IMF: Australian bank capital ratios aren't that high by global standards and need to be increased

Getty/Bryn Lennon

The International Monetary Fund (IMF) has just released the Concluding Statement of the 2015 Article IV Mission.

In it the IMF says that Australia’s “outperformance is fading” and as a result the outlook for Australian growth is lower in the future than what Australians have become accustomed to over the past two decades.

However, on a more positive note it says, “moving from the investment to the production phase of the resource boom was always going to be bumpy and the economy is handling this transition relatively well. But adds, “the recent sharp fall in resource prices has made it more difficult.”

This means Australia has weaker medium-term growth prospects but:

“This weaker outlook can be avoided. Australia has strong institutions, a flexible economy, and is well placed to seize opportunities created by Asia’s rapid growth and rising middle class, helped by the recent free trade agreements. Policymakers should build on these strengths by re-invigorating the reform agenda:

  • Sustaining demand through the resource boom transition
  • Lifting productivity to sustain strong income growth
  • Building resilience to reduce the risk of financial disruption

While the fresh news in this release is the banking system’s resilience, the diagnosis and prescription for sustaining the resource transition and lifting productivity is well known.

The IMF said Australia needs to ensure “unquestionably strong banks.” It highlighted the strength of the banking system which is “highly rated and profitable” with low non-performing loans and funding costs, and acknowledged that the structure of funding had changed and reliance on wholesale funding had declined.

But the IMF said:

“Nonetheless, the system is dominated by four large banks with similar business models which rely significantly on wholesale external borrowing, most lending is housing related, and household debt and house prices are elevated. And although capital ratios have risen since the global financial crisis, this largely reflects a shift towards mortgages and a lowering of risk weights. Implementing the recommendations of the Financial System Inquiry should be a priority.”

The majors won’t like that nor will they like the fact that the IMF agreed with the Murray inquiry that capital levels in Australian banks is not that high.

“While international comparisons are fraught with difficulty, Australian banks do not appear to have particularly high capital ratios and the global trend is upwards. More tangibly, the recent APRA stress test indicates that in a severe adverse scenario, bank capital would have to be substantially higher to ensure a fully-functioning system.”

That’s a devastating statement for the majors in particular who have been fighting such accusations for some time and regularly publish “international comparisons” where they adjust their capital levels higher to reflect how hard the Australian Prudential Regulation Authority (APRA) marks them by international standards.

The IMF, again like the Murray inquiry, finds that more capital is needed:

“Putting a floor of 25-30 percent on mortgage risk weights would help, but capital ratios would also need to rise substantially. Given major banks’ high profitability, such ratios can be achieved at little, if any, macroeconomic cost, especially if done gradually, and will make the financial system, the budget, and the economy stronger.”

Higher capital requirements are a cost of too-big-too-fail status and a government guarantee. But it’s also the safety blanket that investors, depositors and the Australian economy need.

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