How Is The Needle Moving On Australian Banking Sector?

In a report released on 11 July 2019, Australian Prudential Regulation Authority (APRA) urges nation’s three major banks namely the Australia and New Zealand Banking Group Limited (ANZ), the National Australia Bank Limited (NAB), Westpac Banking Corporation (WBC) to hold additional $500 million in capital in response to higher operational risk identified in their self-assessments.

As stated by APRA Chair Mr Byres, the risk governance self-assessments reveal several weaknesses such as cultural issues, weak incentives, complexities and unclear accountabilities and that the capital that requirements will apply until the banks have completed their planned remediation to strengthen risk management.

APRA Modifies Capital Requirements for Big Banks: The Australian Banking Regulator, APRA, has recently amended its timeline for extra capital raising, giving more time to big four banks for raising capital to absorb potential losses. In Australia, APRA governs the capital adequacy requirements of Australian banks. The regulator has asked the banks to increase their total capital by three percentage points of risk weighted assets (RWA) by January 2024 (instead of the four to five percentage points originally proposed). According to APRA, the modification will lift the loss-absorbing capacity of the major four banks.

The APRA has not amended the current four to five % points target of loss absorbing capacity. It will look at the most viable route over the next four years for sourcing the remaining 1 to 2 % points.

As per APRA, this initiative is expected to enable major banks to enhance their loss-absorbing capacity by $50 billion.

Let us have a look at what the additional three percentage points would amount for the big four banks:

Commonwealth Bank of Australia: As CBA has RWA of $447 billion as on 31^st March 2019, the additional three % points reflects an incremental rise of ~$13 billion of Total Capital.

National Australia Bank Limited: An incremental increase of $12.1bn of Total Capital represents the three-percentage point requirement. This is based on its Risk Weighted Assets of $403bn as at 31 March 2019.

Westpac Banking Corporation: Based on its RWA of $420 billion at March end, the additional 3 % points represent ~$13 billion of additional capital.

Australia and New Zealand Banking Group Limited: An incremental rise in the Total Capital requirement of ~$12 billion along with an equivalent fall in other senior funding represents the three-percentage point requirement. This is based on its risk weighted assets of $396 billion as at 31 March 2019.

After the announcement of modification in capital buffer requirements, the outlook for the big four banks was upgraded by the ratings agency, S&P Global Rating from "negative" to "stable". According to the analysts of the rating agency, the increase in the loss-absorbing capacity would reduce the banks’ requirement for financial assistance from the Australian government and hence would lessen the financial burden on taxpayers.

NAB notified in an announcement on ASX that S&P Global Ratings has affirmed the ‘A-1+’ short-term and ‘AA-‘ long term issuer credit ratings for the bank.

APRA Amends Guidance on Residential Mortgage Lending

In May this year, APRA proposed a plan to remove the 7 per cent home loan buffer in the wake of record-low credit growth, continuous fall in property prices and other disturbances in the Australian economy. The regulator confirmed last week that it will proceed with the proposed changes of easing serviceability restrictions on assessments of home loan mortgage.

After the changes, more flexibility has been given to the authorised deposit-taking institutions (ADIs) for deciding their own serviceability floors. According to APRA, the 7 per cent home loan buffer in the prevailing environment is higher than necessary for authorised deposit-taking institutions to maintain sound lending standards.

The modification in the mortgage lending rules is expected to attract more borrowers and give a boost to the Australian property sector that slowed down in the previous months due to falling housing prices. APRA has received support for the removal of home loan buffer from the big four banks of Australia.

Interest Rate Scenario in Australia

At the time when the serviceability guidance was first introduced by APRA to reinforce sound residential lending standards, the official cash rate was 2.5 per cent. Now, it has been reduced to 1 per cent by the Reserve Bank of Australia.

The RBA recently slashed the official interest rates by 0.25 percentage points, taking it to a new low level of 1 per cent. The RBA has reduced the interest rates by 25 basis points in the second consecutive month after June 2019. NAB expects another drop in the interest rates in November this year.

