RBNZ beats sense into corrupt APRA on bank capital

Via Banking Day:

We are all one step closer to an elegant takeover by the Kiwis of Australian financial regulation.

To simplify capital calculations for banks, and in turn, capital floor calculations, APRA is proposing that risk-weighted assets of the New Zealand banking subsidiaries of banks be calculated under Reserve Bank of New Zealand rules for the determination of Level 2 group capital requirements.

“This is a simpler approach that removes the operational burden of duplicate reporting systems for ADIs with exposures subject to RBNZ capital requirements,” APRA said yesterday.

This cutting of at least a little red tape is one process behind a mostly technocratic reform of the rules on measuring and maximising the capital foundations of the Australian banking industry.

There is plenty of bank capital in the system already, or enough anyway, is the guts of APRA’s position, explained in a discussion paper: ‘Revisions to the capital framework for authorised deposit-taking institutions’.

APRA said it remains committed to its previous position that an ADI that currently meets the ‘unquestionably strong’ benchmarks under the current framework should have sufficient capital to meet any new requirements.

Changing the presentation of capital ratios “will not impact overall capital strength or the quantum of capital required to be considered ‘unquestionably strong’,” APRA said, “but instead improves comparability, supervisory flexibility and international alignment.”

There will be an increase capital ratios overall.

The “proposals will change the presentation of capital ratios” APRA said.

“This is because the denominator of the capital ratio calculation – RWA – is changing to be more aligned with the international Basel methodology, while the dollar amount of eligible capital required remains unchanged.

“All else being equal, this will increase capital ratios.”

One key reform is that the counter-cyclical capital buffer will be 1.0 per cent by default for Australian banks – up from zero.

Then the risk-weighting game will become ever more fundamental to the art of pricing and designing credit.

In the case of mortgages, for ‘Standardised ADIs’ the lowest risk weight available will be 20 per cent, down from 35 per cent now. Big banks will love this, as under their advance models they are often already below this on prime mortgages.

Most banks will also love ‘additional segmentation’ by loan purpose: owner-occupier, paying principal-and-interest, and other.

For big banks, the LGD floor (as in, loss given default) will halve to 10 per cent.

The bruise for big banks is no special treatment on recognition of lenders’ mortgage insurance.

In a nod to the crowd, APRA proposes to ease risk weights on SME loans not secured by property from 100 per cent to a 75 per cent risk weight if less than A$1.5 million in size, otherwise 85 per cent; for standardised banks, which is most. For advanced banks, the ‘Retail SME approach for lending’ will also apply at $1.5 million.

Then in one material reform to lower stress levels at the scores of sub-scale banks and credit unions, ADIs below $20 billion total assets, from 2023, can benefit from:

• flat operational risk capital charge of 10 per cent of RWA;
• no counterparty credit risk capital or reporting requirements;
• interest rate risk in the banking book requirements limited to reporting only; and
• no leverage ratio capital or reporting requirement.

To make it easy for neobanks and tiddlers, APRA will even arrange a “centralised Pillar 3
Publication” for these M&A candidates.

Judging by the Pillar 3s Banking Day has seen recently, this can only be to the public benefit.

For winners and losers we turn to the always excellent Jonathon Mott at UBS:

APRA updates ADI capital framework
In a long-awaited announcement, APRA has released an updated capital framework for Australian ADIs. The aim of APRA’s capital framework is to increase flexibility through the cycle, finalise its response to the Financial System Inquiry (2014) and ensure compliance with Basel III. Overall, we would characterise these proposals as being net neutral for the banks. All listed banks which complied with APRA’s previously “unquestionably strong” framework will have sufficient capital to comply with these new proposals.

Mortgage capital weighting increased. Benefits to SME, CRE and Corporate
Given Australian banks’ heavy weighting to mortgages (~65% of total assets), APRA is targeting an increased capital requirement for higher risk exposures including investment property and interest-only loans. High LVR loans (with no LMI) will also see a rise in capital requirements. SME lending, CRE and Corporate & Commercial loans will see a benefit to RWA. Importantly, total capital allocated to housing increases from 34% to 40% of Credit RWA for the Major banks. Overall, APRA estimates that RWA should fall by ~10% for A-IRB banks (Majors) and fall by ~7% for standardised banks.

Higher CET1 ‘capital stack’
Counter-balancing the reduction in risk weights APRA has proposed increasing the minimum CET1 ‘capital stack’. For the Majors, the minimum CET1 rises to 10.5% comprising: 4.5% PCR; 4.0% Capital Conservation Buffer (CCB); 1.0% D-SIB; and 1.0% Count-cyclical Capital Buffer (CCyB). This provides APRA with more flexibility in the extreme economic cycles. We would expect the Majors to operate at a buffer of ~1.5% to this minimum, leaving a new “unquestionably strong” CET1 of ~12%.

Early estimates: Relative winners NAB and ANZ. CBA and WBC more impacted
With WBC’s larger exposure to investment property (37% of mortgages) and interest only (21%), we expect it to see the smallest reduction in RWA, and corresponding boost to CET1. CBA is also overweight mortgages given its large retail franchise, reducing its relative benefit to RWA. We expect NAB to potentially see the greatest benefit to RWA given its SME position, although this is partially offset by a big investment property portfolio (38% of mortgages). ANZ should benefit from a smaller mortgage book, and less exposure to investment property and interest only. Overall, we see these proposed capital changes as net neutral for the banks, although increasing the stated CET1 ratios towards internationally comparable levels is positive.

David Llewellyn-Smith

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