The dark heart of Australian banking


Sighhhh. I’ve written about this in detail a few years ago but nothing has changed and the deceit continues. All of Mega Bank’s divisions continue to present to the market deceptive figures about the strength of their balance sheets and the amount of capital Mega Bank holds compared to banks in other parts of the world. Mega Bank asserts that because APRA has harsher rules in some capital calculations under Basel requirements that its capital ratios when compared to banks in other jurisdictions should be higher, thereby representing greater balance sheet strength. Whilst this claim is based on an Australian Banker’s Association report of 6 or 7 years ago, is not only dubious, IMHO its down right deceptive.

In order to substantiate my claims, I refer you to CBA’s latest result presentation for the half year to Dec 2013.

In essence, the CBA presents that it has better capital ratios when compared to banks regulated by regulators in other jurisdictions than APRA insists it calculates and reports under Australian regulation. Whilst generally, jurisdictions that follow Basel Committee rules on capital calculations use the same calculation rules there is some discretion in the hands of local regulators as well as unknown variation within internal models. So differences do exist, which is why there is an international movement for greater transparency in reporting capital calculations which I reported on a few weeks ago.

This is not a trivial or minor part of CBA’s reporting. CBA reports that whilst its CET1 ratio by APRA is 8.5% it’s a much more healthy 11.4% under international comparisons. The adjusted CBA capital calculation which gives the impression of a stronger balance sheet is referred to in eleven slides in CBA presentation (Slides 4, 19, 49, 51, 53, 55, 57, 58, 112, 113 and 115). So one can conclude its not a trivial matter for CBA. Slide 53 is reproduced below as just one example of CBA’s own capital adjusted calculation compared to offshore banks. Has APRA approved this calculation or reported it to the market?


So what actually is the problem?

Whilst there are 4 areas where CBA reports favourable adjustments, see below, let’s just look at the adjustment that CBA makes for residential mortgages as this is the largest single adjustment and straight forward to challenge.


CBA reports and presents to the market analysts and its shareholders that due to APRA imposing harsher parameters on the calculation of risk weighted assets for residential mortgages that it can add 1.1% to its capital for an analyst or anyone else to compare its capital ratios to offshore banks. For this to be the case, then the regulator in the other jurisdiction must be forcing its banks to use exactly the same calculation and method to calculate risk weighted assets, except for the different calculation parameter that APRA imposes. Is this the case?

CBA claims, and so does all the other divisions of Mega Bank, that the significant difference between APRA requirements and other regulators is the Loss Given Default (“LGD”) required to be used in the internal risk based (“IRB”) models which are used to calculate minimum capital requirements is 20% for residential mortgages whilst other regulators stipulate 10% (Slide 113). This seems to be a straight forward calculable difference, but as the following demonstrates its neither straight forward nor reliable:

  • IRB models to calculate RWAs are just that, internally generated models and no two are the same. There is currently much debate amongst global regulators about how IRB models produce such widely varying results both across and within jurisdictions. It’s most unreliable to assume that for residential mortgages, banks in other jurisdictions have the same IRB models except for a single LGD parameter.
  • To calculate RWAs, an expected loss measure is calculated which is the product of LGD and Probability of Default (“PD”). Unless one knows the PD formula other regulators or banks use in their IRB models, its simply not possible to calculate reliably the effect of a change in LGD.
  • The LGD of 10 % set out by the Basel Committee and used by other regulators is a floor or minimum not a maximum. Regulators in other jurisdictions do not simply apply an LGD of 10% to every loan. LGDs, as is sensible are recognized as higher for higher LTV loans eg >90%. It’s actually not unreasonable to assume that the difference in minimum LGD has very little effect across jurisdictions in the calculation of RWAs for residential mortgages. So how can CBA make such a confident claim that a very large difference exists?
  • Its not possible to understand how CBA calculates the 1.1% capital comparison pick-up as very little information is supplied. However, I believe I can show the absurdity of the number by a simple analysis of the CBA Pillar 3 disclosures.
  • The Pillar 3 disclosures report that the IRB RWA weighting for residential mortgages is 17.6% which when multiplied by the standard 8% capital requirement gives a minimum capital requirement of 1.4% against the actual balance of the mortgage book used in the IRB models. Although this is an impressively small number, its nowhere near as small a number as is assumed that an offshore regulator would calculate for CBA.
  • For CBA to make a claim on that there is a comparison pick up of 1.1%, then there must be an assumption that regulators in those jurisdiction outlined above and as cited by CBA, for RWA purposes weight residential mortgages at 5% with minimum capital requirements of just a tiny 0.4%. I’m sure the Prudential Regulatory Authority in the UK would be happy to present the UK’s banks to the world as having such miniscule RWAs for residential mortgages and gearing of 200:1. Of course this is an absurd proposition!

