The $20b call: Big four await capital ratio ruling
The Reserve Bank is expected to ask the big four Australian-owned banks to pour billions of dollars more of their own money into their businesses today.
The amount of extra capital that ASB, ANZ, Bank of New Zealand and Westpac and smaller banks will need to find could be as high as $20 billion over five years.
That is based on previous consultation documents published by the Reserve Bank.
The central bank is expected to largely stick to its guns for a big capital increase in its final ruling.
The changes will be designed to make it less likely a bank will fall over in a future financial crisis.
But there is likely to be some short-term pain in the form of higher interest rates on loans, which means less lending, and/or lower interest on savings such as term deposits.
Why are the rules changing?
In short, because of the global financial crisis (GFC) that started in 2007. The Reserve Bank, along with many other central banks around the world, has concluded that the impact of bank failures can be worse and longer-lived than previously thought.
When banks become stressed and stop being able to lend, as some overseas banks did during the GFC, then the impact – including on people’s mental health and wellbeing – can be profound.
Isn’t this the responsibility of Australian regulators?
The Australian Prudential Regulation Authority does have rules that cover the amount of capital the Australian banks need to maintain, including for their New Zealand subsidiaries. APRA is also tightening those requirements.
The Australian banking system has been regarded as pretty solid over the years. But there is still a nagging concern that their Kiwi subsidiaries could be hung out to dry in a really serious crisis.
What is the solution?
The Reserve Bank plans to increase the amount of capital that New Zealand-registered banks including ANZ, ASB, BNZ and Westpac need to hold.
When banks lend money, the bulk of that money is in turn ‘‘borrowed’’ from deposits that customers make with the bank.
Requiring banks to hold more capital means they can sustain more losses from bad loans in a downturn while remaining solvent and not putting deposits at risk.
How much capital will do?
That will be revealed today. Not all loans are as risky as each other, so the Reserve Bank will express the new capital requirements in terms of a percentage of their ‘‘riskweighted assets’’ (RWA).
In consultations, it has suggested the big four banks should normally have a ‘‘tier one’’ capital ratio of at least 16 per cent (relative to their RWA), while smaller banks that are less critical to the economy should maintain 15 per cent tier-one capital backing.
Tier-one capital is the most unencumbered type – the kind of capital that banks can most easily lose while still staying in business.
What if there’s a breach?
The bank would face escalating interventions, until at some point the Reserve Bank might step in and put a bank under statutory management. The latter is what a bank failure really amounts to.
Under the draft proposals, if a bank’s tier-one capital ratio fell below a 6 per cent statutory minimum it would be game over.
What capital ratios do the banks need to have now?
They need a 10.5 per cent tier-one ratio, including a ‘‘conservation buffer’’ of 2.5 percentage points.
But the big four banks are maintaining higher ratios than that, averaging 13.4 per cent. That is in part to ensure they stay on the right side of ratings agencies.
Where will it come from?
The Reserve Bank has suggested the big four banks could get the extra capital by cutting their dividends by 70 per cent over five years. That would mean lower payouts to shareholders.
Alternatively, the banks’ Australian owners could raise capital through rights issues, or transfer capital to New Zealand from their Australian operations.
But the banks have suggested they would be more likely to raise interest rates on loans and/or cut interest rates on deposits. In all likelihood, their responses might involve a mix of all of the above.
Should I be worried about my mortgage?
Maybe. There are concerns that interest rate ‘‘spreads’’ – the difference between the average rate banks pay depositors and charge borrowers – would increase.
There have been some suggestions mortgage rates could rise 1 per cent, and counter-claims that that is scaremongering.