Major banks ordered to raise capital buffers to be ‘unquestionably strong’

Banks should not use new requirements designed to make them more resilient to shocks as an excuse to hike interest rates for home loan customers, Treasurer Scott Morrison has warned.

The Australian Prudential Regulation Authority on Wednesday unveiled its long-awaited views on what banks must do to be considered “unquestionably strong,” as recommended by the 2014 financial system inquiry.


How can the banks be ‘unquestionably strong’?

Clancy Yeates explains why APRA has announced the banks need to increase their capital.

It said the country’s largest lenders would need to increase top tier capital – a cushion used by banks to absorb losses – by about 1 percentage point, to 10.5 per cent of their assets. Banks will need to meet the new target by 2020.

When the banking regulator last increased capital requirements in 2015, banks responded by raising interest rates on mortgages, in an attempt to offset some of the drag on their profitability. 

After warning the banks not to pass on the budget’s bank tax to customers, Mr Morrison said they should not try to increase interest rates on home loans in response to Wednesday’s changes.

He noted the widening gap between the banks’ home loan rates and official interest rates set by the Reserve Bank, and said lenders were “well placed” to meet the new standards.

“We already know that the spread between the cash rate and mortgage rates has been widening,” Mr Morrison told BusinessDay.

“I don’t think what is a prudent regulatory policy to promote the strength of our banking system should be used as an excuse to hit customers with bigger costs,” he said.

“Banks that do that have to face their customers.”

Mr Morrison, who in May also announced budget measures to boost competition in banking and make senior executives more accountable, said he was committed to a banking system that was “unquestionably fair” as well as “unquestionably strong”.

“It puts us at the top of the pack when it comes to the resilience of our banking system in the world,” he said of APRA’s changes.

Commentary from the major banks also suggested the impact would be manageable, and shares in the big four banks all rose by 3 per cent, with investors relieved the requirements were not tougher.

ANZ Bank’s chief financial officer Michelle Jablko said that taking into account the impact of already announced asset sales, the bank was set to hit APRA’s 10.5 per cent target “well ahead” of the 2020 deadline.

Westpac finance chief Peter King said his bank was “well positioned” to meet the target, after reporting a 10 per cent capital ratio in March this year.

National Australia Bank’s finance chief Gary Lennon said the bank would be able to hit the targets in an “orderly fashion”.

Commonwealth Bank of Australia’s chief financial officer Robert Jesudason also said the bank was “well placed” to meet the capital requirements.

Macquarie Group told the market the changes would increase the minimum capital requirements of its banking arm, Macquarie Bank, by $1.4 billion. However, the wider group had sufficient excess capital to accommodate APRA’s increase.

Capital provides a loss-absorbing cushion for banks in times of financial stress. Australia’s banks have already raised tens of billions in new equity capital since the global financial crisis in response to a global push from regulators for safer banks.

“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,” APRA chair Wayne Byres said.

“Australia has a robust and profitable banking industry and APRA believes this latest capital strengthening can be achieved in an orderly way.”

Being better capitalised lowers profitability for banks, and APRA estimated that if banks tried to offset the impact of the rule change by changing customer interest rates, they would need to widen the gap between rates on deposits and loans by 10 basis points.

However, their ability to do so would be limited by competition, as many smaller banks will not need to bolster their capital positions.

APRA said it would also continue to look more closely at “risk weights” of the five largest lenders who are able to use financial models that effectively allow them to have relatively skinnier capital buffers than smaller peers.

Analysts expect banks will ultimately be forced to hold more capital against property investor and interest-only mortgages as a result of this review, and such an outcome could lead to further rises in interest rates for these customers.

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