The big banks could see their capital ratios decline by as much as 250 basis points over the next couple of years but the banks’ buffers are high enough to support continued lending, the Reserve Bank concludes in its latest Financial Stability Review.
The RBA said that under a baseline stress test simulation, CET1 capital ratios for major and mid-sized banks are estimated to fall by 140 bps. The fall would be closer to an average of 200 bps if the economic outcome reflects the downside scenario, which assumes a property price fall of 20 per cent.
Australian banks reported a five-fold increase in the charge for bad and doubtful debts over the first half of the year.
And since the start of the year, major and mid-sized banks have raised provisions of around A$8 billion to cover expected losses. This has taken their overall provision coverage of 80 bps of gross loan and acceptances.
The RBA says, based on the banks’ disclosures, provisions could increase to 120 bps of GLA in their most severe, but plausible, scenarios of the current economic contraction.
This equates to a further 40 to 70 bps of common equity tier 1 capital ratios.
The RBA says capital requirements will rise because risk weights applied to existing exposures will increase.
“For example, falls in the prices of property and other collateral, or downgrades of customers’ credit ratings, can increase the risk weights of mortgage and business lending.
The major banks have estimated that these types of increases could subtract 70 to 80 bps of CET1 over the next two years.
These factors could result in 110 to 250 bps decline in capital ratios over the next couple of years.
“However, even before taking into account banks’ ability to generate new capital over this period, these estimates suggest that, even under the major banks’ most severe scenarios, they will still have sufficient buffers available to support further lending.”
In Australia there are two regulatory capital buffers: the capital conservation buffer, which is 2.5 per cent; and the countercyclical capital buffer, which is up to 2.5 per cent.
Banks also hold voluntary management buffers.
The RBA says one issue for bank regulators is to get banks to use their buffers. Banks are subject to restrictions on earnings distribution if they move into their buffers.
Using buffers could also create negative investor sentiment, impacting the cost and supply of funding.
The RBA said: “The risk that negative investor perceptions of buffer use materially affects Australian banks is low because of their reduced funding needs in the immediate future.”
Overall, the RBA said the financial system remains well placed “to withstand the economic effect of the pandemic, while supporting households and businesses”.
It said banks’ liquidity positions have been strengthened as a result of strong growth in household and business deposits, as well as additional funding from the term funding facility.
The RBA warned that some ADIs, especially those exposed to particular geographies or industries, could become unprofitable in a weak recovery, such as the downside scenario.