Contrary to popular belief, Australian Banks are not the safest in the world and should hold more capital to protect against future shocks.
David Murray, chair of the Financial System Inquiry who released their final report yesterday, said Australian banks should be in the top 25 per cent of global banks, but they are currently around middle ground.
The first two of the forty four recommendations is to increase the resilience of the Australian banking system though increased capital levels and the raising of risk weightings for internal ratings-based (IRB) banks to narrow the different risk weights used between the Big 4 including Macquarie and the standardised banks.
As we reported three weeks ago (‘Have the Big 4 just flunked APRA’s stress test?’‘) Australia’s Big 4 banks – ANZ, CBA, NAB and WBC have been flouting their privilege in calculating their own risk ratings, putting super profits ahead of stability with the knowledge that naive taxpayers will be on hand to bail out these “too big to fail” banks. This has lead to a deterioration of mortgage risk ratings applied by the Big 4 and Macquarie.
A recent stress test conducted by the Australian banking regulator shows this is a real possibility. The Big 4 have cut their risk ratings and Tier 1 common equity so fine, that in a simulated collapse of the world’s second largest housing bubble – namely Australia’s – and the collapse of commodity prices (already well under way), all four required extra capital. If they were unable to access the extra capital required, all four of our big banks would effectively be insolvent. The non-advanced banks – all the banks except the Big 4 and Macquarie – who have regulated risk weightings, scraped though the stress test, distressed but generally fine.
It is a fact not lost in the Murray report. The report says Australia should not underestimate the risks of financial crises:
For example, the major banks currently have a leverage ratio of around 4–4½ per cent based on the ratio of Tier 1 capital to exposures, including off-balance sheet. An overall asset value shock of this size, which was within the range of shocks experienced overseas during the GFC, would be sufficient to render Australia’s major banks insolvent in the absence of further capital raising. In reality, a bank is non-viable well before insolvency, so even a smaller shock could pose a significant threat. Following its recent stress-test of the industry, APRA concluded, “… there remains more to do to confidently deliver strength in adversity”
The Murray report also highlights the many tax distortions driving Australia’s significant housing asset bubble and ultimately placing the Australian banking system and entire economy at significant risk. This includes the “relatively heavily” taxed income from bank deposits and fixed income securities, negative gearing and the 50 percent capital gains tax discount.
Another one of the many sensible outcomes from the report is the recommendation to reinstate restrictions on Self Managed Super Fund’s (SMSF) access to limited recourse borrowing suggesting it could pose a significant risk to the economy. Property spruikers have been pressuring people to set up SMSFs and to leverage their retirement savings into the property bubble.
But with so many sensible recommendations, the real test is now what, if any, recommendations the government will adopt. Very few of the Ken Henry Tax Review recommendations including above mentioned tax distortions have been implemented after the release of the 2009 report. Various watchdogs over the years have set up task forces, (e.g. ASIC set up up task force on SMSF leveraging into property in 2012 (‘Alarm bells ring as self managed super funds spruiked as vehicle for leveraged property‘) with no tangible outcomes. We have had the House Standing Committee on Economics to investigate foreign investment in residential real estate (‘Report into foreign investment in residential real estate could come too late‘). The Council of Financial Regulators is said to be exploring macroprudential controls (‘Property bubble a Macroprudential challenge for regulators’), but we are now not expected to see any outcome this side of Christmas, if at all.
It appears all to hard. Maybe the bubble is too big?
» Financial System Inquiry – The Commonwealth of Australia, 7th December 2014.