Last month, Labor MP Pat Conroy asked APRA chairman Wayne Byres a question in relation to the regulatory capital benefit of Internal Ratings Based (IRB) banks versus non-IRB banks.
The question, posed as part of the House of Representatives’ inquiry into APRA’s annual report 2015 (led by the standing committee on economics), sought to understand the difference in risk weights for the two banking categories.
For example, common equity tier 1 regulatory capital (CET1) is said to be the most expensive form of funding, but APRA allows the major banks to hold less of this form of funding against mortgages compared to their competitors, leading to some claims that this creates an uneven playing field within the banking system.
According to APRA’s response, released earlier this month, the difference in the regulatory capital rules equates to a reduction in CET1 capital requirements of approximately $19 billion for the major banks, and an estimate pre-tax funding cost advantage of approximately 14 basis points.
The response reads: “For residential mortgages, IRB ADIs are currently subject to arrangements that are expected to generate, on average, a risk weight of at least 25 per cent; for standardised ADIs, the average risk weight is in the order of 39 per cent…
“Assuming a… target CET1 capital ratio of 9 per cent, the difference in risk weights between the standardised and IRB approaches equates to a reduction in CET1 capital requirements of approximately $19 billion (14 per cent), in aggregate, for the four major banks’ current Australian residential mortgage portfolios.”
APRA went on to outline that the difference in capital requirements will also impact ADIs’ profits and profitability, as an ADI with a higher risk weight will generate (all other things being equal), a higher profit in dollar terms, but a lower measure of profitability (e.g. return on equity).
The regulator added: “The implications of this difference will depend on the impact on an ADI’s overall cost of funding… [but a] simple but conservative example suggests an impact of around 14 basis points.”
However, APRA said that in practice, it is likely that the cost advantage is less than this.
COBA: ‘We need a fairer regulatory framework’
The APRA response has been welcomed by the Customer Owned Banking Association (COBA), an industry body for credit unions, building societies, mutual banks and friendly societies.
COBA CEO Mark Degotardi commented: “APRA has now confirmed that the difference in the regulatory capital rules equates to a reduction in common equity tier 1 capital requirements for the major banks of approximately $19 billion… and estimates that the pre-tax funding cost advantage for a major bank is approximately 14 basis points.
“This estimate is based on conservative assumptions so changing the assumptions would deliver a much larger estimate of the funding cost advantage.
“What it means is that in the mortgage market, the major banks have a head start built into the rules of the game.”
Mr Degotardi said that it was “significant” that the banking regulator had “removed any doubt that major banks gain a funding cost advantage from the regulatory capital rules and also from implied government support being reflected in their credit ratings”.
The COBA CEO added it was “important for all stakeholders to understand the various barriers to a more competitive banking market because only genuine, sustainable competition can deliver better pricing, choice, innovation and service for consumers”.
He said: “Customer owned banking institutions – mutual banks, credit unions and building societies – are eager to build on their 4-million strong customer base, but we need a fairer regulatory framework.”
As such, Mr Degotardi urged APRA to act with “greater urgency in implementing reforms that add to banking system resilience and reduce the advantages major banks have over their smaller competitors” (such as the recommendations that came out of the Financial Systems Inquiry in 2014).
COBA highlighted that it is not the only organisation to voice concern about competition in banking, with the chairman of the Australian Competition and Consumer Commission (ACCC), Rod Sims, and the chairman of the Australian Securities and Investments Commission (ASIC), Greg Medcraft, both telling the House of Representatives’ Economics Committee that there was a lack of robust competition in the banking industry.
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Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.