Australia’s big four banks are facing a new earnings headwind as regulators push for greater insurance against collapse and minimising taxpayer support in times of crisis.
- APRA will demand big banks hold more capital to minimise the need for taxpayer bailouts in times of crisis
- APRA says the new debt won’t be costly, but analysts argue it will dilute earnings
- The new debt will be risky for investors and would be wiped out if a bank fails
The Australian Prudential Regulation Authority (APRA) said banks would have to increase their capital base in coming years in line with the global trend to limit the use of public money to recapitalise failing institutions.
The new buffer to increase the banks’ loss-absorbing capacity would be separate from APRA demands for “unquestionably strong” balance sheets which saw banks raise more than $20 billion capital in recent years.
Unlike the additional “unquestionably strong” Tier 1 capital the banks were required to raise, the new focus will be on so-called Tier 2 capital — a form of debt that converts to “worthless” , or written-off equity in a crisis.
“Tier 2 capital instruments are designed to convert to ordinary shares or be written off at the point of non-viability, which means they will be available to absorb losses and can be used to facilitate resolution actions,” APRA said.
APRA chairman Wayne Byres said the additional capital was to ensure a big bank failure could be resolved in an orderly fashion.
“The resilience of the Australian banking system continues to improve, underpinned by the build-up of capital over the last decade,” he said.
“However, no matter how resilient financial institutions are, the possibility of failure cannot be entirely removed.
“Therefore, in addition to strengthening the resilience of the financial system, it is prudent to plan for the unlikely event of failure.”
Australia’s economy is dominated by the big four banks which account for about 80 per cent of banking sector assets.
Banks’ earnings will be diluted
APRA said the expected additional cost of 0.05 percentage points would be “relatively minor” in context of the big banks’ cost of funds.
CLSA bank analyst Brian Johnson said while the cost of the proposal was still difficult to quantify, if it went through it would certainly dilute bank earnings.
Mr Johnson warned the type of debt the banks would be raising would not be for retail investors to consider.
“It looks like debt when the banks raise it, but it turns to equity, that turns to zero when a bank gets into strife,” Mr Johnson said.
“The other point is [it] may become more expensive as every big bank in the world will trying to raise it [Tier 2 equity] at the same time.”
APRA said it expected the new capital would most likely be raised via “institutional investors, who are likely to understand the risks involved”.
“It is also important that holders of instruments which are intended to be converted or written off in resolution understand the distinctive risks of these investments,” APRA noted.
“It is inadvisable for investors to view such instruments as higher-yielding fixed-interest investments, without understanding the loss-absorbing role they play in a resolution.”
Mr Byers said the events of the global financial crisis demonstrated the impact that failures can have on the broader financial system and the subsequent social and economic consequences.
“The aim of these proposals and resolution planning more broadly is to ensure that the failure of a financial institution can be resolved in an orderly fashion, which protects the interests of beneficiaries and minimises disruption to the financial system,” Mr Byres said.
Credit ratings agency Standard and Poor’s described the policy as pragmatic and did not necessarily prevent a taxpayer bailout of a failing bank.
“APRA’s proposal could lessen the need for the Australian Government to provide financial assistance to banks in a stress scenario and thus lessen the financial burden on taxpayers,” Standard and Poor’s said.
“However, in our view, the proposal suggests no impediments or change in the Australian Government’s attitude to bailing out a systemically important bank, if needed.
“We believe that the Australian Government’s policy stance to remain supportive of the systemically important banks reflects the reliance of the Australian economy on the continued perception that the major Australian banks are financially sound.”
APRA expected to detail the new requirements next year and give the big banks four years to raise the new capital.
Smaller banks would be assessed on a case-by-case basis, but were not expected to be forced to increase their loss-absorbing base.
APRA said it would seek feedback from the banks before the proposals were implemented.