Big bank super-leverage revealed!

From Morgan Stanley:


Our Chart of the Week shows that mortgage risk weightings (RW) under the internal ratings-based (IRB) methodology have risen for CBA and WBC by ~0.9ppt and ~1.7ppt, respectively. WBC noted a 21bp reduction in the CET1 ratio due to: “Changes to the determination of probability of default”. In our view, mortgage RWs will increase further. APRA Chairman, Wayne Byres, observed that internal models “lack credibility as a reliable measure of financial strength” and that regulatory capital for housing held by IRB banks was not sufficient to cover losses under APRA’s 2014 stress tests (refer APRA: The Rule Maker). In our base case, we assume that APRA will lift major bank capital requirements by: 1) adding an additional 100bp D-SIB buffer; and 2) imposing a 20% mortgage risk weight floor that would add ~90bp. This would increase major banks’ average mortgage RW from ~16% currently to ~28%. We estimate that every 5% increase in the RW floor lifts the major banks’ capital requirement by ~A$6bn, with WBC the most impacted and ANZ the least impacted.

For perspective, recall that to reach actual capital levels, IRB discounts must be multiplied by the 8% Basel III capital discount for mortgages, so based on the above figures you reach the very reassuring level of bank capital of $1.30 per $100 of mortgages.

Of course there’s some offset in the Lenders Mortgage Insurers, but only so long as they remain solvent.

And that, my friends, is how big banks turn lousy credit growth into high returns on equity, by employing ludicrous leverage!

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Latest posts by David Llewellyn-Smith (see all)


    • Story of the world.

      I’m being punished for refusing to enter a frothy property/stock market, plummeting commodities market and low yielding bonds market.

      Soon enough punishment will turn into a ‘real’ fine with negative interest rates on savings. Good job world. Amazing skills from the bankers to being able to lobby/manoeuvre us into this situation, you have to hand them that one…

      • Or you could read this as

        For every 100 happy borrowers / voters / consumers there is 1.3 unhappy savers.

        They that Banks / Governments / Business don’t give a flying fuck about the likes of you and me.


  1. In the book Australia: Boom to Bust the author speculates that “at least one of the big 4 will go under” when things swing around, by his calculations the most exposed bank at the time of writing was WBC, however now that has changed to NAB. I ran my own figures over Christmas and came to the same conclusion that NAB is now the weakest link. Guess who I wont be banking with for much longer !!

  2. A house of cards.

    Australia’s finance oligarchy of four big banks have, on average, 1.3% capital supporting giant mortgage books in the middle of the biggest land bubble in our history.

    They are writing fresh loans to anyone with a pulse and creating credit hand over fist with Sydney investors.

    They simply do not have the capacity to absorb losses in a ripple, let alone a down-turn. Their risk-blindness is comprehensively underwritten by you the taxpayer and your guarantee WILL be called.

    Let us make a pact: any bank that requires solvency support from government in the form of capital gets split in half. If we don’t use this coming crisis constructively, it will repeat.

    • Re-nationalise the CBA when the crisis hits (they are already quasi nationalised anyway!), and then have it take on whoever goes down. A bit like the CBA did with the State Savings Banks as they got into trouble. What was it CBA paid for the SSBV? $1……

    • David I love our work, but on this occasion I think you are not thinking big enough.

      These banks are capitalising profits and socialising losses. I propose that the banks lose the ability issue mortgages totally. The state can issue mortgages the banks can sell them. State keeps all the profits and wares the losses. No different to now except the public get some benefit out of it all. It wont happen I know. But it should at least be put out there if we are going to write a $200B cheque to bail the pricks out,

      • Thanks, Rod.

        I do get accused of excess civility.

        In turn, I think your estimate of $200 billion in government transfers to the banks is modest. We are sailing blissfully into the biggest liquidity crisis in history when those o/s bondholders firstly roll over with shorter maturities then decide not to renew their loans to us.

