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!