The regulator said the move would enhance the resilience of top lenders and the broader financial system, and would count toward the potentially billions more in capital APRA has said it would order the banks to hold to shore up their balance sheets and ensure they are “unquestionably strong”.
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This would be around $11 billion across the big four banks. This makes clear the competitive differential driven by the regulatory settings.
“Risk weights” are determined by big banks themselves and allow them to reduce the amount of capital held against various assets to meet a given capital ratio.
Banks could recoup higher costs of writing mortgages by lifting fees for other services.
Second, the banks are likely to substantially satisfy the new requirements from their strong levels of retained earnings and via dividend reinvestment plans.
Therefore, the reduction in the ROE on their biggest asset, mortgages, will reduce the group ROE – unless action can be taken to pass the higher costs of equity on to customers or shareholders.
“The change is credit positive for the risk profiles of these banks as it raises the amount of capital required to be held against their residential mortgages, which, on average, represent around 63% of the loans of Australian banks”, says Frank Mirenzi, a Moody’s Vice President and Senior Analyst.
What are mortgage risk weights?
Moody’s views the increasing capital required by Australia’s major banks to support their ratings against the backdrop of rising tail risks in the housing market. The 25% is an averagerisk weight for residential mortgage exposures, measured across all IRB banks.
“While Westpac is well placed to meet these changes, increased capital does come at a cost”, Westpac chief financial officer Peter King said.
But only Westpac has said how much money it will have to raise.
ANZ said the impact on its capital would be about 55 basis points, or require A$2.3 billion more capital allocated to its mortgage book, while Westpac said it would likely need another A$3 billion or so of capital.
Commonwealth Bank said it expects the amount of common equity Tier 1 capital required for residential mortgages to rise by approximately 95 basis points due to the new rule.
That will increase the capital requirements of the biggest four banks by about A$12 billion ($8.9 billion), according to Goldman Sachs Group Inc. and Morgan Stanley. The aim is to bring the big banks in line with worldwide standards, and with the recommendations of the Financial System Inquiry (FSI).
Macquarie Group, the only other lender to which the new rules apply, saw its shares rise 2 per cent after it said it could cover extra capital requirements from reserves. It said a market update would be provided at its annual general meeting July 23.
National Australia Bank said it was well placed to process the lift in risk weights after raising $5.5 billion from investors in May.
In response to the announcement, CBA said that from that date, the risk weightings of CBA’s Australian residential mortgages would increase to an average risk weight of at least 25 per cent.
The increase is “consistent with the direction of work being undertaken by the Basel Committee on Banking Supervision on changes to the global capital adequacy framework for banks”, APRA said.
The regulator is forcing banks to shore up their capital after a government review last December recommended they should rank among the top 25 percent of lenders globally.
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Given their desire to maximise returns to shareholders, banks will do whatever they can to maintain the existing return on equity in face of increased capital. The increase is being implemented through an adjustment to the correlation factor used in the IRB mortgage risk weight function for each affected ADI.
