By Paul Rickard

The market’s reaction yesterday to APRA’s announcement about bank capital requirements was telling. The major banks won’t need to conduct dilutive capital raisings to meet the new target. As a result, shares in the major banks rose by between 3% and 3.9%, with ANZ the best up 3.9% to close at $29.41.

Following its review of the “unquestionably strong” benchmark - the target set by David Murray’s Financial Systems Inquiry in 2014 - APRA is raising the minimum Common Equity Tier 1 (CET1) ratio for the major banks to an effective 10.5%. This is achieved by increasing the minimum requirement from 8.0% to 9.5%, plus another 1% for a buffer.

Each of the major banks has been taking steps to increase their capital ratios and currently has a CET1 ratio of around 10%. So between now and January 2020, the major banks will need to increase their capital ratios by between .5% and 1%.

Banks CET1 Ratios

ANZ’s, NAB’s and Westpac’s CET 1 ratios have reduced a little in net terms since March following the payment of their dividend in early July, offset by organic capital generated since the end of March. For ANZ, it says that on a pro-forma basis (which takes into account previously announced asset sales including stakes in Shanghai Rural Commercial Bank and UDC) its CET1 ratio on 31 March was already at 10.5%.

APRA says that the increase in capital required can be done in an “orderly fashion”, without equity raisings and without significant changes to dividend policies.

“The average capital growth rate needed through to January 2020 is now in the order of 25-30 basis points per annum. APRA estimates that the major banks should be able to generate this level of additional capital from retained earnings, without significant change to business growth plans or dividend policies, and without consideration of other capital management initiatives such as asset sales or equity raisings. On this basis, APRA considers that the CET1 capital ratio benchmark of 10.5 per cent can reasonably be met by the four major banks in an orderly fashion.”

But any capital increase still means some pain for shareholders through a lower return on equity. ROE’s have been falling for some time as the capital ask has been increasing and revenue growth has been static. Commonwealth Bank has come down from the very high teens to 16.0% in the latest half year, Westpac and NAB both reported 14.0%, while ANZ came in bottom place at 12.5%. Going forward, ROEs of 13% to 15% will become the norm.

Interestingly, APRA has estimated the “customer impact” if the Banks chose to pass on the cost of extra capital by increasing their margins, rather than letting shareholders bare the burden. It says:

“APRA estimates that an instantaneous 100 basis points increase in the CET1 capital ratios of the four major banks would, if entirely passed on through repricing of loans and deposits, require an increase in margins of approximately 10 basis points.”

For the minor banks such as BOQ and Bendigo & Adelaide, APRA is increasing the minimum capital requirement by 0.5%.

But some of the banks are not totally off the hook

While the banks in aggregrate should be able to meet this new target quite comfortably, APRA has yet to finalise the framework that will underpin banks having “unquestionably strong” capital ratios. This framework will take into account global regulatory initiatives from the Basel III accord and other changes to address mortgage concentration risk.

APRA says that changes to the framework should be able to be incorporated within the overall CET1 ratio of 10.5%, however as there may be changes to the risk weights that apply for higher loan-to-valuation ratio loans and for investor lending, the capital impact could  vary from bank to bank.

APRA says that it hopes to release the new draft prudential standards later this year, with consultation to follow in 2018 and the final standards to be determined in 2019.