The bank capital mirage

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By Leith van Onselen

The AFR’s Chris Joye has been on fire recently, systematically tearing apart the myth that Australia’s banks are “well-capitalised” and “safe”.

In today’s AFR column, Joye has taken on APRA’s new boss, Wayne Byres, and showed that in contrast to APRA’s claims that an increase in the home loan share of bank assets from 55% to 65% has been the main driver of the rise in their “risk-weighted” tier 1 capital, it has been actually fuelled by a regulatory artifice that will likely be reversed (thank you Deep T. before Mr Joye):

A central question for David Murray’s financial system inquiry is whether the striking increase in the major banks’ “risk-weighted” capital following the GFC was attributable to extra equity or regulatory artifice. This columnist has highlighted that the majors’ non-risk-weighted capital ratios – that is, the dollar value of equity divided by the dollar value of assets – have seen no improvement since 2004. I’ve argued it was the majors’ cutting home loan risk-weights, which denote the percentage of an asset they hold capital against, from 50 per cent before 2008 to a self-determined 18 per cent today, that yielded a spurious rise in Tier 1 capital…

More than three-quarters of the fall in the numerator of the capital ratio has been driven by the huge drop in the majors’ home loan risk-weights, which will likely be reversed as regulators realise that letting banks leverage 60 to 70 times when lending against frothy housing is imprudent.

The bottom line is that the post-GFC improvement in the major banks’ capitalisation is largely a regulatory fiction and not, as Byres alleges, a “de-risking” of balance sheets.

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This analysis follows Joye’s stellar effort in September when he showed that the actual level of capital held against the banks’ gross loans has actually fallen over the past decade:

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The defining question Murray must focus on is this: “Why are the majors holding less equity capital and more leverage than they were a decade ago, which runs contrary to the universal belief the banks are better capitalised than they were before the global financial crisis?”.

…thanks to the crazy reduction in the major banks’ risk weightings on home loans from 50 per cent before 2008 to 18 per cent today, it looks like equity capital has increased when it really has not…

Seriously, how can anyone still genuinely argue against raising bank capital levels? Doing so is absolutely vital in order to safeguard the safety and stability of the financial system, along with Australian taxpayers, who would ultimately be called upon to bail-out the banks if there was a financial crisis.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.