APRA key in big moment for smaller lenders

Australian Prudential Regulation Authority (APRA) chairman Wayne Byres. Picture: AAP

It’s last drinks at the Last Chance Saloon and the $146bn credit union, building society and mutual bank sector is slouched against the bar, mumbling the same old lines — that the big guys have had it easy for too long and it’s time to even things up.

This delicate task falls to Australian Prudential Regulation chairman Wayne Byres, who is reviewing industry submissions on a new capital framework which could tilt the playing field just enough to create some genuine competition in home lending.

The alternative — that the reforms fall a long way short of what’s required when they become effective on January 1, 2023 — doesn’t bear contemplation.

“We need to make sure that we get this right,” Customer Owned Banking Association chief executive Michael Lawrence says. “Once these reforms are locked in after three years in consultation, it will be a long time before the framework is ever looked at again.”

The proposed changes aim to embed unquestionably strong levels of capital in line with the core recommendation of the 2014 financial system inquiry.

Lawrence says APRA has given COBA a good hearing on the competitive implications of the new framework.

The nub of the issue is that the standardised method used by his members to calculate how much capital should be held against a loan is uncompetitive compared to the lean and mean internal model used by the major banks.

COBA’s submission, obtained by Four Pillars, acknowledges APRA’s assessment that the consequent pricing advantage enjoyed by the majors is “in the realm” of five basis points — not exactly a chasm.

However, it makes the valid argument that every basis point is critical in the current environment of a “tremendous margin squeeze”.

Also, the capital benefit is expanded by other factors, such as access to cheaper funding because the big four enjoy an implicit government guarantee from their status as too big to fail.

COBA says the impact of the uncompetitive, standardised framework is playing out before our eyes.

Smaller lenders are continuing to consolidate (Bank of Queensland’s $1.35bn takeover of ME Bank), and success in attracting well-capitalised new entrants has only been limited (Xinja has handed back its banking licence, and National Australia Bank has taken over 86 400 Holdings).

Speculation has also intensified that parent companies will divest their subsidiary banks (Suncorp and Suncorp Bank).

If competition is measured by the number of new entrants and growth by incumbents, the standardised framework plays a key role because the vast majority of lenders use it.

APRA should therefore ensure that minimum standardised requirements are as low as possible.

For example, risk weights for housing should be lowered to ginger up some meaningful competition.

COBA says it’s particularly concerned about the big four’s competitive advantage in the low-risk home-loan segment.

While APRA introduced a minimum risk-weight floor of 5 per cent, the minimum risk-weight under the standardised framework remains four times higher at 20 per cent.

This creates an incentive for the majors to crowd out their standardised rivals in the low-risk lending segment.

While the prudential regulator is reluctant to stray too far from the 20 per cent minimum set by the Basel intern ational framework, COBA says there are other segments where APRA could reduce capital requirements on residential mortgages.

They include loans with high loan-to-valuation ratios, redraws, lenders mortgage insurance and interest-only treatments.

With the majors already benefiting from much larger scale, COBA also says it’s “critical” for APRA to address the funding advantage they enjoy as a result of being too big to fail.

In 2019, the regulator said it would require the big four to lift total capital by 3 percentage points by January 1, 2024.

APRA should recommit to this timeline, according to COBA, so the non-majors could have the certainty that the issue will be addressed in a timely manner.

“Any delays will continue to tilt the playing field in favour of the major banks,” it says.

Basel reforms pay off

A year after the first cracks began appearing in the US subprime mortgage market, the collapse of Lehman Brothers propelled the global financial system to the edge of a precipice.

COVID-19 has been a very different crisis, involving a progressive and quite deliberate shutdown of the global economy.

Yet the impact on the system a year after the virus appeared in Australia has almost been benign by comparison, with no internationally active bank failing or requiring significant taxpayer funding.

So far, capital and liquidity remain strong due to an unprecedented array of fiscal and monetary measures to support the real economy, which have helped to shield banks from losses and risk.

Regulators are also claiming their share of the credit for implementing a slate of post-financial crisis reforms to improve the system’s resilience, and for developing measures at the start of the pandemic to address some of the short-term stability issues.

The Basel Committee on Banking Supervision — the global standard-setter for the prudential regulation of banks — is examining how much the Basel III reforms strengthened the system.

It’s doing this by testing for any correlation between regulatory action and measures of resilience, such as credit default swap spreads. Unsurprisingly, preliminary findings show that higher regulatory capital is associated with greater resilience.

Also, banks that increased their capital, and therefore their capacity to lend, had a higher rate of loan growth, while the uptake of support measures, such as loan guarantee schemes, was higher for better-capitalised banks.