APRA embraces too-big-to-fail


I’ve come out of my self imposed exile, to point out the howler of bank regulation of 2013. There’s been no or little main stream press on this and no comment that I could find and little wonder. APRA saw fit to release this Information Paper on 23 December 2013.

This paper is very important to the Australian financial system. To quote:

“This Information Paper outlines the approach that the  Australian Prudential Regulation Authority (APRA)  intends to take in implementing the D-SIB (Domestically systemically important banks) framework in Australia. Chapter 2 sets out the principles of the  Basel Committee’s D-SIB framework. Chapter 3 outlines APRA’s framework for determining domestic systemic importance and Chapter 4 identifies the banks assessed by APRA to be D-SIBs in Australia. Chapter 5 outlines the methodologies and considerations taken into account by APRA in determining an appropriate HLA (high loss absorbency) requirement for D-SIBs”

In summary, APRA used the Basel committee’s four objective key indicators of systemic importance: size, interconnectedness, substitutability and complexity to determine Australia’s D-SIBs. No surprise that APRA arrived at the four divisions of Mega Bank.

“On this basis, APRA has determined that the following four banks are D-SIBs in Australia:

  • Australia and New Zealand Banking Group Limited;
  • Commonwealth Bank of Australia;
  • National Australia Bank Limited; and
  • Westpac Banking Corporation”

The D-SIB framework seeks to reduce the probability of failure of banks deemed to be systemically important by increasing their ability to absorb losses on a going concern basis through applying a high loss absorbency (HLA) capital buffer. APRA assesses that:

“The methodologies and benchmarks suggest that an appropriate range for the HLA requirement in Australia would be in the order of one to three per cent of risk-weighted assets”

I always suspect a fix when I see “risk-weighted asset” (“RWAs”) as my blogging history speaks to.

So what did APRA decide?

In one of the most dubious regulatory decisions ever made:

“APRA has determined that the HLA requirement for the four D-SIBs will be one per cent, and must be met in full by Common Equity Tier1 capital“

So 1% of RWAs is the HLA the bottom of the range and why?

“Banks (and other ADIs) in Australia have traditionally held a higher quality capital base than many of their offshore peers, although reported headline ratios appear lower than those peers”

No proof is supplied for this assertion or detailed numbers and comparisons other than:

“and, for advanced banks, requires capital to be held against interest rate risk in the banking book and imposes a floor of 20 per cent for downturn loss-given-default on residential mortgages”

No comparison proof and the fact that imposing a floor on LGD of 20% is meaningless unless one knows and can compare probability of default.

However, a 1% HLA based on RWAs is a penalty that does nothing to restore competition for non-Mega Bank ADIs in the mortgage sector. As Mega Bank has an average risk weighting on residential mortgages of just 16% under their internal risk based models, the average minimum capital is 1.28% (8% x 16%). Add the HLA and the minimum capital is 2.28%. Other Australian banks on the standard method are weighted 40% must hold minimum capital of 3.2% (8% x40%), still almost 1% higher than the identified D-SIBs.

But the cosy relationship between Mega Bank and APRA does not stop there:

“At 1 January 2016, the management capital buffers of the D-SIBs may be lower than current levels given the additional HLA requirement. APRA considers it reasonable if D-SIBs choose to operate with a relatively lower management capital buffer from 1 January 2016 given the nature and size of the extended capital conservation buffer”

So what does that mean? It means that Mega Bank can lower its buffer put for management prudence and risk control to absorb the 1% HLA. So guess what, no change whatsoever in the actual capital requirements of Mega Bank.

This is a true Shakespearean farce!


  1. Welcome back from Tatooine, Deep T, I have missed you. Thanks very much for this post.

    It is remarkable how silent the press has been on these developments. I hadn’t even seen mention of APRAa decision (albeir bleediny obvious) that the big 4 are D-SIBs, let alone an explanation of what the decision means for the big 4’s prudential capital levels.

    I have one request – can you elaborate on what a 20% LGD floor on residential mortgages means?

    • When minimum capital requirements are calculated it’s based on probability of default times LGD. So simple logic tells you that fixing LGD without knowing PD does not enable a comparison to be made with other regions.

      I did a comparison a few years ago between CBA and BoS in the UK on this point. I compared them be cause their mortgage books were about the same size and quality. The UL regulator had a min LGD of 10% and APRA 20 but guess what the required capital was exactly the same. Just fiddle with PD to get the answer you want

      • Thankyou for the explanation. I understand your point about the role of the PD in the calculation. So does each bank determine a PD for its mortgage book (and presumably other books)?

        Also, I take it that the 20% floor is meant to reflect the practice of the banks requiring LMI for >80% LVR loans, but clearly it ignores the thinly capitalized insurers that have written the LMI…

  2. migtronixMEMBER

    Wow just wow! 1% teir 1 capital backs all of that s#*t? Talk about a ponzi! And welcome back DeepT

  3. Thank you, DeepT. There can be no question the big 4 have captured their regulator – a puff of wind would lift this flimsy garment and expose their skinny legs.

