Tag: Capital Ratios

The Unlevel Playing Field – APRA’s Committed Liquidity Facility $243 Billion For 2019

APRA today published a letter relating to the Committed Liquidity Facility which is available to just 15 of the banks in Australia (The LCR banks). These have the back-stop option of calling on funds from the RBA to buttress their liquidity in case of need – so they can meet their obligations under the Basel III regime.

For a fee, if used, these banks essentially have a safety net in times of distress. Now APRA has outlined the arrangements for next year. Of course the other lenders have to operate without these supports.

More evidence of a lack of a level playing field in the system, and how the regulators are supporting the big end of town. No surprise then that big players are regarded by the markets as too big to fail.

But as Australian Government debt is hurtling beyond $500 billion, I have to say their so called justification – lack of liquidity in the local securities (mainly Australian Government Securities and securities issued by the borrowing authorities of the states and territories) is wearing a bit thin.

Why is this facility needed at all?

This is what APRA said today:

The Australian Prudential Regulation Authority (APRA) is today releasing aggregate results on the Committed Liquidity Facility (CLF) established between the Reserve Bank of Australia (RBA) and certain locally incorporated ADIs that are subject to the Liquidity Coverage Ratio (LCR).

APRA implemented the LCR on 1 January 2015. The LCR is a minimum requirement that aims to ensure that ADIs maintain sufficient unencumbered high-quality liquid assets (HQLA) to survive a severe liquidity stress scenario lasting for 30 calendar days. The LCR is part of the Basel III package of measures to strengthen the global banking system.

In December 2010, APRA and the RBA announced that ADIs subject to the LCR will be able to establish a CLF with the RBA. The CLF is intended to be sufficient in size to compensate for the lack of sufficient HQLA (mainly Australian Government Securities and securities issued by the borrowing authorities of the states and territories) in Australia for ADIs to meet their LCR requirements. ADIs are required to make every reasonable effort to manage their liquidity risk through their own balance sheet management before applying for a CLF for LCR purposes.

Committed Liquidity Facility for 2019

All locally incorporated LCR ADIs were invited to apply for a CLF amount to take effect on 1 January 2019. All fifteen ADIs chose to apply. Following APRA’s assessment of applications, the aggregate Australian dollar net cash outflow (NCO) of the fifteen ADIs was estimated at approximately $381 billion. The total CLF amount allocated for 2019 (including an allowance for buffers over the minimum 100 per cent requirement) is approximately $243 billion.

($ billion) 2015 2016 2017 2018 2019
Total forecast NCO 410 402 400 387 381
Available AGS and semis 175 195 220 226 225
Total CLF made available 275 245 223 248 243

When this arrangement was announced in 2011 the RBA said:

The Committed Liquidity Facility

The CLF will enable participating ADIs to access a pre-specified amount of liquidity by entering into repurchase agreements of eligible securities outside the Reserve Bank’s normal market operations. To secure the Reserve Bank’s commitment, ADIs will be required to pay ongoing fees. The Reserve Bank’s commitment is contingent on the ADI having positive net worth in the opinion of the Bank, having consulted with APRA.

The facility will be at the discretion of the Reserve Bank. To be eligible for the facility, an ADI must first have received approval from APRA to meet part of its liquidity requirements through this facility. The facility can only be used to meet that part of the liquidity requirement agreed with APRA. APRA may also ask ADIs to confirm as much as 12 months in advance the extent to which they will be relying on a commitment from the Bank to meet their LCR requirement.

The Fee

In return for providing commitments under the CLF, the Bank will charge a fee of 15 basis points per annum, based on the size of the commitment. The fee will apply to both drawn and undrawn commitments and must be paid monthly in advance. The fee may be varied by the Bank at its sole discretion, provided it gives three months notice of any change.

Eligible Securities

Securities that ADIs can use under the CLF will include all securities eligible for the Reserve Bank’s normal market operations. In addition, for the purposes of the CLF, the Reserve Bank will allow ADIs to present certain related-party assets issued by bankruptcy remote vehicles, such as self-securitised residential mortgage-backed securities (RMBS). This reflects a desire from a systemic risk perspective to avoid promoting excessive cross-holdings of bank-issued instruments. Should the ADI lack a sufficient quantity of residential mortgages, other ‘self-securitised’ assets may be considered, with eligibility assessed on a case-by-case basis.

