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APRA proposes raising ADI capital requirements

APRA proposes raising ADI capital requirements

The prudential regulator is seeking to raise ADI capital requirements to enhance the financial system’s ability to cope with disruption.

The Australian Prudential Regulation Authority (APRA) has proposed increasing the total capital requirements of authorised deposit-taking institutions (ADIs), particularly the big four banks, to improve the financial system’s resilience to shocks and stresses in closer alignment with international practice and minimise taxpayer support.

In its discussion paper, released on Thursday (8 November) for consultation, APRA said that it is seeking to implement a new framework that is “simple, flexible and designed with the distinctive features of the Australian financial system in mind” to ensure that ADIs have sufficient “loss-absorbing and recapitalisation capacity”, as recommended by the 2014 Financial System Inquiry and subsequently supported by the government.

For the big four banks, which control about 80 per cent of banking sector assets, APRA is proposing to lift total capital requirements by 4 to 5 basis points of risk-weighted assets, representing around $17 billion to $21 billion of total capital, which will be absorbed incrementally over a four-year period from 2019 to 2023.

“This is not expected to have an immediate or material effect on lending rates,” the prudential regulator said.

While the banks are free to raise capital in any way they choose, the prudential regulator expects the bulk of the funds to be raised through the issue of Tier 2 instruments.

For other ADIs, APRA is suggesting that a small adjustment might be required depending on the outcomes of resolution planning, though it is unlikely.

“The events of the global financial crisis demonstrated the impact that failures can have on the broader financial system and the subsequent social and economic consequences,” the chair of APRA, Wayne Byres, said.

“The aim of these proposals — and resolution planning more broadly — is to ensure that the failure of a financial institution can be resolved in an orderly fashion, which protects the interests of beneficiaries and minimises disruption to the financial system.”

In its initial response to the proposal, National Australia Bank said that based on its risk-weighted assets of $390 billion, it expects an increase of $16 billion to $19 billion of total capital, “with a corresponding decrease in senior debt issuance”.

Westpac, on the other hand, said that it is presently not possible to determine the actual total cost because the pricing of Tier 2 capital will depend on the market price at the time of issue, and that the issuance will likely reduce the need for other forms of funding, which could also impact the cost of funding.

Patrick Winsbury, associate managing director of Moody’s Investors Service, said that if the proposed changes were implemented, this would “strengthen bank balance sheets further, consistent with APRA’s target of making Australian banks ‘unquestionably strong’”.

“We note that APRA has not chosen to adopt an approach involving total loss-absorbing capacity (TLAC), and has instead opted for a simple and flexible approach,” Mr Winsbury added.

Standard & Poor’s Global Ratings (S&P) said that the proposal could prompt a change to its outlooks on the major banks from negative to stable, adding that the changes “could lessen the need for the Australian government to recapitalise these banks if they were to experience distress”.

However, the ratings agency also expressed its belief that the proposal suggests a “continued heavy reluctance by Australian policymakers and the government to allow a default on any senior unsecured obligations of these institutions”.

“In our view, the proposal suggests no impediments or change in [the] Australian government’s attitude to bailing out a systemically important bank, if needed,” S&P said.

The agency remains unconvinced that APRA or the government is suggesting any “fundamental change in the existing regulatory or legislative framework for bank resolution”, arguing that it is merely proposing to raise total capital requirements, which it agrees will likely be raised through the issue of Tier 2 instruments.

“Nevertheless, the coupons of even the Tier 2 instruments are significantly greater than those for the banks’ senior unsecured debt,” S&P added.

While APRA doesn’t expect any immediate impact on lending rates, S&P expects “further compression in bank earnings and a passing through of increased costs of capital to customers on the asset and liability side”.

APRA is seeking feedback on the proposed changes by 8 February 2019.

Earlier this week, the government announced that it would inject an additional $58.7 million over two years to “strengthen” APRA’s enforcement powers after the regulator was criticised in the royal commission’s interim report for rarely taking wrongdoers to court.

Mr Byres’ chairmanship was extended for another five years for the sake of “stability” at a time when a number of initiatives and interventions are underway to address housing market challenges and improve accountability at financial institutions.

The regulator also this week published the final version of its cross-industry prudential standard, CPS 234, focused on the management of information security at regulated entities, the creation of which was prompted by the “accelerating threat of cyber attacks”.

[Related: APRA finalises information security standard for ADIs]

APRA proposes raising ADI capital requirements
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