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The release of APRA’s International Capital Comparison study last week is its first response to the last December’s Murray Financial System Inquiry. The main finding is that Australia’s big four banks will need to bolster their capital to a significant extent in order for them to be resilient enough to withstand future shocks. The study found Australia’s major banks have common equity tier 1 (“CET1”) ratios outside the top quartile of international peers, even though they are above the median. According to APRA the major banks would need at least 70 basis point of extra CET1 to reached bottom of the top quartile or an extra 200 basis point of CET1 to have them “comfortably positioned”. The Murray report called for banks to be “unquestionably strong”.
One of the major issues is the risk weightings that the big four banks apply to mortgages or the level of capital they are required to hold for every dollar loaned. This varies between the big four and is significantly different from the regional banks. The big four use a system called the internal ratings based approach to calculating regulatory capital and this has allowed the banks to calculate their own level of risk based on their detailed default histories, valuations and customer risk analysis. The regional banks are required to use APRA’s standard risk weighting models. The upshot is that the big four are only required to hold around 18-20% of capital for every dollar of mortgage lending. This compares to the regional banks that are required to hold around 32-35%. This provides the big four with a large competitive advantage over the regionals but also exposes them to greater risks if Australia suffers large house price shocks.
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