AUSTRALIA’S LARGEST BANKS can expect a reduction in their regulatory capital requirements following the implementation of Basel II, according to a senior Australian Prudential Regulation Authority (APRA) official.
While APRA has previously warned banks that a capital reduction is not guaranteed, Charles Littrell, executive general manager, policy research and statistics division at APRA, said there will be a reduction in regulatory capital requirements for banks pursuing the internal ratings-based (IRB), or advanced, approach to Basel II.
“APRA’s expectation is that IRB banks will receive a modest reduction in their regulatory capital requirement. In any event, Basel II constraints on IRB introduction establish an initial maximum reduction of ten per cent,” Littrell said. However, banks may not get a reduction in real terms any time soon. “It is not clear if this regulatory reduction will translate into any actual reduction, at least in the short term – rating agency constraints may intervene,” he added said.
Indeed, at present, the four largest Australian banks have among the lowest Tier 1 capital ratios in the world. The big banks range between 7.5 per cent and 6.9 per cent, with the largest banks from Europe and Canada rising above 10 per cent. While Australian Tier 1 ratios have been relatively static in recent years, this was not always the case. Until the mid 1990s, said Littrell, Australian bankers wore their strong capital position as a badge of honour, whereas these days they take more pride in effective capital management.
“It is striking to me as a long time banker that Australian banks no longer have high Tier 1 ratios, compared to offshore peers,” Littrell said.
While the larger Australian banks’ peers have been building their capital levels in recent years, there is no significant cause for alarm. Australian asset quality is less sound than it was a decade ago, Littrell said, but it remains among the best among developed nations’ banking systems. Nevertheless, he added, the situation remains tenuous.
“On our more optimistic days – and even a prudential regulator has the odd burst of optimism – APRA views the Australian position as emblematic of better management,” he said. “Our bank managements today appear more willing to give any excess capital back to the shareholders than to expend it on ill-considered initiatives. On our more pessimistic days, we observe a share market and equity analyst cadre who, possibly contrary to good economic sense, view any cost cutting or retrenchment as positive news, reward entities who can’t find growth opportunities needing capital, and punish entities who raise capital because they perceive such opportunities. From this perspective, it is easy to wonder if listed regulated entities are under too much pressure to pare their capital to the minimum, leaving an insufficient cushion for unexpected bad times.”
Littrell added that it can be difficult to find the correct balance in terms of capital levels, and that both APRA and its regulated banks tend to prefer the “goldilocks”approach to capital: there should not be too much or too little; just the right amount.
“There are obvious dangers to holding too little capital,” Littrell said. “When challenges inevitably arise, a capital shortfall can threaten firm viability. The dangers associated with too much capital are perhaps less obvious but equally real. From a shareholder’s perspective, an overly generous capital position may make for a lazy balance sheet, or even worse, may signal lazy management. From a regulator’s perspective, a capital surplus creates dangers when management decides to find a use for the surplus in a new strategic initiative, or in a more aggressive approach to the current business that is driven more by the existence of the surplus than the logic of the business initiative. History is rife with examples of banks and other regulated entities that ‘solved’ their excess capital by losing money foolishly; often well in excess of the perceived capital surplus.”