http://www.afr.com/f/free/blogs/christopher_joye/big_banks_may_need_more_capital_T6oXX7XL6wyoNp4J7SHFjL

Big banks may need $41b more capital, UBS says

 

UBS’s top-ranked bank research team have almost doubled their estimates of the amount of capital Australia’s major banks may have to raise in response to David Murray’s financial system inquiry, from $23 billion to $41.1 billion.

In a new report, UBS say that “given Australia’s unique situation as a small, commodity-based economy heavily reliant on foreign capital, with a very concentrated banking system, David Murray is likely to err on the side of caution.

“We believe this means both higher mortgage risk weights and [capital] buffers despite the majors’ vehement objections.”

Australia’s four major banks are pushing aggressively to avoid any increase in their core equity capital, which would immediately lower their leverage and world-beating returns on equity.

In July UBS analysts Jonathan Mott and Adam Lee – who were ranked Australia’s number one bank researchers in two well-respected surveys – calculated that the majors would have to source an extra $23 billion of common equity tier-one capital assuming the FSI recommended a 3 per cent capital buffer for too-big-to-fail (TBTF) institutions. APRA’s current TBTF capital buffer is 1 per cent, which the FSI says is low by international standards.

But UBS’s July report failed to assess any FSI-induced changes to the major banks’ skinny mortgage “risk weightings”, which are a key source of their competitive advantage.

APRA’s second submission

In its second submission to the FSI, the Australian Prudential Regulation Authority said the majors’ average risk-weighting across their home loan books, which make up the majority of their assets, was 18 per cent compared with an average risk-weighting of 39 per cent for all other deposit-takers.

In April last year The Australian Financial Review showed that for the same level of tier-one capital, this risk-weighting differential means the majors are holding more than twice the leverage of competitors when lending against housing, which enables them to produce more than double the returns on equity. The regional banks and smaller deposit-takers have raised the risk-weighting disconnect in their submissions to the FSI.

APRA’s latest banking data also revealed that the majors are carrying substantially less tier-one equity capital and higher leverage than their competitors notwithstanding calls for them to hold more loss-absorbing capital given their TBTF status.

UBS’s new report addresses the prospect of a hike in the majors’ minimum mortgage risk weights. They run scenario analysis around increasing the current average risk weights of 18 per cent to 20 per cent, 25 per cent, and 30 per cent, which would still leave the majors with material capital advantages over peers. In July the Financial Review concluded that the majors would have to find $21.5 billion of extra capital if a 30 per cent risk-weighting floor was introduced.

Getting in line with international standards

In its second FSI submission APRA bluntly noted that “the only proposed option in the [FSI’s] Interim Report that would ensure continued compliance with the internationally agreed Basel framework would be to increase the average risk weight used by [the major banks and Macquarie] operating under the IRB approach”............

 

Problems with self-prediction

APRA also highlighted the problem with the major banks’ predicting their own probabilities of defaults on home loans in the absence of a recession in 23 years and the much lower levels of housing leverage in 1991........