The Australian Prudential Regulation Authority (APRA) has announced its assessment on the additional capital required for the Australian banking sector to have capital ratios that are considered ‘unquestionably strong’. In its assessment, APRA has focused on the appropriate calibration of Common Equity Tier 1 (CET1) capital requirements, recognizing that CET1 is the highest quality capital and therefore most likely to engender confidence in an ADI’s financial strength. APRA’s assessment has been guided by a range of quantitative factors, including international capital comparisons, ratings agency methodologies, and stress test results. Stronger capital ratios will equip the Australian banking sector to handle the periods of adversity in the future. Moreover, APRA will also continue to have regulatory and supervisory tools, both at the level of the system, and for individual ADIs to respond to emerging risks as and when they arise.
For ADIs (Authorized deposit-taking institutions) that use the internal ratings-based approach to credit risk, APRA has concluded that it is necessary to raise minimum capital requirements by around 150 basis points from current levels to achieve capital ratios that would be consistent with the goal of strong’ capital benchmarks. This calibration recognizes that ADIs using the IRB (internal ratings-based) approach are currently operating with a higher capital surplus above regulatory minimum, in anticipation of APRA’s implementation of the FSI’s (Financial System Inquiry) recommendation. APRA therefore expects that some of the increase in minimum requirements might be met through the surplus these ADIs hold more than minimum regulatory requirements. In the case of the four major Australian banks, APRA expects that the increased capital requirements will translate into the need for an increase in CET1 capital ratios, on average, of around 100 basis points above their December 2016 levels. In broad terms, that equates to a benchmark CET1 capital ratio, under the current capital adequacy framework, of at least 10.5%, and it expects the four major banks to meet this benchmark by 1 January 2020.
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Major bank increase in CET1 capital requirements; (Source: APRA)
APRA’s objective in implementing a framework for unquestionably strong capital ratios is to increase the financial strength of ADIs, so that they are able to continue lending and providing other critical economic functions during periods of financial stress. Further, APRA intends to issue a discussion paper on proposed revisions to the capital framework later this year, designed to establish prudential standards that will underpin ADIs having unquestionably strong capital ratios. The new capital framework will likely propose a range of changes including, Basel III changes in respect of credit risk, operational risk and the capital floor, while other changes to address mortgage concentration risk, and to improve transparency, comparability and flexibility.
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Implementation timeline; (Source: APRA)
Australia and New Zealand Banking Group’s (ASX:ANZ) CET1 capital ratio as at 31 March 2017 was 10.1%, equivalent to an APRA CET1 of 10.5% on a proforma basis. Together with the benefits from announced yet to be completed asset sales, ANZ is well placed to achieve the strengthened capital standards. Westpac Banking Corp (ASX: WBC) had reported a CET1 capital ratio of 10.0% at 31 March 2017, and well positioned to meet this new benchmark by proactively taking steps to boost its CET1 capital ratio, while National Australia Bank’s (ASX: NAB) CET1 ratio stood at 10.1% on an APRA basis as on 31 March 2017.
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