Australia's banking regulator just said the majors need to increase capital by 2%

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Capital is the foundation of any banking system. It’s the money a bank has at its disposal to absorb losses and leverage its balance sheet via lending, borrowing, investing and speculating.

The Murray Inquiry wanted more capital in the Australian banking system to guard against a weak economy and potential bank failures, but in response the major banks contended they are already very strong by international standards and that if APRA just allowed them to report capital the way other regulators did, then that strength would become apparent, assuaging the concerns of the Murray Inquiry.

Against that backdrop of competing claims Australian banking’s prudential regulator, APRA, released a study this morning comparing the capital position of Australia’s Big 4 banks against the capital held by 98 international banking peers. APRA said this peer group “operate internationally and have at least €3 billion in Tier 1 capital, are domiciled across 21 different jurisdictions”.

The good news for the majors is that APRA agrees that using international comparisons to their peers “their Common Equity Tier 1 capital ratios would be, on average, in the order of 300 basis points higher.”

The bad news, however, is that it still doesn’t lift them into the top quartile of banks that would be considered “unquestionably strong” by the Murray inquiry and place them in the top quartile. That puts the major bank’s capital ratios “above the median, but not in the top quartile, for Common Equity Tier 1 capital,” APRA said.

That means that while APRA says it isn’t going to tie Australian bank capital ratios “to a continually moving international benchmark,” it still thinks the Big 4 need to increase capital by 200 basis points, 2%, “relative to their position in June 2014”.

APRA also appeared to signal that it will be following the Murray Inquiry’s recommendation for risk weights applied by IRB banks (the majors, plus Macquarie) to their residential mortgages. It said that:

To the extent that APRA increases IRB risk weights, and the major banks respond by increasing their actual capital levels to maintain their existing capital ratios, it will improve their position relative to international peers and contribute to closing the gap to the fourth quartile

That means that which ever way APRA and bank investors look at it, the majors will need to raise more capital.

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