The Australian banking regulator APRA has announced new capital adequacy requirements for authorised deposit-taking institutions (ADIs) that include the big banks like National Australia Bank Ltd (ASX: CBA) and Westpac Banking Corp (ASX: WBC).
The major banks are accredited by APRA to use a more sophisticated internal ratings approach and the regulator believes they’ll need to increase capital adequacy levels “around 100 basis points above their December 2016 levels”. This will translate into a benchmark capital ratio of “at least 10.5 per cent” according to APRA.
Broadly speaking the banks are required to allocate assets (loans) on their balance sheet a risk weighting according to their credit risk and then hold a set proportion of liquid capital in reserve against these assets.
Home loans for example are classified as relatively low risk assets as they are fully collateralised against property.
However, other types of semi-securitised (for example business) lending, collateralised debt obligations, derivatives, or other assets marked to market or interest rate risks across banking books are allocated higher risk weightings.
It is thought forthcoming regulatory changes (including some related to Basel IV) to how risk weightings on assets should be calculated may hurt the home loan focused lenders like Commonwealth Bank of Australia (ASX: CBA) or Westpac more as they will disproportionately lift the requirements for how much capital must be held in reserve on “low risk” assets. These being predominantly housing loans including “interest only” or more leveraged loans on higher loan to value ratios.
This is because APRA is concerned about growing risks in the housing market and “sub-prime” lending that has fuelled house price growth built largely on numerically low rates and subjectively lower lending restrictions.
I first covered in more detail in July 2016 how political pressure and the fallout from the “credit” and “sub-prime lending” crisis of the GFC in 2008 will probably still hurt Australian bank shares out to 2020.
Today APRA’s chairman, Wayne Byers, implicitly acknowledged this stating: “Today’s announcement is the culmination of nearly a decade’s financial reform work aimed at building capital strength in the financial system following the global financial crisis.”
In other words these reforms are all about politicians globally demanding regulators toughen up regulations on the banks to avoid the humiliation of another GFC that would see them having to bailout reckless bankers with taxpayer funds again.
Over the last few years in particular inter-governmental pressure has been exerted via central bank policymakers on regulators to make the banks “unquestionably strong” and this is something I covered in more detail in this September 2016 article.
In May 2017 bank investors also wore an arbitrary Federal government levy of 6 basis points on certain liabilities due to the government guaranteed (implicitly at least) central bank’s role as an effective lender of last resort, with the “unquestionably toughening” regulatory cycle still having potential to hurt investor returns.
A best-case scenario is that the banks ride out the requirement to carry more stagnant capital (that cannot be lent out profitably) and deleverage by a mix of assets sales, cost cutting, restructuring, and passing the bill onto customers via higher lending rates.
However, the worst case scenario is that the banks are forced once again to either raise capital from investors or cut dividends. Either of these moves could seriously hurt share prices and investor returns over the years ahead.
If the banks' term-deposit rates stay low your lifestyle expectancy could stay low with them.
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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a makes us better investors. The Motley Fool has a . This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.