More details have emerged about upcoming changes to global bank capital rules, known as “Basel 4”, that are to be released at the end of the year by the Basel Committee on Banking Supervision. From The AFR:
…the powerful Bank for International Settlements found over the weekend there is “considerable” scope to toughen global rules that limit the leverage of global banks, in an attempt to constrain risk-taking during booms…
Michael Raffan, a partner at Freshfields who oversees the firm’s advice to global banks, said Basel 4 would introduce more granularity into capital calculations for mortgages and seems likely to require banks to carry more capital against loans with lower equity deposits provided by the borrower…
The Basel 4 changes will also introduce “floors” to ensure big banks authorised to use their own “internal ratings-based” models don’t deviate too far from the “standardised” models used by all banks.
…mortgages with an LVR of 60 to 80 per cent would require an uplift to risk weightings of 20 percentage points for the big banks. For the 80-to-90-per-cent bucket, risk weightings would need to rise by 15 per cent, and for 90-per-cent-plus LVRs, risk weightings would rise by almost 15 per cent.
The mooted changes represent a blow to Australia’s big four banks and Macquarie, who have used their IRB models to reduce the capital held against their mortgages to paper thin levels, in turn juicing the amount of mortgage lending and profits.
For example, in 2013, the big four banks’ capital charges on their total residential mortgage books ranged from only around 15% to 23%, with the average capital charge against mortgages a meager 1.2% to 1.9% (see below charts).
Accordingly, the big four banks have engaged in incredible levels of leverage – measured as the dollar value of equity divided by the dollar value of assets – averaging 22-times over the past two decades.
In its response to the Murray Financial System Inquiry, APRA has already announced that it will raise the average IRB mortgage risk weights to at least 25% from 1 July 2016, which has led to the major banks undertaking capital raisings to increase their capital levels.
The Government has also endorsed APRA introducing a leverage ratio to act as a backstop to ADIs’ risk-weighted capital positions.
So times are already changing.
What should become clear is that any reforms announced by the Basel Committee are likely to make the capital environment much tougher for Australia’s banks, and therefore Australia’s highly indebted mortgage holders.
The days of hyper loose capital requirements around mortgage lending and extreme leverage are coming to an end, which is yet another sign that the Great Australian Housing Bubble is on borrowed time.
