New APRA Capital Ratios Could be Credit Positive

Moody's believes APRA's new proposals for the reporting of capital ratios could end up being credit positive for the Aussie banks, arguing that "both options would be credit positive because each would improve the comparability of Australian banks' capitalisation to global peers". I wrote about this in the AFR on Friday/Saturday, commenting (excerpt only, read the full column here):

With this in mind, APRA recently released a significant new consultation paper calling for feedback on the way it calculates bank equity capital ratios. Because APRA is so globally parsimonious in its approach to measuring capital on a bank's balance-sheet, the majors' reported common equity tier one (CET1) ratios look low by global standards.

Yet as APRA explains in its study, if our banks were assessed according to the same rules offshore peers use, their published CET1 ratios would be 4.85 percentage points (or almost 50 per cent) higher. In CBA's case, for example, its official CET1 ratio of 10.7 per cent jumps to 15.5 per cent on an internationally harmonised basis, which ranks it fifth in the world (among large banks).

This creates several problems. First, when banks raise funding overseas, their leverage looks superficially higher than it actually is relative to rivals. Following APRA's move to establish unquestionably strong equity buffers, the four majors clearly rank among the eight best capitalised banks on a globally consistent basis.

Yet there is no official APRA reporting on precisely what these internationally harmonised capital ratios would look like (there is only an indicative methodology). This probably means our banks have to pay more to raise money globally than they should do, which flows-through to lower deposit rates and dearer home loans.

A second concern relates to the fact that the automatic regulatory trigger in the banks' hybrids, or additional tier one (AT1) capital securities, is set at a 5.125 per cent CET1 ratio benchmarked against globally elevated risk-weighted assets.  If a bank's CET1 falls to or below this threshold, the hybrids get converted into equity.

Yet because Aussie bank CET1 ratios are artificially low as a function of APRA's conservatism, this in turn means the gap between their actual CET1 ratio and the 5.125 per cent trigger in unusually skinny. If one were being globally consistent, this gap should be between CBA's 15.5 per cent CET1 ratio and 5.125 per cent, not between 10.7 per cent and 5.125 per cent. (My data-scientists looked at 360 global hybrid issues and found that 70 per cent had triggers at 5.125 per cent.)

This has two adverse consequences. First, APRA is given far less flexibility to avoid bank bail-ins compared to regulators elsewhere. And, secondly, Aussie bank hybrids are likely unnecessarily expensive (i.e. credit spreads are too wide). The latter is amplified by the fact our banks are heavily reliant on domestic retail markets to source this capital, which has the unfavourable effect of internalising loss-absorption (many big banks source their hybrid money from external markets).

It certainly makes sense for APRA to ensure banks are competing on a level global playing field when it comes to raising funding, which necessitates globally comparable capital ratios. This is especially critical for a country like Australia that runs perpetual current account deficits as a result of the need to important foreign capital (via the banks) to underwrite local investment.

And given APRA always has the option of invoking its "non-viability" clause in hybrids at any time (converting them into equity to provide extra capital), the argument for ensuring its decision-making flexibility is not needlessly hampered by unusually small buffers above the 5.125 per cent trigger is no less compelling.