From Clancy Yeates at The Age:
Quelling investor fears over moves to strengthen the financial system, the Australian Prudential Regulation Authority on Wednesday said major banks would have until 2020 to increase their levels of top-tier capital by about 1 percentage point, to 10.5 per cent.
The target was much more favourable to banks than some analyst predictions, with some bank watchers in recent months warning lenders may need to raise large amounts of equity or cut dividends to satisfy APRA’s long-running push for “unquestionably strong” banks.
Markets are now confident banks will hit APRA’s target, estimated to require about $8 billion in extra capital from the big four, through retained earnings or by selling new shares through their dividend reinvestment plans…..
“The scenario where banks had to raise significant capital appears to be off the table for now,” said managing partner at Arnhem Asset Management, Mark Nathan.
Mr Nathan said the banks’ highly prized dividends also looked “safer”, though were not likely to increase. National Australia Bank and Westpac in particular have high dividend payout ratios, which could put dividends at risk from other factors, such as a rise in bad debts……
APRA’s chair Wayne Byres said the changes could be achieved in an “orderly” way, and the new target would lower the need for any future taxpayer support for banks.
“APRA’s objective in establishing unquestionably strong capital requirements is to establish a banking system that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community,” he said.
APRA chairman Wayne Byres used the words “lower the need for any future taxpayer support.” Not “remove the need…..” That means banks are not “unquestionably strong” and taxpayers are still on the hook.
A capital ratio of 10.5% sounds reasonable but the devil is in the detail. Tier 1 Capital includes convertible (hybrid) debt and risk-weighted assets are a poor reflection of total credit exposure, including only that portion of assets that banks consider to be at risk.
Recent bailout experiences in Europe revealed regulators reluctant to convert hybrid capital, included in Tier 1, because of fears of panicking financial markets.
Take Commonwealth Bank (Capital Adequacy and Risks Disclosures as at 31 March 2017) as a local example.
The Tier 1 Capital Ratio is 11.6% while Common Equity Tier 1 Capital (CET1), ignoring hybrids, is more than 17% lower at 9.6%.
But CBA risk-weighted assets of $430 billion also significantly understate total credit exposure of $1,012 billion.
The real acid-test is the leverage ratio which compares CET1 to total credit exposure. For Commonwealth this works out at just over 4.0%. How can that be described as “unquestionably strong”?
Minneapolis Fed President Neel Kashkari conducted a study last year in the US and concluded that banks need a leverage ratio of at least 15% to avoid future bailouts. Even higher if they are considered too-big-to-fail.