The Australian Prudential Regulation Authority (APRA) has continued to burnish its conservative credentials by being the first regulator to publish proposals to implement the Basel III endgame standard, also known as “Basel IV”, says Fitch Ratings.
APRA proposes to implement a stricter variant of the international reforms published last December on an accelerated timeline. We do not expect Australian banks to have any difficulty meeting the proposed capital requirements, but changes in risk weights could lead to modest adjustments to the mix of their loan portfolios over time.
The changes published in two discussion papers on 14 February 2018 amend elements of the “unquestionably strong” requirements that were first outlined in July 2017. APRA proposes to adopt tougher risk-weighted asset (RWA) standards, including the controversial output floor, which will prevent modelled capital requirements from falling below a certain level, by 1 January 2021, without the five-year phase-in period that most countries are likely to allow. The discussion paper details extensive “gold-plating” of capital requirements, with increased requirements for retail exposures, loan and credit card facilities, and investment and interest-only residential mortgages compared to international norms. Similarly, APRA has proposed a minimum 4% leverage ratio, which is above the globally agreed 3% minimum.
Australian banks are already well on the way to meeting APRA’s “unquestionably strong” requirements, and the regulator has indicated that the latest changes should not require additional capital beyond what is needed to meet those requirements. However, the “unquestionably strong” 10.5% common equity Tier 1 ratio target for banks using internal models is likely to be reduced to offset the increase in RWAs that will most likely result from the changes in these discussion papers. This is in line with what Fitch had expected when the target was first announced. APRA said it will conduct a quantitative impact study with the banks before finalising the changes to ensure that they are in line with the benchmarks outlined in July 2017.
APRA’s proposed minimum leverage ratio should have no impact on the banks’ capital holdings – reported leverage ratios are already well above the 4% minimum at banks using the advanced models, and well above 3% at the standardised banks.
The proposed standards are unlikely to result in significant changes to banks’ business models, but they may lead to modest adjustment to loan portfolios. For example, the proposed changes to residential and, possibly, commercial mortgage risk-weights would increase charges for riskier loan types, such as investor and interest-only lending, relative to amortising owner-occupier loans for both advanced and standardised banks. This may result in banks increasing pricing for the riskier loan types or emphasising growth in owner-occupier loans. Similarly, increased capital charges for off-balance sheet facilities and credit cards could result in banks repricing products, or raising fees.
APRA also plans to further narrow the gap between the mortgage risk-weights under the advanced and standardised approaches, which is likely to provide some competitive benefit to the smaller banks that use the standardised approaches. APRA expects to release draft revised prudential standards after it has received feedback on its proposals, which is due by mid-May 2018.