The decision to cut the interest rates was taken by the central bank due to the ongoing fluctuations in the Australian economy including the property market slump, disappointing inflation figures, rising unemployment rate and low growth in wages. The central bank expects that the current easing of interest rates will aid employment growth and build greater confidence over inflation reaching its target.

According to the RBA governor, Philip Lowe, the housing prices have started stabilising after around two years of decline, and they are expected to improve further with the current interest rate cut.

The Australian housing sector is showing signs of price recovery, indicates the Hedonic Home Value Index released by a property consultant, CoreLogic. A modest increase in the property prices has been seen in Sydney and Melbourne in June this year.

Response of Big Four Banks on Interest Rates Cut

The RBA took an unusual step of consecutive cuts to its official cash rate, making it very clear that it wants the Australian banks to pass on the maximum rate cut to borrowers.

Australia and New Zealand Banking Group Limited is the only one that passed the full 0.25 percentage point cut to the customers. However, the bank passed on only 0.18 percentage points cut last month when the RBA reduced interest rates to 1.25 per cent.

After ANZ, the Commonwealth Bank of Australia, the National Australia Bank Limited and the Westpac Banking Corporation were the next to slash rates. However, they did not pass the full benefit of the latest interest rate cut to all of their home loan borrowers.

NAB has announced that it would make a 0.19 percentage-point cut to its tailored home loan variable interest rates. However, it passed the June's RBA rate cut to borrowers in full.

The Commonwealth Bank of Australia has cut interest on mortgage by 0.19 percentage points, after passing on the previous cut in full. Westpac has also passed on only 0.20 per cent cut out of 0.25 per cent cut announced by RBA.

Let us have a look at the stock performance of the big four banks of Australia on a YTD basis:

The Australian financial system has experienced a substantial change in the last two decades with the banking system undergoing progressive privatization and deregulation. The Australian banks have evolved over time and hold a majority of financial assets in Australia. They participate in almost all the different areas of financial intermediation besides the traditional deposit-taking and lending activities.

Overview of Australian Banking Sector: In Australia, the Reserve Bank of Australia (RBA) regulates the payment system and sets the monetary policy. However, the Australian Prudential Regulation Authority (APRA) supervises institutions across the banking sector and promotes financial system stability in Australia. APRA regulates Australian-owned authorised deposit-taking institutions, Foreign subsidiary banks, Branches of foreign banks, Providers of purchased payment facilities and Restricted Authorised Deposit-Taking Institutions, in accordance with the Banking Act in Australia.

The Australian Banking sector is dominated by four major banks of Australia - the Australia and New Zealand Banking Group Limited (ANZ), the National Australia Bank Limited (NAB), Westpac Banking Corporation (WBC) and the Commonwealth Bank of Australia (CBA). As these are the largest banks operating in Australia, it has been observed that a downturn in these banks put an enormous impact on the economy and the financial system. As was the case witnessed when the banking royal commission identified misconduct in the Financial Services Industry.

More About Banking Royal Commission

The Royal Commission was established on 14 December 2017 after years of public pressure, to figure out any misconduct in Australia’s financial services entities. The Commission’s inquiry was held from 14 December 2017 to 4 February 2019, and the final report was submitted to the parliament on 4^th Feb.

The Commission highlighted some deficiencies around governance and culture in the financial system in its report. Many financial entities were found to be causing substantial loss to its customers but earning a significant profit. It was found that the institutions kept profit above the interests of customers. A widespread misbehaviour in the financial services industry was spotted that often went unpunished. Besides other financial institutions, the big four banks also came under the scrutiny.

The inquiry report indicated that the country's largest lender, Commonwealth Bank of Australia was involved in charging fees for non-existent services. The bank was also accused of charging fees from dead customers.

The Royal Commission also recommended some changes to the regulatory framework of APRA. Following which, APRA announced its plans related to some specific recommendations contained in the Royal Commission’s Final Report. In April 2019, APRA informed about its new Enforcement Approach that emphasized on addressing and preventing serious prudential risks in the financial industry.

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