IMF pushes to recalculate Aussie majors capital ratios

The International Monetary Fund has strongly endorsed some of the key findings of the Murray inquiry, brushing aside contentions by Australia's majors that they are as well capitalised as their global peers - particularly given the sector's heavy reliance on mortgages.

The latest IMF report on Australia's economic outlook, released yesterday, has warned that the "exceptionally strong income growth" Australians have enjoyed for the "last couple of decades" has come to a halt with the waning of the resource investment boom and the recent sharp fall in the terms of trade.

"Improving this outlook requires policymakers being on the front foot to enable Australia to make the most of its considerable potential," the report said.

On the downside, a pick-up in non-resource business investment "may remain elusive", a house price correction could knock confidence and demand, and China could slow more sharply.

On the upside, domestic demand could respond more quickly to recent monetary policy stimulus, and the exchange rate could depreciate further, stimulating the tradable sector, the report noted.

"This means supporting aggregate demand in the shorter term and boosting productivity in the longer term. And ensuring banks are unquestionably strong would reduce vulnerabilities," according to the IMF.

In looking at how effective prudential policy has been in dealing with areas of risk in the housing market the IMF said: "We expect APRA's approach to succeed, but it may need to be intensified, for example, if investor lending and house price growth do not slow appreciably in the second half of the year.

"Such intensification could include requiring banks with fast-growing investor lending to hold more capital, raising risk weights on investor lending, and restricting the duration of interest-only loans."

And while acknowledging Australia's need to ensure it had "unquestionably strong banks", the IMF noted "the system is dominated by four large banks with similar business models which rely significantly on wholesale external borrowing, most lending is housing related, and household debt and house prices are elevated."

So, while capital ratios have risen since the global financial crisis, in the case of Australia's banks, "this largely reflects a shift towards mortgages and a lowering of risk weights," the IMF reported.

The IMF also advised that, contrary to the views of the local banking lobby, Australian banks do not appear to have particularly high capital ratios and the global trend is upwards.

"The recent APRA stress test indicates that in a severe adverse scenario, bank capital would have to be substantially higher to ensure a fully-functioning system," the IMF said.

"Putting a floor of 25 to 30 per cent on mortgage risk weights would help, but capital ratios would also need to rise substantially.

"Given major banks' high profitability, such ratios can be achieved at little, if any, macroeconomic cost, especially if done gradually, and will make the financial system, the budget, and the economy stronger."

This was very much in line with the subsequent discussion from the Murray Financial System Inquiry, so it was unsurprising to see the IMF concluding that implementing the FSI recommendations should be a priority.