APRA’s stricter capital and liquidity rules for smaller banks to prevent US-style crisis

The nation’s banking watchdog moves to head off a US-style liquidity crisis by forcing smaller banks to hold more government bonds.

Australia’s banking watchdog has tabled changes to capital and liquidity requirements that will increase costs for smaller banks, in a move to prevent failures like those seen in the US banking crisis earlier this year.

In a letter to banks on Wednesday, the Australian Prudential Regulation Authority proposed changes to address “gaps” in how small banks manage liquidity risks, including how they value assets, and to prevent potential contagion risks.

The proposals include a requirement that all banks, and not just the bigger banks, value liquid assets like bonds at their market value, and that they hold more government bonds.

This means that any so-called “unrealised losses” will have to be accounted for, even if bonds that have suffered declines in their market values haven’t been sold.

California-based Silicon Valley Bank and other regional lenders in the US collapsed earlier this year as a result of runs when depositors learned that losses in the value of the banks’ investments – due to rapid interest rates rises – were denting the bank’s capital.

Silicon Valley Bank and other regional lenders in the US collapsed earlier this year due to money problems. Picture: Rebecca Noble/AFP

The digital connectedness of today’s banking system meant the bank runs happened at a much faster speed than regulators and executives were expecting.

Lax regulation in pockets of the US banking system were blamed for the ensuing crisis. On Wednesday, APRA said its proposals would ensure that all banks’ liquidity portfolios are based on prudent valuations and able to absorb stress as intended.

“This year’s banking turmoil overseas highlighted the threat that can arise when banks don’t regularly update the value of their liquid assets (and) reinforced the importance of minimising contagion risks,” said APRA Member Therese McCarthy Hockey.

“These targeted revisions aim to ensure that stress at one bank doesn’t have an outsized impact on the system, that liquid assets are prudently valued, and that banks are adequately prepared to access central bank liquidity where needed.”

She said the regulator recognised the financial impacts the proposals would have on “some smaller banks” and the regulator would consider options to “mitigate” some of that during a consultation process.

To reduce contagion risk, the regulator is proposing to no longer count bank bills, certificates of deposits and bank-issued debt securities as eligible liquid assets for small banks.

Such instruments currently account for about 60 per cent, on average, of the smaller bank’s existing liquid assets. To maintain the same level of liquidity, these banks would need to replace the newly restricted securities with lower yielding government bonds, the regulator said.

The impacted banks, which are part of APRA’s Minimum Liquidity Holdings regime, include mainly credit unions, mutual banks, and a handful of smaller institutions, such as Judo Bank.

Forcing those banks into government securities rather than bank bonds will come at a price, but the extent of the impact will depend on the composition of each bank’s liquid portfolio.

The bigger banks, including the big four, Macquarie, the regional lenders and subsidiaries of foreign banks already comply with most of the requirements as part of its Liquidity Coverage Ratio requirements.

The proposals also include a requirement to have processes and systems in place to provide clear information to the regulator when asking for “liquidity assistance” in periods of stress.

“APRA’s proposal would dampen the earnings of (banks) on the MLH regime, without corresponding mitigating actions,” the regulator said.

“To ameliorate potential impacts, APRA is seeking feedback on policy options that would assist authorised deposit taking institutions in managing adjustments to their liquidity portfolios.”

Options could include providing the banks with transition times and reviewing the calibration of the banks’ “minimum liquidity requirements, taking into account that liquid assets would be higher quality and more prudently valued,” it said.

APRA will undertake a consultation process that will include workshops until mid next year.

The proposals will be reflected in changes to two prudential standards: APS 210 Liquidity and APS 111 Capital Adequacy: Measurement of Capital.