Buried in the Reserve Bank’s latest Financial Stability Review is the best news the country (and the governments) have had since the COVID-19 pandemic started ravaging the economy in February – Australia’s banks are healthy and have more than enough capital to support the economy during the slowdown without getting into trouble.
And that’s good news for their customers, for the country, and especially for shareholders nervous about banks being forced to raise more capital.
While the banks are being supported by the Reserve Bank there the Term Funding Facility (which has lent them $81 billion of a $200 billion maximum) to re-lend to customers, the central bank says they have enough capital to withstand any losses from that lending and to repay the RBA.
“Australian banks have high capital levels, are profitable and most of their loans are well secured. Banks’ capital has been supported by retaining a higher share of earnings, for which there was guidance from the Australian Prudential Regulation Authority (APRA),” the RBA pointed out in the FSR.
(It must also be pointed out that banks, some shareholders and banking analysts questioned and criticised APRA and the RBA’s insistence on high capital levels. These ‘experts’ have now gone all quiet).
The RBA says the banks have already socked away provisions: “In Australia, the four major banks have raised provisions of around $7½ billion to cover expected losses since the start of the year.”
The bank says that could rise by up to $4 billion based on the bank’s most severe projections of financial stress for their customers. The annual reports from the NAB, ANZ, and Westpac in the next three weeks will tell us just how they see the outlook.
The smaller Bank of Queensland reports its 2019-20 results on Wednesday (which will be down sharply) and will give us a clue with its decision on its final dividend.
Those early provisions, a big capital raising by the NAB, West’s $1.3 billion fine over money laundering claims from AUSTRAC, and fears about a big hit to revenue and earnings from the recession, have seen the share prices of the big four banks fall this year.
Commonwealth Bank shares are down 15% so far in 2020, Westpac shares are off 22% and NAB and ANZ shares are down 24% each.
“While the Australian financial system is in a strong position, risks are elevated,” the RBA warned. “These risks to the financial system would be exacerbated by a weaker-than-expected economic recovery, for example, stemming from further setbacks on the health front or international political tensions.”
“However, stress tests of the Australian banking system indicate under a baseline scenario based on the economic forecasts in the Bank’s August 2020 Statement on Monetary Policy (SMP) banks will remain very well capitalised, not even entering their capital conservation buffers.
“Even if the economic contraction is substantially more severe under a downside scenario, banks would remain above their minimum capital requirements.
“Given their strong balance sheets, banks will be well placed to continue lending, supporting the economic recovery and so in turn the Australian financial system,” the RBA forecast.
And for investors that is doubly good news because while the banks remain well capitalised they won’t use up their reserves to the extent where they are forced to raise new capital from shareholders.
In the FSR, the RBA explained that in fact there are a major reason or two why the banks won’t dip into the capital buffers regulators led by APRA forced them to build up.
“However, for a number of reasons some banks may be unwilling to draw down their buffers, especially in the current environment.
First, banks may want to maintain capital buffers so that they are not constrained in making payments to investors in their Additional Tier 1 capital instruments or distributing profits to shareholders through dividends or buying back shares. Once regulatory buffers are entered, banks face automatic restrictions on the share of earnings that can be distributed.
Second, lower capital ratios may cause market participants to question the soundness of individual banks, which could increase their cost of, or limit access to, debt and equity funding.
Third, in an uncertain environment such as the current COVID-19 shock, banks may take a conservative approach to capital management by protecting themselves against the risk that credit losses turn out to be larger than the amount they have provisioned.
And then there is the risk that investors might become unhappy with the banks.
“The risk that negative investor perceptions of buffer use materially affects Australian banks is also low because of their reduced funding needs in the immediate future. Australian banks have strong funding positions following an increase in deposits and their use of the Bank’s Term Funding Facility.
They are therefore not expected to issue much wholesale debt over the next couple of years, reducing the impact that market perceptions could have on funding costs. APRA’s decision to allow capital ratios to remain below the ‘unquestionably strong’ benchmarks until these ratios can be achieved without unnecessarily disrupting the economy gives banks time to rebuild capital buffers organically, which reduces the likelihood that they will need to issue equity at unfavourable pricing.
It is therefore unlikely that there will be much of a short-term cost of using buffers, even if it causes capital ratios to be temporarily lower.
