The increased capital requirements for the banks have been brought on by a need to shore up capital against residential mortgage exposure. Announced by the Australian Prudential Regulation Authority (APRA), the increased capital requirements will be a blow to some banks while others have already built up reserves in expectation of the coming changes. The capital requirements for risk weights that the big banks are required to hold will go up from 16 percent to 25 percent.
The big banks which include Commonwealth Bank, National Australia Bank, Westpac, ANZ and Macquarie Bank all use internal ratings-based (IRB) approach to gage credit risk. They follow recommendations from the Financial System Inquiry and will have to increase their IRB risk weights for all Australian residential mortgages but will not have to include loans to small businesses that are secured by residential mortgages.
Since the higher risk weights will not actually be required until July 1st of 2016, there is a chance that the measures could be altered according to international reviews from the Basel Committee. Some banks have taken the news better than others.
Preparing for Increased Capital Requirements
Commonwealth Bank sees the changes as a way to further improve its position relative to its peers since it is expected to raise the amount of common equity tier 1 (CET1) capital required for residential mortgages by around 95 basis points.
NAB had been expecting the changes and has been raising $5.5 billion in capital in anticipation.
Westpac would not be ready if the changes were made effective immediately and will have to raise another $3 billion to get into its preferred range. Westpac’s chief financial officer Peter King believes that the cost of the higher capital requirements will be felt by the customers and shareholders.
ANZ’s mortgage lending book will require an additional $2.3 billion to get its capital requirements up to standard. ANZ believes it will not have any problems gathering the capital before the changes take place.
Macquarie Bank was the best prepared for the changes and will be able to meet the increased capital requirements from its existing surplus of capital and earnings.
The APRA’s changes are meant to strengthen the big banks against problems in the residential mortgage market. The increased capital requirements are going to give the banks the buffer they need if the market goes belly up. Although some of the banks might struggle to make the capital available in the next year it is better to be prepared.