The Reserve Bank has discretion to broaden the eligibility criteria and conditions for the various asset classes at any time. The Bank will provide one years notice of any decision to narrow the criteria for the facility.

Interest Rate

For the CLF, the Bank will purchase securities under repo at an interest rate set 25 basis points above the Board’s target for the cash rate, in line with the current arrangements for the overnight repo facility.

Margining

The initial margins that the Reserve Bank will apply to eligible collateral will be the same as those used in the Bank’s normal market operations. Consistent with current practice, each day the Bank will re-value all securities held under repurchase agreements at prevailing market prices.

Termination

Subject to the ADI having positive net worth, the Reserve Bank will give at least 12 months notice of any intention to terminate the CLF. The Bank’s commitment to any individual ADI will lapse if the fee is not paid.

 

 

Australia’s proposals to improve comparability of bank capital are credit positive

The Australian Prudential Regulation Authority (APRA) has released a discussion paper proposing two options to improve the transparency, comparability and flexibility of Australia’s bank capital framework. Both options would be credit positive because each would improve the comparability of Australian banks’ capitalisation to global peers says Moody’s.

APRA’s proposals are not intended to change the quantum of bank capital, but to improve the comparability of reported capital ratios.

Australian banks’ reported capital ratios are generally lower than banks with comparable capital strength in other jurisdictions because of the regulator’s conservative implementation of Basel capital requirements. Banks using the internal ratings-based (IRB) approach to calculate capital ratios will be most affected. Investors’ better understanding of the true strength of Australian banks’ capitalisation will support the banks’ access to international capital markets where, in aggregate, they raise about two-thirds of their long-term debt. APRA’s first option would not change how Australian banks’ capital ratios are calculated. Instead, banks would use a regulator-endorsed methodology to report an additional “internationally comparable” ratio to facilitate comparison to global peers. This approach is broadly in line with current practice and IRB banks already disclose their own calculations of internationally comparable capital ratios, but the introduction of a regulator-endorsed methodology will add credibility and consistency to the calculation of the internationally comparable capital ratio.

APRA’s second option would remove aspects of conservatism in the definition of capital and banks’ calculation of risk-weighted assets (RWAs), making the calculation of capital ratios more consistent with global peers. Australian bank capital ratios would likely rise under this approach, so APRA would also lift minimum regulatory capital ratio requirements to ensure that banks retain the same level of capital. APRA also raised the possibility of increasing the size of the capital conservation buffer. APRA believes that increasing the spread before a bank’s capital ratio breaches this buffer will increase its capacity to begin a recovery action and for APRA to take supervisory action.

The key areas of conservatism within the current APRA capital framework largely relate to the calculation of RWAs. For example, APRA requires a minimum 20% loss-given-default assumption for residential mortgages, which is higher than in most jurisdictions. APRA also requires capital held at a Pillar I level for interest rate risk in the banking book, an approach that is not required under the Basel capital framework. The regulator’s definition of regulatory capital is also conservative in that it requires certain investments, tax assets and capitalized expenses to be deducted from capital.

To facilitate comparison to their global peers, Australia’s four major banks – Australian and New Zealand Banking Group Ltd., Commonwealth Bank of Australia, National Australia Bank Limited and Westpac Banking Corporation – have begun reporting their own calculations of internationally comparable Common Equity Tier 1 (CET1) capital ratios. On average, these self-reported ratios are 520 basis points higher than their headline regulatory CET1 ratio.

Conservative RWA calculations are the biggest driver of the differences between APRA and internationally comparable capital ratios Major Australian banks’ internationally comparable CET1 ratios are higher than APRA ratios

We note that APRA’s proposals come at time when other regulators are also proposing changes to their capital frameworks following the finalization of the Basel III capital rules by the Basel Committee. For example, Sweden’s regulator has proposed moving mortgages’ 25% risk-weight floor to Pillar I from Pillar II, which will increase RWAs and lower Swedish banks’ reported CET1 capital ratios. As a result, the difference between Australian bank capital ratios and their global peers may start to narrow, irrespective of APRA’s proposals. Depending on the outcome of a consultation on the discussion paper , APRA expects to release draft prudential standards in 2019 and finalise the standards by mid-2020.

