant to the prudential supervision of local deposit-takers. To lift the majors' CET1 ratio towards the 75th percentile, APRA concludes that they would only have to increase equity by about 70 basis points above their June 2014 levels, which was circa 8.6 per cent on average according to Bank of America Merrill Lynch. 
  
But APRA notes that because its analysis makes a range of assumptions that are likely to be quite favourable to the majors, and the major banks’ CET1 ratios have declined relative to peers overseas since June 2014, it believes “that the Australian major banks are likely to need to increase their capital ratios by at least 200 basis points...to be comfortably positioned in the fourth quartile”. In dollar terms UBS's No. 1 ranked analyst, Jonathon Mott, estimates that this represents a CET1 shortfall of about $24 billion of additional capital beyond that the banks had already raised by June 2015 (or $30 billion on June 2014 levels). That's consistent with the lower bound of estimates I had previously canvassed. Yet this number may be a low-ball for two reasons. APRA has yet to respond to the FSI’s recommendation of introducing a minimum average "risk-weighting" of between 25 per cent and 30 per cent for the majors’ residential mortgage assets and there are likely to be higher risk-weights applied to their non-residential assets as a consequence of Basel 4.  UBS's research implies that the combined impact of all of this will be about another $16 billion in CET1, resulting in a total short-fall of $40 billion. The AFR's Chanticleer says the majors will only be given 12 months to boost CET1 in response to the announcement APRA is about to make on the increase in average residential mortgage risk-weight floors. This will presumably be met by dividend reinvestment plans, asset sales, and secondary offerings.


Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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