Bank capital adequacy ratios to change

The chair of the Australian Prudential Regulation Authority (APRA), Wayne Byres, has revealed that the regulator’s work on bank capital is being brought “to the finish line” with soon-to-be-announced changes to bank capital adequacy ratios.

Speaking at the AFR’s Banking and Wealth Summit last week, Mr Byres said: “There are a number of key outcomes that these changes are designed to achieve. The first point I would make, however, is that we believe the banking system is adequately capitalised. The result of this reform will not be that the industry needs to raise additional capital.

“What we are seeking to do is complex and multifaceted. We want to make the capital regime:

• more risk-based – by adjusting risk weights in a range of areas, some up (e.g. for higher risk housing) and some down (e.g. for small business);
• more flexible – by changing the mix between minimum requirement and buffers, utilising more of the latter;
• more transparent – by better aligning with international minimum standards, and making the underlying strength of the Australian framework more visible;
• more comparable – by, in particular, making sure all banks disclose a capital ratio under the common, standardised approach; and
• more proportionate – by providing a simpler framework suitable for small banks with simple business models.

“Inevitably, there are some trade-offs needed between these objectives. Making the system more risk-based and flexible, for example, does not always line up well with a simplicity and proportionality objective. 

“We also need to make sure the proposals are calibrated to meet the previously announced ‘unquestionably strong’ benchmarks. That means adjusting one area of the framework often requires an offsetting adjustment somewhere else.”

Mr Byres said that APRA is now “putting the finishing touches to the consultation package”, which will be released “in the next few weeks”.

In the new package, he said that bank capital adequacy ratios will change so that they will “tend to be higher”.

“That is because the changes we are proposing will, in aggregate, reduce risk-weighted assets for the banking system. Given the amount of capital banks have will be unchanged, lower risk-weighted assets will produce higher capital ratios,” he said.

However, he flagged that it would not mean that banks will be able to hold less capital overall. 

“A key objective is to not increase capital requirements beyond the amount needed to meet the ‘unquestionably strong’ benchmarks,” he said.

“Nor is it our intention to reduce that amount. The balance will be maintained by requiring banks to hold larger buffers over their minimum requirements.”

“What we are effectively doing is changing the unit of measurement for bank capital adequacy.”

He gave the analogy of changing metrics from inches to centimetres, elaborating: ”The number of units goes up, but you are no taller.

“In our case, bank capital ratios will go up, but the dollar amount of capital the banking system has to hold should be largely unchanged.”

Housing loans in focus

He said these changes would help “improve risk sensitivity” to ensure that capital is “better allocated according to risk” and also “make the framework more flexible, especially in times of stress”.

“Housing loans, which dominate the industry’s balance sheet, will be a particular area of focus,” Mr Byres noted.

“Within the standardised approach, for example, you can expect to see that lower-risk loans – such as amortising loans with low loan-to-valuation ratios – will get lower risk weights, but higher-risk loans – for example, loans with extended interest-only terms – will get relatively higher risk weights.”

He continued: “Holding a larger proportion of capital requirements in the form of buffers means there is more buffer available to be utilised in times of crisis, helping preserve the flow of credit at a time when it is most needed. 

“Some of this will involve an expansion of the capital conservation buffer, and some will be achieved by establishing a non-zero countercyclical capital buffer as the default setting. Both of these steps are mirroring steps being considered elsewhere in the world.”

Mr Byres also suggested that Australian bank capital ratios “look relatively low” on a global basis, which “undersells their financial strength” 

“By changing the way we measure capital adequacy, without reducing our overall requirements, we will not remove this issue entirely, but we will make the differential smaller and easier to understand,” he said.

The APRA chair concluded by saying that the regulator’s “unquestionably strong” objectives had been achieved, but stated that the strengthening was done by “encouraging, coaxing and cajoling the industry to build up capital in anticipation of new standards”. 

“We now need to finalise those standards to ensure that the strength we have benefited from is a lasting feature of the system,” he said.

[Related: APRA revises proposed regulatory changes for mortgage lending]