The new higher target set for Australian banks’ common equity Tier 1 (CET1) ratios will support their credit profiles and bolster the banking system’s resilience to downturns, says Fitch Ratings. The four major banks should all be able to meet the requirements comfortably through internal capital generation and existing dividend re-investment programmes.
The Australian Prudential Regulation Authority (APRA) has increased the minimum CET1 ratio from 8% to 9.5% for the major banks – ANZ, CBA, NAB and Westpac – and has given them until January 2020 at the latest to meet the new targets. The capital requirements have been raised in response to the recommendation by a 2014 financial system inquiry (FSI) that Australian banks’ capital ratios should be “unquestionably strong”. The decision to focus on CET1 and take a long-term, through-the-cycle approach, rather than tying capital ratios to the top quartile of international banks, was in line with our expectations.
The major banks already have CET1 ratios that are 150bp-200bp above the current minimum in anticipation of the changes. This capital surplus is likely to fall to a more normal 100bp as the new standards are implemented, which implies CET1 ratios will rise to at least 10.5%, from an average of around 9.5% at end-2016.
It is possible that the major banks will issue fresh equity if they see a benefit in raising the extra capital ahead of schedule. There is also a chance that lending rates could be increased to offset the cost of holding more capital. However, the new capital requirements are unlikely to create significant pressures for any of the four major banks, with APRA estimating that the additional capital could be raised by the deadline without any changes in business growth plans or dividend policies.
The minimum CET1 ratio for smaller banks using standardised models is set to rise by about 50bp, but most already run surpluses above the current requirement and are unlikely to need additional capital.
APRA had hoped that the FSI recommendation could be addressed together with revisions to the risk-weighting framework that are currently being debated by the Basel committee. The new international framework is likely to raise internal-ratings based risk weights for investor mortgages and mortgages with high loan-to-value ratios. This change would further add to Australian banks’ capital needs, but strengthened capital requirements for mortgage lending are already part of APRA’s future regulatory plans to ensure banks are unquestionably strong – and it expects any further capital requirements to be met “in an orderly fashion”.
The paper that APRA released to announce the new minimum capital ratios also noted that capital is just one aspect of creating an unquestionably strong banking system, with liquidity, funding, governance, culture, risk management and asset quality also important. APRA reiterated that its supervisory philosophy will continue to assess all of these factors – as well as the operating environment – when assessing bank risk profiles. It also highlighted improvements since the 2008 global financial crisis in some of these areas, such as liquidity and funding.