        On your proposal the state issue mortgages, I would like to see state banks reestablished. Socialistic, I know, but we urgently need more bank competition.

      • David, I think one could argue we need less bank competition, at least in regards to mortgages, as it is the competition between the banks & non-banks that have led to ever larger mortgages being handed out, not to mention the orgy of investment loans, that have put us into the current position.

        Regardless, if we have any bank failures, the remedy should be along the Swedish lines, where the bank is nationalised, restructured/split up, and re-floated. None of this blank cheque bailout nonsense. If we are going to socialise the losses, we should socialise the profits as well.

      • hamish – that is what is happening with every nationalised bank in Europe at present. Good in theory, but not so good in practice, because bad debts keep appear for years after a crisis – it just doesn’t happen at once. Secondly, once the market gets crushed, capital that once existed that could have been allocated to a new float, has now gone to money heaven. Governments then find that although re-capitalised, they have may have these banking assets on their books for decades, as opposed to years.

        One benefit is that yet the government debt balance sheet blows out – but so does the asset side of the equation. Which means that the implementation of macro prudential measures should be noticeably more comprehensive and easier to implement.

  3. Well, no wonder they just keep pushing prices higher. Whether its 1.3% capital or 0.3% capital, the magnitude of the crash would be the same. at this point.

    But yes, to think savers are being punished for this, and with likely Cyprus confiscation in the future, it is abhorrent that it has come to this. Feels like every single member of government, RBA and APRA should be at least jailed for not making significant noise about this. Every central bank and government head around the world, including the rating agencies. The budget “crisis” is nothing compared to this. Even if houses keep booming for a decade or two to come, a correction due to a dependency ratio crunch will come and obliterate this nation.

  4. felixthecatMEMBER

    Thanks for the comment at the end H&H. I didn’t understand anything in that article. If there is virtually no capital behind the loan book, I hope there are some high grade liquid assets standing between the bondholders, shareholders and a possible implosion of the housing market

  5. How anyone can think that it is a good idea to delegate our money creation (printing) functions to private business and let them profit from the process as well as decide allocation and manage risk?

    Also can we finally put the quantity theory of money to rest now? Banks expand our money supply by a factor of 10 or even 100 and somehow we are not drowning in inflation. There is no magic in banks that lets them print without consequence where a government doing the same would cause the sky to fall.
    Time to take our money back and use this for strengthening the economy not just enriching a wunch of bankers.

    • “How anyone can think that it is a good idea to delegate our money creation (printing) functions to private business and let them profit from the process as well as decide allocation and manage risk?”

      This to me is the key point. How did this come to pass, and why is it even legal?

      A licence to print money, available only to a select few. Money for jam.

      • I suspect the bankers were asked to design a monetary system that would be beneficial to all and this is what they designed. They assumed that the “beneficial to all” bit was meant as a joke.

    • Strange how they cover a couple of ‘bad scenarios’ for the unsuspecting yield hunter – but forget the big daddy of them all – getting converted to bank equity as your Megabank watches its pencil thin equity slice approach zero.

      But at least ASIC have a website now!

      They can deny responsibility – just like all the financial planners that will have ticked the box saying they explained the risk.

      The number of financial planners who could explain (let alone value) the APRA terms surrounding conversion to equity would comfortably fit in an Econovan.

      Full-on pointy headed credit analysts have no idea how to price this risk. Hence zero insto support for these garbage products.

      Just tick the box…

  6. Serious question for the shadow APRA on this blog. How do you think regulators should calculate how much capital there should be and what is the answer

    • 1.3% Beyond comprehension. Land priced at all time highs and double anything reasonable, borrowing growing exponentially, interest rates being slashed and at all time lows, economic headwinds galore…

      50% Getting better. Land is around 50% overvalued, so post mean-reversion capital will be reduced to zero… so they’d covered for fair value.

      100% Almost no risk to the financial system. APRA and RBA decision makers are a disgrace allowing anything other than this and need to think about it in jail for a few decades.