Corrupt APRA waters down bank capital framework

From Martin North [my emphasis]:

The Australian Prudential Regulation Authority (APRA) has released its response to the first round of consultation on proposed changes to the capital framework for authorised deposit-taking institutions (ADIs).

The package of proposed changes, first released in February last year, flows from the finalised Basel III reforms, as well as the Financial System Inquiry recommendation for the capital ratios of Australian ADIs to be ’unquestionably strong’.

ADIs that already meet the ‘unquestionably strong’ capital targets that APRA announced in July 2017 should not need to raise additional capital to meet these new measures. Rather, the measures aim to reinforce the safety and stability of the ADI sector by better aligning capital requirements with underlying risk, especially with regards to residential mortgage lending.

APRA received 18 industry submissions to the proposed revisions, and today released a Response Paper, as well as drafts of three updated prudential standards: APS 112 Capital Adequacy: Standardised Approach to Credit Risk; the residential mortgages extract of APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk; and APS 115 Capital Adequacy: Standardised Measurement Approach to Operational Risk.

The Response Paper details revised capital requirements for residential mortgages, credit risk and operational risk requirements under the standardised approaches, as well as a simplified capital framework for small, less complex ADIs. Other measures proposed in the February 2018 Discussion Paper, as well as improvements to the transparency, comparability and flexibility of the ADI capital framework, will be consulted on in a subsequent response paper due to be released in the second half of 2019.

After taking into account both industry feedback and the findings of a quantitative impact study, APRA is proposing to revise some of its initial proposals, including:

  • for residential mortgages, some narrowing in the capital difference that applies to lower risk owner-occupied, principal-and-interest mortgages and all other mortgages;
  • more granular risk weight buckets and the recognition of additional types of collateral for SME lending, as recommended by the Productivity Commission in its report on Competition in the Financial System; and
  • lower risk weights for credit cards and personal loans secured by vehicles.

The latest proposals do not, at this stage, make any change to the Level 1 risk weight for ADIs’ equity investments in subsidiary ADIs. This issue has been raised by stakeholders in response to proposed changes to the capital adequacy framework in New Zealand. APRA has been actively engaging with the Reserve Bank of New Zealand on this issue, and any change to the current approach will be consulted on as part of APRA’s review of Prudential Standard APS 111 Capital Adequacy: Measurement of Capital later this year.

APRA’s consultation on the revisions to the ADI capital framework is a multi-year project. APRA expects to conduct one further round of consultation on the draft prudential standards for credit risk prior to their finalisation. It is intended that they will come into effect from 1 January 2022, in line with the Basel Committee on Banking Supervision’s internationally agreed implementation date. An exception is the operational risk capital proposals for ADIs that currently use advanced models: APRA is proposing these new requirements be implemented from the earlier date of 1 January 2021.

APRA Chair Wayne Byres said: “In setting out these latest proposals, APRA has sought to balance its primary objectives of implementing the Basel III reforms and ‘unquestionably strong’ capital ratios with a range of important secondary objectives. These objectives include targeting the structural concentration in residential mortgages in the Australian banking system, and ensuring an appropriate competitive outcome between different approaches to measuring capital adequacy.

“With regard to the impact of risk weights on competition in the mortgage market, APRA has previously made changes that mean any differential in overall capital requirements is already fairly minimal. APRA does not intend that the changes in this package of proposals should materially change that calibration, and will use the consultation process and quantitative impact study to ensure that is achieved.

“It is also important to note that the proposals announced today will not require ADIs to hold any capital additional beyond the targets already announced in relation to the unquestionably strong benchmarks, nor do we expect to see any material impact on the availability of credit for borrowers,” Mr Byres said

As Deep T has noted previously, the claim that Australian ADI’s capital positions are “unquestionably strong” is a myth, with Deep T instead describing them as “unquestionably average” (see here and here).

Specifically, unquestionably strong is meant to represent Australian banks’ capital being in the top 25% of international bank peers. However, a true comparison of the major banks’ capital positions places them near the tail end of international banks.

In fact, Deep T places the total amount of undercapitalisation of Australia’s banks at close to $90 Billion, which represents “the burden being taken by the Australian taxpayer under the too big to fail doctrine”.

