Via Martin North:
APRA has released a paper on Loss-Absorbing Capacity of ADI’s.
It shows that currently major Australian banks are at the lower end of Total Capital compared with international peers. As a result of proposed changes, major banks (Domestic systemically important banks in Australia, D-SIBs) will see their funding costs rise – incrementally over four years – by up to five basis points based on current pricing. This is intended to build in more financial resilience by lifting the capital requirements, centred on tier 2. Other banks may also be impacted to an extent.
If the D-SIBs were to maintain an additional four to five percentage points of Total Capital they would have ratios more in line with their international peers. But not in the top 25%, and the banks overseas are also lifting capital higher… so some tail chasing here! Is this “unquestionably strong”?
- for other ADIs – likely no adjustment, although a small number may be required to maintain additional Total Capital depending on the outcome of resolution planning, which would inform the appropriate amount of additional loss absorbency required to achieve orderly resolution. This assessment would occur on an institution-by-institution basis.
Tier 2 capital instruments are designed to convert to ordinary shares or be written off at the point of non-viability, which means they will be available to absorb losses and can be used to facilitate resolution actions. Tier 2 capital instruments have been a feature of ADI capital structures in various forms since being introduced as part of the 1988 Basel Accord. These instruments have been used as part of resolution actions in other jurisdictions, supporting orderly outcomes.
It is also important that holders of instruments which are intended to be converted or written off in resolution understand the distinctive risks of these investments. In the context of AT1 instruments, APRA has noted that it is inadvisable for investors to view such instruments as higher-yielding fixed-interest investments, without understanding the loss-absorbing role they play in a resolution.15 In the case of the Australian ADIs’ Tier 2 capital instruments, these are mostly issued to institutional investors, who are likely to understand the risks involved.
As ADIs will be able to use any form of capital to meet increased Total Capital requirements, APRA anticipates the bulk of additional capital raised will be in the form of Tier 2 capital. The proposed changes are expected to marginally increase each major bank’s cost of funding – incrementally over four years – by up to five basis points based on current pricing. This is not expected to have an immediate or material effect on lending rates.
APRA proposes that the increased requirements will take full effect from 2023, following relevant ADIs being notified of adjustments to Total Capital requirements from 2019.
In addition to the proposals outlined in this discussion paper, APRA intends to consult on a framework for recovery and resolution in 2019, which will include further details on resolution planning.
APRA Chairman Wayne Byres said one of APRA’s core functions as Australia’s prudential regulator is to plan for, and if required, execute the orderly resolution of the financial institutions it regulates.
“The resilience of the Australian banking system continues to improve, underpinned by the build-up of capital over the last decade.
“However, no matter how resilient financial institutions are, the possibility of failure cannot be entirely removed. Therefore, in addition to strengthening the resilience of the financial system, it is prudent to plan for the unlikely event of failure.
“The events of the global financial crisis demonstrated the impact that failures can have on the broader financial system and the subsequent social and economic consequences.
“The aim of these proposals and resolution planning more broadly is to ensure that the failure of a financial institutions can be resolved in an orderly fashion, which protects the interests of beneficiaries and minimises disruption to the financial system,” Mr Byres said.
All hail Deep T.