Whilst I’ve kept this post to addressing the residential mortgage comparison, I also believe that the other adjustments above may also have some issues. I cannot believe it’s likely that regulators in other jurisdictions do not require interest rate risk on the banking book (“IRR BB”) to be taken into account in their banks’ IRB models.

What does all or any of APRA, ASIC or the ASX think about reporting such patently incorrect claims of capital strength? Where are the savvy equity analysts in the Australian market that can pick up this misreporting and grill the banks about it?

It’s not just CBA that makes these dubious claims, its all of the Divisions of Mega Bank so this is a serious system transparency problem which must be addressed.


  1. notsofastMEMBER

    Australia’s Foreign Controlled Banks.

    No longer controlled by Australians and they no longer have Australia’s best interests at heart.

    But the buck stops with the Australian Taxpayer.

    Can someone please advise Tony Abbott…

    • He knows already I think.
      Treasury certainly knows RBA knows APRA knows also.

      Time for advising is past.

      This needs a public coherent campaign from outside the banking tent.

  2. It’s difficult for me as an outsider to fully comprehend your post, Deep T. Therein might lie the problem? Even IF all your concerns were addressed, and were found wanting, 99% of the population would have less idea than me about the implications, and so they would be ignored. What we see on the nightly news is all that matters; and from that every truth that matters is either omitted, or camolgalgued in a whirl of confusion ( your analysis!). NB: I’ll need several re-reads. Thx.

    • Well, perhaps if MB chose to publish something on the many clear evidences that our authorities (in AU and NZ) are actively preparing for Cyprus-style bank bail-ins — a subject that is simple enough and “close to home” enough for any bozo to immediately take a keen interest in — then the reasons WHY that is even vaguely necessary just might start to get some attention.

      Cast ….

      Gently reel them in.

  3. Looks like Mega Bank is printing money out of thin air.
    No wonder the property market is buoyant.
    Once the printing press of mortgage debt runs dry the party is over.

    • Mitch all banks print money out of thin air, that simply how the monetary system in Australia, and most other countries, works these days.

      That isn’t the issue that Deep T is mentioning.

      He is, once again, demonstrating that the capital buffers, that is un-encumbered liquid assets, held by the banks are far too low in comparison to their encumbered assets ( read loans mostly) which is a risk to financial stability.

      You can do some background reading on this in one of his previous posts here

  4. LabrynthMEMBER

    So what is the real gearing level the bank has for resi mortgages?

    Is it the 200:1 ratio you mentioned in your last dot point? or is it much more complicated than that.

    • CBA has 1.4% capital against residential mortgage risk or a gearing of almost 75:1

      The point of the 200:1 gearing is the absurdity of CBA’s assertion that APRA is a harsh regulator because if APRA are as harsh as CBA reports, regulators in other jurisdictions would be allowing their banks to be geared to the ridiculously high level of 200:!.

