The prudential regulator has lifted the target for major Australian banks’ equity capital ratio to “at least 10.5 per cent”, up from current levels of common equity tier 1 capital (CET1) of around 9.5 per cent, in order to meet the “unquestionably strong” benchmark set down by the financial system inquiry.
This will require the banks to raise billions of dollars of additional equity, although this may be able to be achieved by building more equity organically via retained earnings rather than conducting equity capital market raisings.
APRA said banks should implement the changes “in a timely manner” and consider whether they can achieve the new benchmark more quickly than its official deadline of January 2020.
Australian Prudential Regulation Authority chairman Wayne Byres said in a highly-anticipated statement on Wednesday morning that APRA’s objective is to establish a banking system “that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community”.
APRA will also consult with the market on new prudential standards that will come into effect in 2021. It will release a discussion paper later this year on “on proposed revisions to the capital framework”, APRA said. This will include potential changes to the framework for risk weightings for mortgages.
APRA’s changes to the common equity tier 1 (CET1) capital will increase the minimum requirement for all the major banks by around 150 basis points, from a current target of 9 per cent.
Given banks are already operating above their current minimum CET1 in anticipation of APRA’s changes, the new requirements will translate to the need for an increase in CET1, on average, of around 100 basis points above December 2016 levels, APRA said.
But it added that some of the increase in minimum requirements “might be met through the surplus these [banks] hold”.
For non-major banks, the new requirements will require an increase in the capital ratio by around 50 basis points.
Banks will now have to determine whether they can build the new equity capital organically, via dividend reinvestment plans, or through equity raisings. All have been running scenarios, and are expected to make statements to the ASX on Wednesday morning.
APRA said in a release the capital build “should be achieved in a timely manner” and by 2020, it said five years would have elapsed since the release of the final financial system inquiry report. “Against that background, APRA encourages [banks] to consider whether they can achieve the capital benchmarks more quickly,” it said.
According to sensitivity analysis published by Morgan Stanley ahead of APRA’s announcement, a 10.5 per cent CET1 ratio – with mortgage risk weights kept around current levels – results in a capital shortfall of $2.6 billion at Commonwealth Bank, $1.9 billion at National Australia Bank and $700 million at Westpac Banking Corp. ANZ Banking Group is estimated to have a capital surplus of $1.4 billion at a CET1 of 10.5 per cent.
However, if mortgage risk weightings are increased from current levels later in the year, this would mean that higher levels of equity will be required.
The average CET1 ratio of the major banks has risen from 8.9 per cent in the 2014 financial year to 9.85 per cent in FY16 and is expected to rise to 10.2 per cent in FY17 and 10.4 per cent in FY18 based on Morgan Stanley’s estimates.
At the first half of 2017 based on pro forma numbers, ANZ had the strongest CET1 of 10.9 per cent, followed by Westpac at 10.2 per cent, NAB at 10 per cent and CBA at 9.5 per cent.
“Today’s announcement is the culmination of nearly a decade’s financial reform work aimed at building capital strength in the financial system following the global financial crisis. Australia has a robust and profitable banking industry and APRA believes this latest capital strengthening can be achieved in an orderly way,” Mr Byres said.
“Capital levels that are unquestionably strong will undoubtedly equip the Australian banking sector to better handle adversity in the future, and reduce the need for public sector support.
“However, a strong capital position still needs to be complemented by sound governance and risk management within ADIs, and on-going proactive supervision by APRA.”
APRA said its additional discussion paper later this year will also provide options to improve transparency and international comparability of bank capital ratios.
It said it expects to consult on draft prudential standards giving effect to the new framework in late 2018, leading to the release of final prudential standards in 2019, which are anticipated to take effect in early 2021.