Note: The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating and Baseline Credit Assessment

APRA to make ADI capital framework “more transparent, comparable and flexible”

The Australian Prudential Regulation Authority (APRA) has sought industry feedback on potential approaches to adjust the capital framework for authorised deposit-taking institutions (ADIs) to make capital ratios more transparent, comparable and flexible. Importantly, the proposals in this paper are not intended to change the quantum or allocation of capital.

The idea of harmonising with international comparable measures is a good thing in my book, but is this a case of “fiddling while Rome burns” in that the issues we are facing are more significant as lending is still too hot, and households are under the debt pump? But then APRA conveniently reverts to type with its narrow obsession on financial stability interpreted as capital ratios. Safe ground, but myopic.

In its current program of reform of the ADI capital framework, APRA is pursuing three principal objectives:

  • the quantum of capital – to achieve an overall level of capital that meets the ‘unquestionably strong’ aspiration set by the Financial System Inquiry (as set out in APRA’s July 2017 Information Paper);
  • the allocation of capital – to improve the risk sensitivity of current capital requirements, where possible, by more appropriately aligning capital requirements to underlying risks (as set out in APRA’s February 2018 Discussion Paper);
  • the comparability of capital – to improve the transparency, comparability and flexibility of the capital framework where possible, without materially jeopardising either of the other two objectives.

APRA is also considering measures to make the capital framework more flexible in times of stress. These measures include increasing the size of the Capital Conservation Buffer relative to the size of the minimum Prudential Capital Requirement and potential changes to the point of automatic regulatory interventions. Such realignment of regulatory capital ratios would enhance supervisory flexibility in times of financial or economic stress, either at an individual ADI level or for the banking system as a whole. It may also enhance the usability of capital buffers held by ADIs to manage their capital positions during periods of stress.

The prospective approaches are outlined in a discussion paper released today for industry consultation.

The approaches would not change the amount of capital ADIs are required to hold beyond the unquestionably strong capital benchmarks announced in July 2017.[1] Rather, APRA is considering whether to alter the way ADIs’ capital requirements are calculated and disclosed to facilitate greater domestic and international comparability and transparency of ADI capital strength.

Though Australia’s capital framework is largely based on internationally agreed minimum standards set by the Basel Committee on Banking Supervision, APRA takes a more conservative approach to the definition of capital and the calculation of risk-weighted assets in some areas. Consequently, Australian ADIs typically have lower reported capital ratios than overseas peers with comparable capital strength.

Chairman Wayne Byres said: “APRA’s robust capital framework improves the quality and quantity of the capital held by ADIs, but makes international comparisons more complex.

“The reliance of the Australian banking system on international markets for funding makes it important that investors understand and have confidence in their capital strength during ordinary times and in periods of market disruption.”

The discussion paper released today outlines two general approaches designed to aid ADIs in representing and communicating their capital strength:

Under one approach, ADIs would continue using existing definitions of capital and risk-weighted assets, but APRA would develop a methodology allowing them to improve the credibility and robustness of internationally comparable capital ratio disclosures; or Under a second approach, APRA would change the way ADIs calculate capital ratios to instead use more internationally harmonised definitions of capital and risk-weighted assets. To maintain the strength and risk-sensitivity of the capital framework, there would need to be corresponding increases in minimum ratio and/or capital buffer requirements.

APRA is open to considering these approaches independently or in combination, or indeed retaining its current methodology, and is seeking industry feedback on whether the benefits of the suggested approaches outweigh the regulatory burden and associated increase in complexity.

Separately, the discussion paper proposes measures to make the capital framework more flexible in times of stress, including by increasing the size of regulatory capital buffers relative to minimum regulatory capital requirements.

Mr Byres noted: “None of the changes under consideration would change the level of capital ADIs are required to hold to meet the unquestionably strong capital benchmarks. However, by modifying and realigning regulatory capital ratios, APRA will potentially have greater supervisory flexibility to react to situations of bank-specific or system-wide stress, and allow institutions to return to a position of sufficient capital strength.”

Federal Reserve’s Review of Banks’ Capital Plans Highlights Some Gaps

In a release late last week, the FED said that as part of its annual examination of the capital planning practices of the nation’s largest banks, the Federal Reserve Board did not object to the capital plans of 34 firms but objected to the capital plan from DB USA Corporation due to qualitative concerns.

