Fitch Ratings states that an increase in the minimum average Australian residential mortgage risk-weight for banks accredited to use the internal ratings-based (IRB) approach for regulatory capital calculations was expected, and is only the first step in higher capital requirements for these banks. Greater levels of capital are likely to be required over the next 18-24 months as further measures from Australia’s 2014 Financial Services Inquiry (FSI) are implemented and adjustments to the global Basel framework are finalised.
The announced increase in minimum mortgage risk-weights is the first response to the final FSI report, published December 2014, which also recommended Australian banks’ capital positions be ‘unquestionably strong’. The latter recommendation is aimed at improving the resilience of the banking system given its reliance on offshore funding markets, its highly concentrated nature, and the similarity in the business models of most Australian banks. The change in mortgage risk-weights should provide a modest boost to the competitiveness of smaller Australian deposit takers that currently use the standardised approach for regulatory capital calculations.
The change announced by the Australian Prudential Regulation Authority (APRA) on 20 July 2015 is likely to be the first of a number of changes made to strengthen the capital positions of Australian banks. APRA referred to the higher risk-weights as an interim measure, with final calibration between IRB and standardised models expected once the Basel committee’s review of the framework is completed – this is unlikely to be before the end of 2015.
The move will result in minimum average risk-weights for Australian residential mortgage portfolios increasing to at least 25% from around 16% at the moment. APRA estimates this would increase minimum common equity tier 1 (CET1) requirements by about 80bps for Australia’s four major banks – Australia and New Zealand Banking Group Limited (ANZ; AA-/ Stable), Commonwealth Bank of Australia (CBA; AA-/ Stable), National Australia Bank Limited (NAB; AA-/ Stable), and Westpac Banking Corporation (Westpac; AA-/ Stable). This is equivalent to nearly AUD12bn for the four banks based on regulatory capital disclosures at 31 March 2015. The only other bank to be impacted is Macquarie Bank Limited (A/ Stable) which has estimated a CET1 impact of about 20bps, or AUD150m.
The higher risk weights will be implemented on 1 July 2016, giving the affected banks nearly 12 months to address capital shortfalls. Sound profitability means that shortfalls could be met through internal means – the AUD12bn is equivalent to about 40% of annualised 1H15 net profit after tax for the four major banks. Fitch expects the banks will look at increasing the discount on dividend reinvestment plans, and/or underwriting participation in these schemes to meet shortfalls. However, raising capital in equity markets is also an option to address both the requirement early and in anticipation of future increases in regulatory capital requirements. Banks have already begun increasing capital positions, with a number of the major banks announcing capital management activity at their 1H15 results.
The size of the increased capital requirement will vary across the banks based upon their loan portfolio compositions – CBA and Westpac have the largest Australian mortgage portfolios and therefore their minimum capital requirements are expected to be the most impacted.
