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Higher Capital Demands Loom For The Big Four
BY GLENN DYER - 18/04/2017 | VIEW MORE ARTICLES BY GLENN DYER

The Reserve Bank has sent investors a powerful message that Australian banks will face further pressure on revenue, profits and dividends from higher capital needs in coming years to make them ‘stronger for longer’.

After two years of rising capital calls (forcing them to sell assets here and offshore) and weak revenue and earnings growth, the banks, led by the big four, the CBA, NAB, ANZ and Westpac - will all face more years of similar pressures from 2018 onwards.

And at the same time the RBA has warned banks against doing anything to reverse the slide in their returns on equity, and suggested that the recent strong rebound in bank share prices might be out of whack with reality as they start grappling with the higher capital standards to be imposed by key regulator, APRA.

And we are talking what could be large amounts of new capital - from around $16 billion estimated by the NAB late last year, to between $25 to $30 billion according to a report in 2016 from the Commonwealth.

"It is likely that Australian banks will need to increase their capital ratios over coming years to comply with APRA’s framework for ‘unquestionably strong’ standards. APRA expects that banks will be able to manage any increase in capital requirements with appropriate capital planning,“ the RBA said in last week’s bi-annual Stability Review.

The RBA said that co-regulator, APRA “will provide further guidance in coming months on what capital standards it believes are necessary to make banks ‘unquestionably strong’.”

That means the banks will have to hold more capital to support their activities, and one of the areas that looks like being the subject of intensive examination is mortgage lending for housing.

"It (APRA) has reiterated that revisions to the capital framework will be guided by a range of factors, including the recommendation in the Financial System Inquiry that CET1 (Tier 1) capital ratios should be in the top quartile of international peers, stress test results, rating agency measures and allowing for flexibility throughout the economic cycle.

"It will also consider banks’ broader risk profiles, including funding and liquidity, earnings and governance.

“As part of this process, APRA will review whether and how to adjust risk weights on mortgages,“ The RBA said. If APRA had not been looking at lifting the amount of capital banks will be required to hold against each loan, the regulator would not have mentioned it.

It will be a major area of work for regulators and possibly the most important regulatory move to further control home lending on top of the crackdowns on interest only loans in late 2014-15 and this year, and forcing banks to stiffen their testing of the capability of each borrower to repay their loans.

The big banks had been expecting APRA to define what an “unquestionably strong” bank means by the end of last year. Now it is later this year. What it will involve is the regulators forcing the banks to raise more capital to boost their top tier capital levels by lifting the required equity buffers to rise from 1% to 2%. This means the majors’ minimum CET1 (top tier) ratios will rise from 8% to 9%.

According to the RBA, at the moment the major banks’ aggregate leverage ratio increased a little over the second half of 2016 to 5.1% and remains well above the planned 3% minimum due to be introduced in 2018.

“The leverage ratio is a non-risk-based measure of a bank’s Tier 1 capital relative to its total exposures, and is intended to be a backstop to the risk-based capital requirements,” The RBA said in its Stability Review.

The RBA pointed out that "APRA has reiterated that revisions to the capital framework will be guided by a range of factors, including the recommendation in the Financial System Inquiry that CET1 capital ratios should be in the top quartile of international peers, stress test results, rating agency measures and allowing for flexibility throughout the economic cycle. It will also consider banks’ broader risk profiles, including funding and liquidity, earnings and governance.”

On top of this regulators, led by the RBA and APRA are watching the banks closely to make sure they don’t get up to anything that might be too risky as they seek to offset the downward pressure on returns from the higher capital needs.

"The rise in bank capital over the past two years, combined with minimal profit growth, has reduced banks’ ROE below its historical average of 15 per cent. Lower ROE seems likely to persist as banks accumulate more capital to meet an ‘unquestionably strong’ standard,“ the RBA said.

"So far banks have mainly responded to lower ROE by repricing their loans and selling lower-return wealth management and international assets. Westpac also recently lowered its ROE target.

“However, it is possible that Australian banks may attempt to restore their ROE to historical levels by taking on additional risk in ways that are not fully captured by regulatory risk weights,” The central bank warned. And home lending is clearly one area where the regulators are concerned, judging by comments elsewhere in the Stability Review.

This all means considerable change ahead for banks, bank investors and creditors. It means greater pressure on earnings, on dividends and revenue growth, meaning investors could be facing several years of tougher times from the banks.

That is not the message the markets have been sending in recent months as the banks have shaken off the blues and seen their share prices recover strongly.

The RBA points out that bank share prices have risen strongly over the past six months, in line with global trends.

"Increases to analysts’ earnings forecasts have been much more moderate, resulting in banks’ forward earnings yields declining (particularly compared with the broader market). However, banks’ earnings yields are still similar to the levels prevailing pre-crisis, despite a large decline in risk-free rates,” The RBA wrote.

In other words, you could argue that bank shares are overbought and could be in for a slide.



View More Articles By Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

At the AFR he was a finance writer, Finance Editor, News Editor and Chief of Staff. At the Nine Network he was supervising producer of Business Sunday for more than 16 years. He has also written for other online and analogue print publications here and overseas.



 

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