    Over the last three months the $A has moved from $US 1.00 to .89c. Somebody, somewhere has taken a 10% haircut on Australia’s $800 billion+ net foreign debt, featuring borrowings the big 4 have used to fund their domestic mortgage business.

    Yes, yes, the change has been dispersed by time, currency and institution, but it is there nonetheless.

    If the RBA jawbones the currency lower, will these counterparties be willing to renew their short term loans? No. This doesn’t make the whole $800 billion due and payable, but it does change the appetite for $A lending.

    Don’t Buy Now!

  4. The problem is that the banks are allowed to use their own risk weighting models that do not require any adjustment as prices grow faster than inflation.

    There is no transparent feedback for higher prices which indicate increased risk.

    There is no transparent feedback for potential dramatic increases in supply such as will happen if we have housing construction increases to take up employment slack as the mining construction boom washes off.

    When was the last time any bank economist published a forecast of recession more than 3 months before one started?

  5. migtronixMEMBER

    Looking at Markit WBC/NAB/CAB have the same CDS price – 107.5. Coincidence? Or does everyone know Aussie banks are/will be backstopped by APRA/gov.
    CAB gov on the other hand is much cheaper — there’ll be money to be made picking the timing of compression of that spread (shorting sovereign bonds)

  6. mine-otour in a china shop

    An excellent review of this paper – transpareny to APRA probably means not showing any of the data or RWA models underpinning the banking sector calculations, and releasing the data on December 23rd when most people had started their Christmas breaks.

  7. In a phoney press release not issued today, chief executive of the Australian Association of Bankers, Dave Freidenberg, welcomed APRA’s decision, and stated that “the AAB looks forward to its continued participation in developing a world class regulatory framework for banks, and representing the views of our banks on how to ensure Australia has the best banking system possible.” Mr Freidenberg stated, however, that he was not aware of any pressure from Australia’s banks on the regulator to dilute its capital requirements.

    “We must ensure there’s a level regulatory playing field for all banks. Our banks face significant competition on both sides of the balance sheet, which means greater market discipline to manage risks. Our banks and indeed our whole financial system already face immense challenges in expanding in a post-GFC environment. Accordingly, we would caution policymakers against moving too far ahead of other jurisdictions, and acting in an overzealous fashion. We are concerned that unnecessary and onerous requirements for local banks would give an advantage to overseas banks, forcing our local banks to divert massive resources to meeting a new regulatory burden, and away from companies and households. Meeting the needs of customers, including families and small businesses, must be a central goal of our regulatory system.”

  8. Does APRA have any idea whatsoever what it is doing?

    I used to naively believe that Government agencies served to protect society from the riskier aspects of the free market.

    However, the older get and the more I see, I am firmly of the view that the function of public agencies is almost wholly to facilitate the industries they are supposed to regulate.

    • If we gave bonuses to regulators based on how much money they clawed back from industry, like industry give bonuses to lobbyists based on how much money was removed from the taxpayer we might start getting somewhere.

      It’s the incentives stupid (not aimed at you)!

      • It is always the incentives… Then who is determining the incentives? It is crony capitalism stupid (not aimed at you)! it is a pure systemic problem.

      • Well a big part of the problem is that there is no short term, clearly quantifiable dollar value benefit from mitigating a risk. This is primarily why regulation is a public function.

        However, the wage/skill (not the same thing…) gap and the unreasonable involvement and influence of industry is a systemic problem. It’s about time regulators stood strongly over industry, rather than pander to it.

    • migtronixMEMBER

      Exactly right Ben and, for mine, it has to start with the audit/compliance firms (KPMG/PWC/Delloitte) – at certain level of enterprise GAAP don’t exist.

  9. I’ve heard Australia does not have a ‘reserve’ requirement but a ‘capital’ requirement. I understand this article is all about our banks ‘capital’ requirements.

    I understand a 10% reserve requirement on a $100 loan means that the bank must hold $10 cash, and in this way, fractional reserve lending can multiply the money base up to 10 times the cash base.

    But what does a capital requirement actually mean? Is anyone able to help / point me to a place that explains the differences?

    Thanks in advance.

    • Capital usually means shareholders’ capital, on the source part of the balance sheet. Reserves are usually created from the retained profits. I am not sure whether this is exact now, but at least it was in the past in Europe.

  10. MsSolarFelineAU

    Ladies and Gentlemen, I clicked on http://www.apra.gov.au/adi/Publications/Documents/Information-Paper-Domestic-systemically-important-banks-in-Australia-December-2013.pdf.

    The page I am reading says:
    Server Error in ‘/’ Application.

    The resource cannot be found.

    Description: HTTP 404. The resource you are looking for (or one of its dependencies) could have been removed, had its name changed, or is temporarily unavailable. Please review the following URL and make sure that it is spelled correctly.

    Requested URL: /adi/Publications/Documents/Information-Paper-Domestic-systemically-important-banks-in-Australia-December-2013.pdf.

    Ohhh deer….