In the AFR I write today that one of the most enduring legacies left by the royal commissionwill be more conservative and risk-averse banks. This process was already underway after the Australian Prudential Regulation Authority (APRA) embraced the 2014 financial system inquiry recommendation that the banks deleverage. (direct AFR link here)
Since then the four majors have raised more than $50 billion in tier one equity and reduced balance-sheet leverage from more than 25 times to around 18 times today. Given a static return on assets, lower leverage translates into smaller returns on equity, as we have seen.
Most of the majors had also decided to divest themselves of non-core businesses, including exposures to Asia and the UK, funds management concerns and life insurance licences.
Since the Coalition's failed 2014 attempt to roll back the future of financial advice laws to enable banks to pay bonuses to advisers pushing in-house products, droves of planners have departed the oligopoly en masse to set up independent shops. So the whole process of vertically-integrating what were once simple savings and loan businesses into diverse financial supermarkets was being reversed.
Lower leverage and simplified business models may be bad for growth-seeking shareholders.
The royal commission will reinforce this dynamic. While lower leverage and simplified business models may be bad for growth-seeking shareholders, it is a welcome development for those sitting higher up the capital structure holding hybrids, subordinated bonds, senior bonds and deposits. In short, the probability of the banks blowing up because of excess leverage and/or unforeseen risks in non-core operations (or geographies) is falling fast.
And the generation of bank bosses who had an incentive to swing for the bleachers for short-term home runs irrespective of the long-term consequences for taxpayers is being superseded by a more cautious cohort that simply want to bat their balls back.
Later this year APRA will turn its mind to the question of how much loss-absorbing capacity our banks need. APRA has already dealt with this question from the vantage of "going-concern" capital, which speaks to the equity buffers the banks are building on the basis of APRA's new "unquestionably strong" capital ratio targets of "at least 10.5 per cent". On a risk-weighted basis, this ranks the majors among the best capitalised banks in the world.
The total loss-absorbing capacity (TLAC) rules being slowly introduced overseas may prove to be one of the more significant, and hazardous, consequences of the GFC. They mandate the sum of the going-concern (Tier 1) capital a bank needs to withstand a shock coupled with the "gone-concern" resolution capital a bank requires if it is to be expeditiously wound up or resuscitated via accelerated bankruptcy...
Christopher Joye is Co-Chief Investment Officer of Coolabah Capital Investments, which is a leading active credit manager that runs over $2.2 billion in short-term fixed-income strategies. He is also a Contributing Editor with The AFR.