APRA’s unquestionably average bank capital information paper


Published by the  Australian Financial Review, Wednesday 19 July


The recommendation of the Financial System Inquiry that Australia’s major banks should be unquestionably strong was based on the premise that they needed to retain access to offshore funding markets even during a crisis. This is probably still true even though banks are much less reliant now on short-term wholesale funding than they were.

The key point, though, is that offshore markets need to understand the strength of the local banks. The Australian Prudential Regulation Authority’s paper suggests increasing the level of equity funding of Australian banks will do this. Clearly more capital will help perceptions. The paper then goes through contortions proving to itself that its new rule will make banks unquestionably strong. The contortions are necessary because APRA has a whole series of opaque rules on how banks are managed which it needs to convert into foreign equivalents. Only once these adjustments are made, is it clear how well our banks stack up globally.

If the objective is to ensure foreign investors are confident about our banks, then APRA should be making it clear to them. It should be getting rid of a lot of special domestic rules and should conform as closely as possible to international practice. The APRA paper actually tells us that its 2015 measure under-estimated the amount of capital in the banks by 300 basis points when normalised to international standards. Such local regulatory idiosyncrasies make it harder for offshore entities to understand the strength of the Australian banks.


Moving ahead of international regulators

In establishing the capital levels required of the banks APRA made a number of assumptions. In place of the FSI recommendation that “a baseline target in the top quartile of internationally active banks is recommended”, APRA has chosen a different level: “the quantum of capital has been calibrated with a view to positioning Australian authorised deposit-taking Institutions (ADIs) comfortably within the top quartile of international peer banks”. Being in the top quartile is quite different to being comfortably within the top quartile.

Not only is APRA setting a higher standard than that recommended by the FSI, it is also extrapolating the improvement in capital levels of other banks globally in setting the level. Since the financial crisis, banks worldwide have been raising their capital levels. APRA has assumed that this process will continue in setting its standards. It is not clear whether this is justified.

The United States administration has expressed its desire to roll back a range of banking regulations, and Europe has a long tradition of agreeing to international rules and then not enforcing them. There is clearly a risk that our regulator will have moved well ahead of where actual banking regulation is in other jurisdictions. The point here is that the focus of the new regulations is on international comparability, so what is happening globally is important.


Imposing fresh new costs

The second half of the APRA paper focuses on the competitive impact of its recommendations. It affirms APRA’s insistence that the concept of “unquestionably strong” should apply to all ADIs and then suggests a smaller increase in the capital required for smaller banks than large ones. The case for a smaller increase is basically that the current regulatory model for the smaller ADIs is conservative. This seems completely ad hoc. First, it is not clear why all ADIs need to be unquestionably strong at all, and second does APRA really feel that the standardised framework for measuring risk in smaller banks is inappropriately conservative? This chapter needs rethinking.

The final section of the paper looks to how the new rules might be implemented and what the consequences might be. First, APRA says it expects not to have to change the rules again after the final Basel implementation; so we have some certainty which will be appreciated by the sector. It then argues that the banks will be able to reach the new targets from retained earnings and hence with little disruption to their business plans. Only in the very final section of the paper does it suggest that the new rules might lead to an increase of up to a 10 basis point uplift in the pricing of loans.

One looks in vain for any sort of cost-benefit analysis.

This is the most disappointing aspect of the paper. Once again we have APRA imposing costs on the economy without any review process and without real evaluation of the costs. It may be good policy but we really cannot tell.