  5. “The financial sector can support growth but it can also cause crisis. The present crisis has exposed gaps in economists’ understanding of this dual potential. This paper grounds an alternative approach in the credit nature of money, and in an older distinction between credit flows that grow the economy of goods and services (the GDP), and credit that inflates markets for financial assets and property. This increases the debt-to-GDP ratio and can be a helpful catalyst of the real sector. But if it overshoots, it leads to bloated financial markets and the pursuit of capital gains rather than profit, with rising costs due to high asset values, rising inequality, falling fixed capital formation, rising uncertainty, and fraud and corruption. Unfortunately, overshooting is built into the system due to the nature of money, banking and compound interest. That is why financial deregulation leads to credit booms and busts.

    A return to financially sustainable growth in the longer term requires a shrinking of the mortgage, consumer credit and nonbank financial sector which is a creditor to the real sector, and absorbs a continuing flow of liquidity in interest payment and financial fees that would otherwise be effective demand for goods and services…

    According to the three MegaBanks who provided sufficient detail in their most recent Annual Reports — CBA, WBC, and ANZ — in 2013 they sucked $96.375 billion out of the economy in Interest Usury Income alone.

    You can likely add around $33-$34 billion to that figure for NAB.

    $130 billion per annum.

    That’s one hell of an “economic black hole” (h/t Pfh007) just to support the continuing growth of the cancerous tumour called MegaBank, in “return” for their “vital role” in creating electronic accounting entries and “lending” them to us.

    • But how much did they return by way of interest payments?

      but a lot of the interest payments went offshore.

      and some of the interest payments to offshore would have had withholding tax, but maybe some didn’t have much because of tax treaties.

      It’s a lot more complex than gross income!

      • CBA, WBC and ANZ paid out $56.818 billion in Usury Expenses, so $39.557 billion Net Income, on usury alone. Nice.

        And yes, a lot of the usury paid out would indeed have flowed offshore.

        And yes, it is more complex than just gross income; I’m well aware of that.

        Just continuing to point out the utter insanity of our continuing with this cancerous, enslaving “money” system.

        I’d be fairly confident that not a single MB reader has any clue as to the magnitude of the great big sucking sound — carefully concealed behind the wall of noise of economic data and purportedly intelligent commentary — which sucking sound is that of the banksters’ converting our daily labours into their real wealth, via the usury mechanism.

  6. I could write an equally technical article on dentistry so that very few people could understand.

    I wonder if the author could give a few examples of the end result of all this?
    For instance, if the unemployment rate is 12%, and properties crash by 30%, how would your article relate to this strong possibility?

    • “if unemployment is 12% and properties crash by 30%”??

      First the mortgage insurers would go insolvent and then Mega Bank would not be able to fund without the help of the RBA. Technically Mega Bank would be insolvent and would collapse without government support.

      What is it with dentist? Most of the dodgy failed tax schemes I’ve ever seen had large amounts of dentists as investors. Is there something about financial literacy and working on teeth that make them incompatible. 🙂 Only half serious

      • I’m 63 and don’t do dodgy… Paid things off one at a time with very little debt at anytime.

        But good to see you can handle constructive criticism with ease… you’ll be better at your job, as I was with mine.

      • I believe this would make Glenn Stevens the most irresponsible governor of the RBA we’ve ever had.
        Cutting the cash rate to below zero after inflation has caused a huge increase in the price of residential property that was already extremely expensive.
        The RBA is gambling.

        If the banks do fail, the taxpayer will not be able afford to bail them out, and as we are part of the G-20, bail-ins will be preferred, or the RBA will have to extend Financial Repression for 30 years… probably both.

      • The mortgage insurers were probably insolvent in 1992/3.

        I recall visiting the institutional shareholder in one to ascertain their attitude to their subsidiary to whom my employer bank had a significant exposure.

        Look at what happened to the various State Bank and numerous bank owned finance companies and merchant banks in the aftermath of 92/93 and Westpac which was widely regarded to have been insolvent (ignoring RBA lender of last resort) due to illiquidity at the time. From memory AMP and Packer took big placements.

