Australian banks will face an even tougher time over the next two years or so in boosting earnings after the key regulator, APRA, said it was raising the amount of capital banks will have to hold against housing loans – except those for small business loans secured by residential mortgages.
The move will force the banks to add an extra $11 billion to their capital base to allow them to continue to finance their huge holdings of home mortgages, but at a higher cost for borrowers.
But investors were sanguine yesterday. The big four banks all posted gains, with the ANZ rising 1.3%, while CBA added 0.4%, the NAB 0.3% and Westpac 0.1%.
Coming on top of the estimated $28 billion the banks will need to find to meet the new capital rules, announced last week, the big banks in particular face additional pressure in the next few years years so far as profits and costs are concerned from having to find the extra capital.
They have already started doing so – Westpac has sold down its stake in BT, and is running its dividend reinvestment programs as are other banks.
Other asset sales (NAB’s insurance business) are underway, while the NAB has taken the biggest step so far by raising more than $5 billion from shareholders (much of which will be used to refinance the UK banking business ahead of its spinoff later in the year).
And the ANZ has started the sale process for its Esanda business lending loan book, while there is talk of the Commonwealth looking to sell non-core assets – all with the aim of raising more capital.
This though will be a situation that will have enormous implications for the health of the stockmarket and the portfolios of millions of self-managed super fund and other investors in the next one to two years, given the way the banks dominate the stockmarket and the investments of self-managed super funds.
And there could be extra pressures for the wider eocnomy as well from making housing loans more expensive. Housing finance approvals have already started slowing (in the May data from the Australian Bureau of Statistics) and this move today will add to the tightening of lending standards being imposed by banks, especially in the area of investor lending which has financed much of the current boom in Sydney and Melbourne.
There is also a danger that the higher capital needed for all home loans will add to the pressures on housing finance for new home construction – which is already showing signs of slowing. New home and apartment construction are supporting the rest of the economy through the transition form the resources investment boom.
That growth will slow as the banks adjust their capital bases and interest rates to meet the new risk weights and that in turn could see the new home and apartment sectors slow over the next year to 18 months.
APRA made it clear in yesterday’s release this move was in line with the recommendation from the Financial System Inquiry chaired by David Murray.
In his interim report last year Murray said “the increase in housing debt and banks’ more concentrated exposure to mortgages mean that housing has become a significant source of systemic risk”.
That view is supported by APRA and by the Reserve Bank in last week’s submission to a Federal parliamentary inquiry into housing.
“The increase in IRB mortgage risk weights addresses a recommendation of the Financial System Inquiry (FSI) that APRA ‘raise the average IRB mortgage risk weight to narrow the difference between average mortgage risk weights for ADIs using IRB risk weight models and those using standardised risk weights,” APRA ssaid.
The banks have known this change has been coming, but their fight to ease the pain has been on a much lower level than the campaign against the increase in capital.
Yesterday’s statement from APRA has a more direct reference to the Murray inquiry than last week’s announcement and makes it clear the banks have lost, just as the end result of last week’s move to force them to hold more capital will end up a loss, despite them claiming an early ‘win’.
APRA said this morning that from July 1, 2016 the big banks and others using what’s called an Internal ratings-based (IRB) approach to credit risk will have to lift the average risk weight from 16% to 25%.
That is an interim move and the regulator said the final figure would not be known until global banking regulators have finished work on changes to the global capital adequacy for banks.
Seeing a number of countries around the world are experiencing rapid housing booms (and a build up in debt) from Hong kong, to Singapore, Canada, NZ, the UK, Denmark, Norway and now part of the US, the final word on capital adequacy so far as residential loans are concerned might end up a bit higher. Global regulators are very concerned at the growing threat from rising household debt from these housing booms.
"The increased IRB risk weights will apply to all Australian residential mortgages, other than lending to small businesses secured by residential mortgage. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI. In order to provide these ADIs sufficient time to prepare for the change, the higher risk weights will come into effect from 1 July 2016.
"The residential mortgage portfolio is the largest credit portfolio for ADIs and, in aggregate, IRB accredited ADIs hold the material share of these exposures. Therefore, strengthening the capital adequacy requirement for residential mortgage exposures under the IRB approach will enhance the resilience of IRB-accredited ADIs and the broader financial system,” APRA said yesterday.
The exemption for small business lending secured by residential mortgages is an important exemption because it means the banks will have no excuse to slow or slash small business lending because of the higher risk weights. In many cases, small business lending based on residential mortgages already attracts higher capital requirements for the banks.
