APRA unveils capital framework overhaul for lenders

Banks will have to hold more capital against riskier mortgages, as part of the biggest overhaul to regulatory capital requirements in almost five years.

APRA chairman Wayne Byres says the new capital requirements will help Australia’s banking system remain in strong shape. Picture: AAP

Banks will have to hold more capital against riskier mortgages and change their reporting of key buffers from 2023, as part of the biggest overhaul to regulatory capital requirements in almost five years.

The Australian Prudential Regulation Authority on Monday released its long-awaited final capital framework for the nation’s major and smaller banks, to align with international Basel III requirements. As well as boosting capital requirements for riskier home loans, the new rules loosen capital rules for loans to small business.

The capital changes are likely to prompt further pricing differences between the types of loans borrowers opt for, to reflect the risk lenders are taking. Banks will also play closer attention to the size of the deposit provided for a new loan.

There will be a period of consultation by APRA on the changes, but only for the guidance material on the capital requirements. The new framework will come into effect in January 2023, which may frustrate parts of the banking sector that were pushing for a longer implementation period to update their systems and investor reporting.

In Europe, similar capital changes have been delayed by the European Commission, which has flagged rolling out a new regime from 2025.

“In terms of the winners and losers there will be subtle differences between all the banks,” said Regal Fund Management’s Mark Nathan. He was referring to the composition of the lending books of the big four, which all differ on the proportion of interest-only and investor loans and small business lending.

“Banks more exposed to high LVR (loan-to-value ratio) or interest-only lending will see their capital requirements increased, while SME lenders will see capital reductions,” Mr Nathan added.

“There are also a number of initiatives that will help with the comparability between banks. For example, APRA will now require the major banks to also publish their capital position as calculated on a standardised basis.”

Commonwealth Bank is the largest mortgage provider domestically, while National Australia Bank is the biggest lender to small business. Westpac has been reducing its exposure to mortgages categories such as those where only interest is paid for a number of years, in anticipation of APRA’s changes. The bank’s latest accounts showed interest-only loans accounted for 15.8 per cent of its portfolio as at September 30, compared to 20.6 per cent a year earlier.

APRA said under the new framework – which stipulates in detail the amount of capital banks should hold across different areas – the average common equity tier one capital of the major banks would remain stable at $50bn, but the composition of the funds put aside would change.

For riskier mortgages for example, the amount of capital set aside will jump by about 25 per cent. That means banks will hold a higher level of capital against interest-only and investor mortgages, compared to less risky home loans where borrowers are paying principal and interest.

Lower-risk mortgages will see a decline in the capital set aside against them.

APRA chairman Wayne Byres said the changes would provide stability in the banking system and protect depositors in times of financial stress.

“Although Australia’s banking sector is already strongly capitalised by international standards, the new capital framework will help ensure it stays that way,” he said.

“The fact that Australian banks already have the capital needed to meet the Basel standards, without the need for lengthy transitional periods and phase-in arrangements that will be needed in many other countries, is evidence of the underlying strength.”

APRA also introduced more simplified capital requirements for smaller, less complex banks – with less than $20bn in assets – following constant criticism from smaller players of an unlevel playing field.

“The development of a simplified approach for smaller banks avoids unnecessary regulatory burden, without jeopardising prudential safety. It has been designed to benefit a large number of institutions – about three-quarters of domestic banks will be able to take advantage of the simplified approach,” Mr Byres said.

For small business loans that are not secured against property, APRA is lowering capital requirements. In part the regulator is doing that by raising the loan size threshold to $1.5m from $1m, so that more loans are eligible for lower capital treatment.

The new blueprint from APRA is a step away from the 10.5 per cent “unquestionably strong” capital threshold which has been in place, with the major banks all comfortably above that level. APRA said the actual common equity capital ratio of the major banks was 11.5 per cent as at September 2020, and under the new formula the threshold would sit at 10.25 per cent and the actual level at 12 per cent.

“APRA expects that the major banks will likely operate with CET1 ratios (calculated under the new methodology) above 11 per cent from 2023,” the regulator said in an information paper released on Monday.

Buffers that the banks can draw on in times of stress were revised. Major banks will have to hold a capital conservation buffer of 5.75 per cent from 2023, compared to 3.5 per cent currently.

APRA has consulted on its new regime for four years, and in December 2020 signalled its direction on the changes. In Monday’s information paper the regulator said since the global financial crisis Australian banks had increased the highest-quality capital they held as a group to $260bn, from about $130bn.

It said the new rules were designed to “underpin and reinforce” the banking sector’s strength and position more than half of the $260bn in capital as buffers that are available in times of financial stress.

In July, APRA said its proposed capital rules would boost competition, as they narrowed the gap in requirements between large and smaller banks.