  7. Hi DeepT, can you provide any information on how risk is being modeled in the long tail sections?
    I’ve been playing around with a number of VAR tools and found that they all have huge problems dealing with non-Gaussian long tails. It seems to me that residential mortgage defaults would definitely have a very fat tail and one that is only likely to only appear in recessionary times (i.e. the recessionary tail distribution will be significantly different from the normal tail distribution) this raises some very interesting modeling problems, and even suggests that their model must actively modify the risk distribution curve.

    Personally I’ve included some non Gaussian long tails but the simulation tools generally fail because they assume distributions with monotonically decreasing probability distributions so non monotonic curves cause numerical instability.

    • Yes, it is the extreme deviations from the norm that appear less often than say 25 to 30 years (a working generation/the length of corporate memory) that are the problem. And when those events occur, it is hitting the fan in multiple countries, sectors and households including fear of bank collapse causing runs.

  8. This is another example of the problems of the superannuation funds and brokers being owned by the banks.

    Who is there left to do independent, transparent, widely available detailed analysis of the banks?

    Only overseas banks have the knowledge base, resources and exposures to warant the effort but they also have a vested interest in not disclosing too much.

    The ratings agencies are not reliable as they are not independent.

    Comparative pricing of term debt not guaranteed by government and Credit Default Swaps is probably the best available indicator of market opinion.

    Thanks DT for your articles on the banking system.

  9. To me this is just a symptom of the fact that there is nothing else in the economy, and all manner of high faultin’ jargon will be employed at all levels to obscure this simple fact.

    Residential mortgages have been an increasing component of the banks’ loan books, however, at the same time they have been reducing the risk weighting they assign to this part of their loan book. This reduces the amount of capital required (all else being equal), which gives them every incentive to keep writing home loans in preference to other types of lending, as they can generate a higher return on capital and sustain growth in dividends.

    So, we essentially have a regulatory system that has responded to the GFC by giving our banks a free pass to maintain or even grow return on capital to pre GFC levels, thereby ensuring the banks becoming even more systematically important, and perhaps one day allowing the banks to argue that there is no need to reserve capital against risks in the system, as they are the system. It doesn’t surprise me that equity analysts, credit rating agencies or everyone else has their head in the sand on this issue.

    How do you short the entire system and not go broke or crazy while you wait for it to implode ? Find out in tomorrow’s Members Only Macrobusiness report.

  10. Some fine analysis here Deep T, takes a real dedicated bank analyst to dissect the Pilar 3 like this. Im sureAPRA believes it wears the hair shirt on LGD’s compared to its BIS peers and on the surface, as you explain, it looks like it does.

    What you need to do is bury a level deeper than this. Look instead at the capital requirements for Lenders Mortgage Insurance providers (AGN 112 I think). Look at how APRA watered down the capital requirements on LMI providers post their consultation papers. Kinda amazing apra keeps these on its web site as it shows how it bent to this whim of this monopoly (yes a bigger monopoly than even the banks with only 1 real LMI provider in the market). Look at how much capital apra makes LMI providers set aside for the riskiest of risky mortgages it insures for the banks. Remember these are the mortgages that people take insurance out against because they don’t have the cash for a decent deposit (either can’t save enough or don’t have the discipline to save). And on these riskiest of the risky mortgages?

    And then the banks take this risky mortgage insurance and use it as a credit mitigant to offset the cost of their capital. Talk about insurance leverage on bank leverage on an asset bubble ( housing ) geared to a leveraged commodity bubble (China). Beautiful!

    Please do the same level of analysis on LMI. Follow it through to the bank leverage and capital. Look at the correlation risk ( ie all banks insuring their riskiest mortgages in a correlated market to 1 event and 1 insurer) . Look at the mortgage assessment criteria ( ie Henderson poverty). While your there look at the cross-holding and correlated risk that the new APS210 is too….all there in annual reports and APRA websites……..