Mortgage rates could face “upward pressure” after the prudential regulator this week told banks to hold more capital to meet “unquestionably strong” benchmarks, according to economists.
In an announcement on Wednesday, the Australian Prudential Regulatory Association (APRA) said that in order to meet an “unquestionably strong” capital benchmark, a CET1 capital ratio of at least 10.5 per cent is required for banks which use an internal ratings based (IRB) approach to credit risk. Those lenders, including the big four and Macquarie Group, have until 1 January 2020 to hit the target.
Non-major authorised deposit-taking institutions (ADIs) will also be required to increase capital by around 50 basis points by 1 January 2020 as well.
Shane Oliver, chief economist at AMP Capital told Mortgage Business there was a “risk” that in needing to hold on to more capital, banks could impose higher rates.
“Because of the higher capital ratio it puts downwards pressure on bank margins which they may [respond to] by raising mortgage rates and rates to borrowers, both business and households,” he said.
It was unlikely shareholders would take a hit, he added, but in the first place lenders will look to get the extra capital from their initial public offerings (IPOs). The step after that would be to raise rates: “A high capital ratio adds to the cost of funding; a high capital ratio, the more capital a bank is required to hold. That capital is usually used to… fund lending activities, so the more capital a bank has to hold, the greater its cost of funding [loans].
Ernst and Young’s Oceania banking and capital markets leader Tim Dring echoed Mr Oliver. He argued that increasing capital ratios could be a cost that is “ultimately born by consumers and businesses through increases in interest rates and fees and charges.”
APRA’s announcement comes off the back of the 2014 Financial System Inquiry (FSI) which recommended that APRA set capital ratio standards for ADIs that are “unquestionably strong”.
APRA chairman Wayne Byres said yesterday that “APRA’s objective in establishing unquestionably strong capital requirements is to establish a banking system that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community.
“Today’s announcement is the culmination of nearly a decade’s financial reform work aimed at building capital strength in the financial system following the global financial crisis. Australia has a robust and profitable banking industry and APRA believes this latest capital strengthening can be achieved in an orderly way.
Mr Dring said there is “no disputing” how important a “more resilient sector is”, while Mr Oliver added that the regulator’s call reflected the “catastrophic” impact the failure of a major bank would have on the Australian economy.
“The failure of a relatively small bank or a small lender could be handled relatively easy in the context of the larger economy whereas the failure of one of the big banks could cause catastrophic implications for the economy, so that's largely why I guess they've been asked to hold more capital than the smaller banks.”
Changing lender landscape
The difference in the CET1 ratio increase (1.5 per cent for IRB banks in comparison to 0.5 per cent for other ADIs) could see a slight shift in the lending landscape, Mr Oliver said.
“You could argue that because their [non-IRB lenders] capital standards are lower, that does provide them a slight edge over the big banks or reduces the advantage the big banks otherwise have.”
“The big banks overall tend to be able to borrow in money markets at a cheaper rate than smaller banks and they have the advantage of being large in scale, which some would say gives them a bit of an oligopolistic power and has harmed the competitiveness [of the market],” he said.
However, whether APRA’s policy translates into a greater market share for the smaller lenders remains to be seen, he added.