Regional banks fare well under FSI capital reforms

Anticipated reforms to bank capital methodology will be of material benefit to regional banks, an analysis by Standard & Poor's suggests.

But regional banks will need to adopt the most advanced methodology for modelling capital and credit risks in order to benefit most from any reforms.

Last year's Financial System Inquiry suggested changes that would align the mandated capital-requirements for major banks and all other Australian banks.

The recommendation in the Inquiry's Final Report was to "raise the average IRB [internal ratings based] mortgage risk weight to narrow the difference between average mortgage risk weights for ADI's using IRB risk-weighted models and those using standardised risk weights."

According to S&P the major banks must hold an average risk weight of 18 per cent of residential mortgages, and the other banks must hold 39 per cent. The FSI recommended the requirement for the majors be increased.

The FSI considered a risk weight range of between 25 per cent and 30 per cent for IRB banks as appropriate.

S&P calculated the implications for IRB banks of an average risk weight for residential mortgages of 27.5 per cent.

The S&P calculations show the major banks would need to raise a combined A$18 billion in new capital in order to maintain their tier one capital ratios.

The regional banks would have a combined A$1.3 billion in "surplus" capital, should they achieve IRB accreditation and be subject to the same 27.5 per cent as the major banks for residential mortgages, S&P found.

The S&P report found that "if the proposed changes were implemented, they would result in a higher level of capital held against mortgage loans across the entire industry, which would be positive for our overall credit view of the Australian banking system, particularly in light of growing concerns about property price inflation."