Australian banks told to hold billions more dollars against home loan risk

The increase in IRB mortgage risk weights addresses a recommendation of the Financial System Inquiry (FSI) to narrow the difference between average mortgage risk weights for ADIs using IRB risk weight models and those using standardised risk weights – i.e. many non-major banks.

The change will come into effect on 1 July 2016.

David Ellis, an analyst at investment-research firm Morningstar, said the changes to home-loan risk-weights would have a small near-term impact on the banks, particularly Commonwealth Bank, the country’s biggest mortgage lender.

Or they could change the way they pay dividends, either by issuing more shares under dividend reinvestment plans or by reducing the growth in dividends, which increases retained earnings – a key part of bank capital. Banks will strenuously oppose higher capital requirements, already warning that “the cost of holding higher capital will inevitably be borne by customers and shareholders”.

In a major announcement this morning Australian banking’s prudential regulator (APRA) has materially increased the amount of capital that the major banks and Macquarie have to hold against their home loan lending books.

“The additional capital that will be required to be held against residential mortgages will better align the banks’ capital positions with the growing tail risks arising from their residential mortgage exposures during a period of high investor demand and an associated rapid acceleration in house prices in Sydney and Melbourne”, adds Mirenzi.

After climbing in 2014, bank stocks have come off their peaks in recent months, with uncertainty around capital requirement changes widely named as an issue of confidence.

APRA has served Australian taxpayers well in the past, especially prior to the financial crisis, and should be permitted to enforce higher standards of risk and capital management on banks, especially those too big to fail.

Because equity is more expensive than debt, APRA’s action could reduce bank returns on equity if the additional costs are not passed on.

APRA said that it has “sought to turn up the dial of supervisory scrutiny” on Australia’s banks, which have had to demonstrate what they are doing to manage their risk profiles.

Australia’s share of non-performing housing loans has been extremely low by global standards since the Reserve Bank of Australia began collecting data almost 20 years ago, according to APRA’s submission. The 25% is an averagerisk weight for residential mortgage exposures, measured across all IRB banks.

But only Westpac has said how much money it will have to raise.

“The impact to ANZ’s capital position of approximately 55 basis points is largely as expected following the financial [system] inquiry and is manageable during the APRA transition timetable to 1 July 2016”, ANZ said.

The regulator said it will monitor the impact of its current initiatives and would consider taking further measures to ensure that emerging risks are contained.

Westpac said that if the Apra move was imposed today, its common equity tier one ratio would fall to about 8.5%, and it would need to allocate another $3bn to lift it towards the top end of its preferred 8.75% to 9.25% range. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI.

Analysts estimate that the additional buffer will amount to between 11 billion Australian dollars (US$8.1 billion) and A$12 billion for the four largest banks combined.

Westpac’s Mr King said notwithstanding the changes, the bank’s Australian bank residential mortgage portfolios “remain high quality”.

Australia’s smaller lenders – which have a risk weighting of 35 percent – have persistently argued the current risk rating status quo gives the major’s a competitive advantage.