APRA dismisses special pleading

It would be "pointless and unhelpful" for Australian financial institutions and financial regulators to stand against the tide of international reform, APRA's bank supervisory chief told a symposium at Bond University on Friday.

Wayne Byres, executive general manager diversified institutions division at the Australian Prudential Regulation Authority, reprised, in an extended version, a talk given the day before in Melbourne (and reported on Friday in Banking Day).

Byres' chief theme is the same as that advanced by APRA's chair, John Laker, and the Treasury secretary, Ken Henry; which is that banks need to conform to new international norms on bank regulation.

Byres said the Australian system did perform well during the financial crisis in 2008 relative to other countries but a lot of public sector support and intervention went into achieving that outcome.

Australian financial institutions can expect to see implementation of the full gamut of higher minimum capital requirements, tougher rules on the composition of capital, higher quality liquid assets, greater emphasis on long-term funding, forward-looking loan loss provisioning and new remuneration structures.

Byres highlighted what he called a fundamental change in regulatory thinking in response to the "too big to fail" problem. Under the Basel framework, large, diversified institutions tended to have the lowest capital requirement.

Byres said that in future: "Once scale becomes sufficiently large to be seen as a threat to the stability of the system as a whole it will increasingly be viewed as a negative rather than a positive and bring additional regulatory burdens and oversight. In other words, disincentive to scale may be introduced."

He said that from APRA's point of view it was difficult to argue that "further strengthening of the system is not justified."

Byres said: "We were not immune from some of the trends that occurred throughout the world. To remain competitive and improve their returns to shareholders our banks did increase their levels of leverage, until implementing a sharp reversal via substantial capital raisings beginning in late 2008.

"Business lines and transactions were pursued which, with the benefit of hindsight, some institutions now regret pursuing. And liquidity planning was probably not as robust as first thought. These trends may have been less significant than in other countries but they were evident here nonetheless."

Byres said: "We are a small, open economy participating in a global financial system and any attempt to declare independence from the rest of the world will inevitably be counter-productive. While our banking system is so reliant on offshore funding it is vital that we are seen to be playing by the international rules of the game.

"APRA does not see any case for implementing a framework which the rest of the world would judge to be weak or less robust than the international norms.

"Even if we attempted to implement a weaker set of rules, international markets and counterparties would hold Australian banks to the international standards and measures in any event."

Byres said it was a legitimate concern of local banks that an uneven playing field will emerge if Australia is rigorous about enforcing new reforms but other countries only pay them lip service.

He said there would be some tailoring for Australian conditions. The Basel II framework has more than 80 explicit national discretions which APRA had to take a view on.

APRA has tended to be tougher when it has modified international standards, such as its position on regulatory capital, but not always. It has adopted a less prescriptive approach to remuneration requirements than the limits and caps recommended by the Financial Stability Board.

Byres said: "In the area of capital adequacy, higher minimum levels of equity capital are inevitable but we already have a profitable banking system which is operating with strong capital levels.  We expect the new rules will reduce banks' reported capital ratios, but at this point we do not expect the Australian banking system to be found to be short of capital under the new risk-based measures."

As with his earlier talk, Byres acknowledged the banking industry's discontent over the likely reintroduction of the leverage ratio.

"The leverage ratio will be an interesting development for Australian banks.  Our banks tend to operate with relatively high levels of leverage, but this is mitigated by the relatively low risk profile of their balance sheets (driven by large mortgage portfolios).  We see limited benefit from a leverage ratio if the risk-based ratio is correctly implemented and policed.  

"Nonetheless, if it is to be introduced, we will need to work with our international counterparts to calibrate the minimum leverage ratio so that it does not act as the binding constraint on normal banks in normal times."