Due in part to recent changes to the tax law that negatively affected capital levels, two firms will maintain their capital distributions at the levels they paid in recent years. Separately, one firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Comprehensive Capital Analysis and Review, or CCAR, in its eighth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms’ planned capital actions, such as dividend payments and share buybacks. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

“Even with one-time challenges posed by changes to the tax law, the CCAR results demonstrate that the largest banks have strong capital levels, and after making their approved capital distributions, would retain their ability to lend even in a severe recession,” said Vice Chairman Randal K. Quarles.

When evaluating a firm’s capital plan, the Board considers both quantitative and qualitative factors. Quantitative factors include a firm’s projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm’s capital planning process, which incorporates risk management, internal controls, and governance practices that support the process.

This year, 18 of the largest and most complex banks were subject to both the quantitative and qualitative assessments. The 17 other firms in CCAR were subject only to the quantitative assessment. The Board may object to a capital plan based on quantitative or qualitative concerns.

The Board objected to the capital plan from DB USA Corporation due to qualitative concerns. Those concerns include material weaknesses in the firm’s data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress.

The Board issued a conditional non-objection to the capital plans of both Goldman Sachs and Morgan Stanley and both firms will maintain their capital distributions at the levels they paid in recent years, which will allow them to build capital over the next year. Each firm’s capital ratios, under the capital plans they originally submitted and with the one-time capital reduction from the tax law changes, fell below required levels when subjected to the hypothetical scenario. This one-time reduction does not reflect a firm’s performance under stress and firms can expect higher post-tax earnings going forward.

The Board also issued a conditional non-objection for the capital plan from State Street Corporation. The stress test revealed counterparty exposures that produced large losses under the hypothetical scenario, which assumes the default of a firm’s largest counterparty under stress. The firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Credit Suisse Holdings (USA); Discover Financial Services; Fifth Third Bancorp; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; RBC USA Holdco Corporation; Regions Financial Corporation; Santander Holdings USA, Inc.; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; UBS Americas Holdings LLC; and Wells Fargo & Company.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio–which compares high-quality capital to risk-weighted assets–of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.

BIS Confirms Banks Use “Lehman-Style Trick” To Disguise Debt, Engage In “Window Dressing”

The Banker’s Bank, in their annual report confirmed that there is evidence that some banks are massaging their quarter end results to fit within certain capital ratios using Repurchase Agreements (REPO’s).  So Central banks’ own financial operations with bank counterparties are making a mockery of any macroprudential regulation attempts by central banks … plain alarming!

From Zero Hedge.

Several years ago we showed how the Fed’s then-new Reverse Repo operation had quickly transformed into nothing more than a quarter-end “window dressing” operation for major banks, seeking to make their balance sheets appear healthier and more stable for regulatory purposes.

As we described in article such as “What Just Happened In Today’s “Crazy” And Biggest Ever “Window-Dressing” Reverse Repo?”,Window Dressing On, Window Dressing Off… Amounting To $140 Billion In Two Days”, “Month-End Window Dressing Sends Fed Reverse Repo Usage To $208 Billion: Second Highest Ever“, “WTF Chart Of The Day: “Holy $340 Billion In Quarter-End Window Dressing, Batman“, “Record $189 Billion Injected Into Market From “Window Dressing” Reverse Repo Unwind” and so on, we showed how banks were purposefully making their balance sheets appear better than they really with the aid of short-term Fed facilities for quarter-end regulatory purposes, a trick that gained prominence first nearly a decade ago with the infamous Lehman “Repo 105.”

And this is a snapshot of what the reverse-repo usage looked like back in late 2014:

Today, in its latest Annual Economic Report, some 4 years after our original allegations, the Bank for International Settlements has confirmed that banks may indeed be “disguising” their borrowings “in a way similar to that used by Lehman Brothers” as debt ratios fall within limits imposed by regulators just four times a year, thank to the use of repo arrangements.

For those unfamiliar, the BIS explains that window-dressing refers to the practice of adjusting balance sheets around regular reporting dates, such as year- or quarter-ends and notes that “window-dressing can reflect attempts to optimise a firm’s profit and loss for taxation purposes.”