It’s amazing that only months after the Hayne Royal Commission found the banks guilty of irresponsible lending that Australia’s prudential regulator can: 1) lower the interest rate buffer on new mortgages; 2) lower smaller bank mortgage capital requirements; and 3) water down the bank capital framework.

APRA has clearly been corrupted.

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Comments

    • Too much boost and the turbo shyts itself. All car guys know this. RBA just blew the head gasket.

  1. Actually, the very concept that bank capital means anything (regarding risk) is flawed. Banks aren’t like other firms because banks can create money out of thin air. The incorrect understanding arises from a wrong belief that banks are simply financial intermediaries, rather than what they actually are: financial intermediaries AND creators of credit that is considered equal to money in our economies.

    Take the example of Credit Suisse during the GFC. In 2008 it found itself undercapitalised according to the requirements of the Basel II Capital Accord and needed to raise 7 billion pounds to remain compliant. To achieve this, it struck a deal with foreign investors (mainly from Qatar), to purchase newly issued shares and raise Tier 1 capital in the process.

    Here’s the thing, the investors bought the shares using credit that they borrowed from Credit Suisse, credit that Credit Suisse created out of thin air. Read that again and take the time to understand what it means for everything you think you know about “capital adequacy”. Take as long as you need.

    Yes, banks can conjure up “capital adequacy” out of nowhere. It means nothing, so what APRA does is largely irrelevant and the capital framework itself is largely irrelevant; meaningless ink spilled on paper to maintain an illusion that banks are only financial intermediaries. In a pinch, Australian financial regulators will do what the Swiss regulators did and look the other way while the Big 4 magically raise capital levels.

    Credit Suisse wasn’t the only bank to do this during the GFC, but is was the only bank to publicly seek (and receive) permission from regulators to conjure its own capital out of thin air (which is how we know so much about it about it). Other banks did it more covertly.

    For more information, read this: https://www.sciencedirect.com/science/article/pii/S1057521915001477#s0085

    – section 5 covers the flawed model of bank regulation
    – section 5.2.1 covers the Credit Suisse case

    • Seems like kind of an important point. I liked this line “The question is considered why the economics profession has failed over most of the past century to make any progress concerning knowledge of the monetary system, and why it instead moved ever further away from the truth as already recognised by the credit creation theory well over a century ago.”

    • Yep, the banks are a column of smoke with a license to trade on the full faith and credit of the public.

  2. APRA’s job is to look after the banks. To make sure they are ok.
    Financial stability involves making sure the banks don’t go broke. If that requires allowing them to lend more so be it.

    • RussellMEMBER

      And so be it if lending goes nuts again and people get burned. They should have known better… as long as the banks are all ok, then the world is good. The banks after all have been protected by the RC. Not one of the bankers has gone to jail? Forging signatures, stealing, rigging documents and the likes… and not one minute in jail. So all is good with the world. After all, let’s reward the banks with lower requirements and the likes. What a system hey?

      • proofreadersMEMBER

        And the only sensible/reasonable “answer” to that almost rhetorical question is: how good is Straya?

  3. Must be irritating for APRA that the RBNZ are contemplating higher capital ratios for banks operating in NZ.
    Regulators and the banking industry love agreement.

  4. Even StevenMEMBER

    I have finally read through Deep T’s posts. I’ll distill it:

    Deep T says Australian banks have ‘average’ levels of capital relative to international peers
    This is because Deep T gives zero credit to any of APRA’s supposedly conservative framework in the way capital is calculated (relative to international Basel framework).
    Consequently Deep T estimates an additional $90bn capital is required to bring banks to ‘unquestionably strong’ (I think this is an approx 40-50% increase from current levels if my numbers are right).

    I can’t pretend to understand the details – it’s highly technical. But I would be surprised if it’s as grim as Deep T outlines. For Deep T to be correct, it would mean that APRA is categorically lying in all its statements on this topic.

    I have no love of the banking system but colour me a little sceptical on some of Deep T’s claims.

  5. proofreadersMEMBER

    While APRA is hard at it “reworking” its prudential requirements, it may as well, “loosen up” on its Net Stable Funding Ratio?

    What’s the point of an irrelevant ratio relating to having some semblance of a stable deposit base, when the RBA and private banks basically are driving most depositors to end up in at-call accounts as there is very little point for a depositor in having money locked up in a term deposit that now definitely pays 3/8ths of nothing?