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Will increased capital requirements put an end to the big banks’ party?

Australian banks are likely to be impacted by upcoming changes to regulatory standards that will increase capital requirements.

The Federal government’s Financial Systems Inquiry recommended that Australian banks be required to increase their equity capital to equal that of the top 25% of globally active banks and increase the risk weighting that they apply to their home loans.

The Basel Committee responsible for setting the global banking regulatory framework has also indicated changes will be made that will likely result in increased capital requirements for Australia & New Zealand Banking Group (ASX:ANZ), Commonwealth Bank of Australia (ASX:CBA), National Australia Bank Ltd. (ASX:NAB) and Westpac Banking Corp (ASX:WBC). Reserve Bank Governor Glenn Stevens also weighed in this week supporting the proposed changes.

The capital requirements mean banks have to hold a higher percentage of their risk weighted assets as capital. While such a move will reduce the risk that shareholders will lose their whole investment in the unlikely event that the bank goes bust, the higher capital requirements will also impact return on equity.

This is because banks can meet the new capital requirements using one or a combination of three main methods. They can raise extra capital – by issuing new shares, for example. They can reduce their total loan portfolio. Or the banks can lower the overall risk of their loan book – by reducing loans to higher risk opportunities such as start ups, and/or increasing the proportion of loans to low risk housing and large businesses. Each of these methods is likely to result in a hit to shareholders return on equity.

Industry consultation on David Murray’s Inquiry ended on 31 March and Joe Hockey has now had the report for five months.

Although some have advocated for holding off on implementation of higher capital requirements until the Basel committee has released what analysts are dubbing the ‘Basel IV’ standards, Murray himself has pointed to a potential increase in competition as a reason to implement his recommendations locally as soon as possible. “I would be more inclined to move on it because competition is important and urgent and I think the factors we pointed to in the housing market are significant,” he said.

The regional banks such as Suncorp Group Ltd (ASX: SUN) and Bendigo and Adelaide Bank Ltd (ASX: BEN) are likely to be more competitive with the big banks as a result of higher capital requirements as they have a risk weighting on mortgages of about 39% compared to the big banks’ weighting of just 18%.

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Motley Fool contributor Joshua Anderson has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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