For banks, however, it may also reflect responses to regulatory requirements, especially if combined with end-period reporting. One example is the Basel III leverage ratio. This ratio is reported based on quarter-end figures in some jurisdictions, but is calculated based on daily averages during the quarter in others. The former case can provide strong incentives to compress exposures around regulatory reporting dates – particularly at year-ends, when incentives are reinforced by other factors (eg taxation).”

But why repo? Because, as a form of collateralised borrowing, repos allow banks to obtain short-term funding against some of their assets – a balance sheet-expanding operation. The cash received can then be onlent via reverse repos, and the corresponding collateral may be used for further borrowing. At quarter-ends, banks can reverse the increase in their balance sheet by closing part of their reverse repo contracts and using the cash thus obtained to repay repos. This compression raises their reported leverage ratio, massaging their assets lower, and boosting leverage ratios, allowing banks to report them as being in line with regulatory requirements.

So what did the BIS finally find?  Here is the condemning punchline which was obvious to most back in 2014:

“The data indicate that window-dressing in repo markets is material”

The report continues:

Data from U.S. money market mutual funds point to pronounced cyclical patterns in banks’ U.S. dollar repo borrowing, especially for jurisdictions with leverage ratio reporting based on quarter-end figures (Graph III.A, left-hand panel). Since early 2015, with the beginning of Basel III leverage ratio disclosure, the amplitude of swings in euro area banks’ repo volumes has been rising – with total contractions by major banks up from about $35 billion to more than $145 billion at year-ends. Banks’ temporary withdrawal from repo markets is also apparent from MMMFs’ increased quarter-end presence in the Federal Reserve’s reverse repo (RRP) operations, which allows them to place excess cash (right-hand panel, black line).

This is problematic because this central-bank endorsed mechanism “reduces the prudential usefulness of the leverage ratio, which may end up being met only four times a year.” Furthermore, the BIS alleged that in addition to its negative effects on financial stability, the use of repos to game the requirement hinders access to the market for those who need it at quarter end and obstructs monetary policy implementation.

This is hardly a new development, and as we explained in 2014, one particular bank was notorious for its use of similar sleight of hand: as Bloomberg writes, the use of repo borrowings is similar to a “Lehman-style trick” in which the doomed bank used repos to disguise its borrowings “before it imploded in 2008 in the biggest-ever U.S. bankruptcy.”

The collapse prompted regulators to close an accounting loophole the firm had wriggled through to mask its debts and to introduce a leverage ratio globally.

How ironic, then, that it is central banks’ own financial operations with bank counterparties, that make a mockery of any macroprudential regulation attempts by central banks, and effectively exacerbate the problems in the financial system by implicitly allowing banks to continue masking the true extent of their debt.

Higher asset threshold for US SIFI designation will ease some banks’ regulatory oversight, a credit negative

From Moody’s

Last Wednesday, the US Senate passed the Economic Growth, Regulatory Relief, and Consumer Protection Act. A key component of this bill increases the asset threshold for a bank to be designated a systemically important financial institution (SIFI) to $250 billion of total consolidated assets from $50 billion, the threshold defined in the Dodd-Frank Act of 2010.

For US banks with assets of less than $250 billion, the higher asset threshold for SIFI designation is likely to lead to a relaxation of risk governance and encourage more aggressive capital management, a credit-negative outcome.

SIFI banks are subject to the enhanced prudential standards of the US Federal Reserve (Fed). The regulatory oversight of SIFIs is greater than for other banks, and SIFIs participate in the Fed’s annual Dodd-Frank Act stress test (DFAST) and the Comprehensive Capital Analysis and Review (CCAR), which evaluate banks’ capital adequacy under stress scenarios. Furthermore, transparency will decline with fewer participants in the public comparative assessment the stress tests provide.

In 2018, the 38 bank holding companies shown in the exhibit below are subject to the Fed’s annual capital stress test. Passage of the bill into law would immediately exempt four banks with less than $100 billion of assets from the Fed’s enhanced prudential standards, which includes the stress test and living will requirements. These banks will have the most leeway in relaxing risk governance practices and managing their capital.

