APRA under global pressure on Big Four

David Walker
An International Monetary Fund report has provided the clearest sign yet that Australia will be forced to require its Big Four banks to hold extra capital.

The IMF's latest Financial System Stability Assessment of Australia was released on Friday. It shows the Australian Prudential Regulatory Authority is under strong international regulatory pressure to adopt a tougher capital requirements stance for domestic systemically important banks, or D-SIBs.

IMF exhibit 1

IMF exhibit 1

The Big Four oppose any extra capital requirements. The Australian Bankers Association's CEO, Steven Münchenberg, said last night that APRA already had mechanisms for dealing with the D-SIB issue through the additional prudential requirements it currently applies to individual banks on a case-by-case basis.

But Münchenberg also told Banking Day last night that he believed APRA was "not comfortable" that international rules would let them continue without imposing additional capital charges on the Big Four.

The IMF report confirms that the Big Four Australian banks are domestic systemically important banks - indeed, moreso than banks in any other major economy.

As reported in Banking Day, the Basel Committee last month finalised rules requiring stronger loss-absorbency rules for D-SIBs, including holding extra capital.

APRA has not set out what new rules, if any, will apply to Australia's Big Four under the D-SIB framework.

But the local supervisor appears to doubt the need for explicit additional capital requirements. Australian regulators have recently depicted capital requirements as being just part of the prudential toolkit. And APRA chair John Laker hinted in July that he might not impose additional D-SIB capital charges on the Big Four.

The IMF, however, devotes an entire section of its report to "a case for higher loss absorbency" for the Big Four.

It notes that Australia's four major banks hold 80 percent of banking assets and 88 percent of residential mortgages (see chart), more than in any other comparable major economy. They are among each other's largest counterparties and their default frequencies are likely to change together. If one of them failed, it says, then "the impact on the financial system and the economy would be potentially substantial."

Using one methodology, it says that as of the end of 2011 maintaining a 99.9 per cent probability of not defaulting on any payment would require the Big Four to hold additional tier 1 capital of between -0.9 per cent (i.e., less capital) and 2.8 per cent of risk-weighted assets.

A 99.95 per cent probability of not defaulting would require from 1.4 to 5.2 per cent of risk-weighted assets using the same methodology.

"How much additional capital may be ultimately required will depend on APRA's risk tolerance", the report says.

The IMF also says that because creditors know authorities will not let the Big Four fail, they can borrow more cheaply. For this reason, it argues, they should bear some of the cost of making the system safer.