The 21 banks at the right of the top exhibit that have assets of $100-$250 billion1 could become exempt from enhanced prudential standards 18 months after passage of the bill into law. However, the Fed will have the authority to apply enhanced oversight to any bank holding company of this asset size and will still conduct periodic stress tests. In the 18 months after passage into law, it will be up to the Fed to develop a more tailored enhanced oversight regime for the $100-$250 billion asset group. The Fed also could continue to apply the same enhanced prudential standards. Therefore, it is difficult to assess the potential for their easier risk governance practices until more about the regulatory oversight is known.

If many of these banks are no longer required to participate in the public stress tests, it would reduce transparency. The quantitative results of DFAST and CCAR provide a relative rank ordering of stress capital resilience under a common set of assumptions. The loss of such transparency is credit negative.

For the largest banks, those with more than $250 billion in assets that remain SIFIs, there are no changes in the Fed’s supervision. The bill also specifies that foreign banking organizations with consolidated assets of $100 billion or more are still subject to enhanced prudential standards and intermediate holding company requirements.

In order to become law, the bill must also be passed by the US House of Representatives and signed by the president. This year’s annual Fed stress test will proceed as usual with submissions by the banks due 5 April, with results announced in June.

 

APRA approves ING Bank (Australia) Limited to use internal models to calculate regulatory capital

The Australian Prudential Regulation Authority (APRA) today announced that it has granted approval to ING Bank (Australia) Limited to begin using its internal models to determine its regulatory capital requirements for credit and market risk, commencing from the quarter ended 30 June 2018.

ING is the first authorised deposit-taking institution (ADI) to be accredited since APRA revised the accreditation process in 2015. Consistent with suggestions from the 2014 Financial System Inquiry, APRA’s changes were intended to make the process more accessible for ADIs to achieve accreditation, without weakening the overall standards that advanced accreditation requires.

APRA continues to engage with other ADIs seeking accreditation to use internal models for calculating regulatory capital requirements.

Moody’s On APRA’s Credit Reforms

Last Wednesday, the Australian Prudential Regulation Authority (APRA) proposed key revisions to its capital framework for authorized deposit taking institutions (ADIs). The revisions cover the calculation of credit,
market and operational risks. These proposed changes are credit positive for Australian ADIs because they will improve the alignment of capital and asset risks in their loan portfolios. Moody’s says the key proposals are as follows:

  • Revisions to the capital treatment of residential mortgage portfolios under the standardized and advanced approaches, with higher capital requirements for higher-risk segments
  • Amendments to the treatment of other exposures to improve the risk sensitivity of risk-weighted asset outcomes by including both additional granularity and recalibrating existing risk weights and credit
    conversion factors for some portfolios
  • Additional constraints on the use of ADIs’ own risk parameter estimates under internal ratings-based approaches to determine capital requirements for credit risks and introducing an overall floor to riskweighted assets for ADIs using the standardized approach
  • Introduction of a single replacement methodology for the current advanced and standardized approaches to operational risks
  • Introduction of a simpler approach for small, less complex ADIs to reduce the regulatory burden without compromising prudential soundness

A particularly significant element of the new regime is a reform of the capital treatment of residential mortgages, given that more than 60% of Australian banks’ total loans were residential mortgages as of January 2018.

The improved alignment of capital to risk for residential mortgages will come from hikes in risk weights on several higher-risk loan segments. APRA proposes increased risk weights for mortgages used for investment purposes, those with interest-only features and those with higher loan-to-valuation ratios (LVR). At the same time, risk weights for some lower-risk segments likely will drop. For example, under the standardized approach, standard mortgages with LVR ratios lower than 80% will require risk weights of only 20%-30%, down from 35% under current requirements.

The higher capital charges on investment loans will better reflect their higher sensitivity to economic cycles. During periods of economic strength investment loans perform well. As Exhibit 1 shows, on a national basis
and during a time of strong economic growth, defaults on investment loans have been lower than owner occupier loans.

However, in Western Australia, where the economy has deteriorated following the end of the investment boom in resources, defaults on investment loans have been higher than owner-occupier loans, as Exhibit 2 shows.

Investment loans also are sensitive to the interest rate cycle. During periods of rising interest rates, investment loans tend to experience higher default rates than owner-occupier loans, as shown in Exhibit 3.

ANZ comments on APRA capital discussion paper

ANZ today noted the release of the Australian Prudential Regulation Authority’s (APRA) discussion paper on revisions to capital requirements and confirmed ANZ’s APRA CET1 position of 10.8% as at December 2017 is already in compliance with APRA’s existing Unquestionably Strong requirements.

The paper outlines proposed changes to the capital framework following the finalisation of the Basel III reforms in December 2017 and changes to its risk framework, with APRA’s implementation timetable extending to 2021.

ANZ will continue to consult with APRA to fully understand the impact of the proposed changes. APRA has confirmed that if the proposed changes result in an overall increase in risk weighted assets, it will reduce the capital ratio benchmark of 10.5% flagged in July 2017.

ANZ’s current capital ratio of 10.8% includes the proceeds of the sale of Shanghai Rural Commercial Bank and a small benefit of the sale of its Asian retail and wealth businesses. Further benefits will be achieved following completion of other asset sales, including the sale of the Australian wealth businesses.

APRA has also proposed a minimum leverage ratio requirement of 4% for Internal Ratings-Based (IRB) banks and changes to the leverage ratio exposure measure calculations for implementation by 1 July 2019. ANZ’s leverage ratio at December 2017 is 5.5%.

ANZ’s previously announced buy-back up to $1.5 billion of shares on-market relating to the sale of ANZ’s 20% stake in Shanghai Rural Commercial Bank remains ongoing.

ANZ Chief Financial Officer Michelle Jablko said: “The divestment of non-core businesses should continue to provide ANZ with the flexibility to consider further capital management initiatives in the future. Further initiatives will be considered once we receive the proceeds of our announced sales and will remain subject to business conditions and regulatory approval.”

APRA Kicks Off Capital Framework Discussion

The Australian Prudential Regulation Authority (APRA) has released two discussion papers for consultation with authorised deposit-taking institutions (ADIs) on proposed revisions to the capital framework.

The key proposed changes to the capital framework include:

  • lower risk weights for low LVR mortgage loans, and higher risk weights for interest-only loans and loans for investment purposes, than apply under APRA’s current framework;
  • amendments to the treatment of exposures to small- to medium-sized enterprises (SME), including those secured by residential property under the standardised and internal ratings-based (IRB) approaches;
  • constraints on IRB ADIs’ use of their own parameter estimates for particular exposures, and an overall floor on risk weighted assets relative to the standardised approach; and
  • a single replacement methodology for the current advanced and standardised approaches to operational risk.

The paper also outlines a proposal to simplify the capital framework for small ADIs, which is intended to reduce regulatory burden without compromising prudential soundness.

The papers include proposed revisions to the capital framework resulting from the Basel Committee on Banking Supervision finalising the Basel III reforms in December 2017, as well as other changes to better align the framework to risks, including in relation to housing lending. APRA is also releasing a discussion paper on implementation of a leverage ratio requirement.

In the papers released today, APRA is not seeking to increase capital requirements beyond what was already announced in July 2017 as part of the ‘unquestionably strong’ benchmarks.

During the process of consultation, APRA will undertake further analysis of the impact of these proposed changes on ADIs. This analysis will include a quantitative impact study, which will be used to, where necessary, calibrate and adjust the proposals released today.

APRA Chairman Wayne Byres said that, taken together, the proposed changes are designed to lock in the strengthening of ADI capital positions that has occurred in recent years.

“These changes to the capital framework will ensure the strong capital position of the ADI industry is sustained by better aligning capital requirements with underlying risks. However, given the ADI industry is on track to meet the ‘unquestionably strong’ benchmarks set out by APRA last year, today’s announcement should not require the industry to hold additional capital overall,” Mr Byres said.

APRA has also released today a discussion paper on implementing a leverage ratio requirement for ADIs. The leverage ratio is a non-risk based measure of capital strength that is widely used internationally. A minimum leverage ratio of three per cent was introduced under Basel III, and is intended to operate as a backstop to the risk-weighted capital framework. Although the risk-based capital measures remain the primary metric of capital adequacy, APRA has previously indicated its intention to implement a leverage ratio requirement in Australia. This approach was also recommended by the Financial System Inquiry in 2014.

APRA is proposing to apply a higher minimum requirement of four per cent for IRB ADIs, and to implement the leverage ratio as a minimum requirement from July 2019.

In addition to the two papers released today, APRA will later this year release a paper on potential adjustments to the overall design of the capital framework to improve transparency, international comparability and flexibility.