Australian banks are high on the list of being 'too big to fail'. Not only do they dominate the stock exchange, they also are the main players in Australia's $5 trillion property market, by far the biggest pool of capital in the country. If they got into trouble, the repercussions would be profound on the whole economy.
True, they are not too big to fail in the way some of the global investment banks have been. Since 2007, the entire world's financial system has depended on their survival. A recent stress test has found that many European banks are a long way from being out of the woods. Twenty four have failed a stress test.
The current financial services inquiry, which has been fronted by a former CEO of Commonwealth Bank David Murray, is looking like asking the banks for more equity capital, according to the AFR. This could have an effect on the capital available for dividends:
"Recommendations are yet to be finalised, but interviews with sources close to the inquiry revealed it will recommend the four major banks substantially increase their “common equity tier-one capital” buffer to compensate for the lower funding costs they receive because investors perceive them as “too big to fail”.
The Financial System Inquiry is also preparing to impose a minimum “floor” on the “risk-weightings” the major banks apply to their home loans, which will create a more level playing field for competitors.
The inquiry is focused on creating a more resilient financial system that can withstand shocks and weather frozen funding markets, however, the Financial Review understands it has a preference for encouraging banks to boost “going concern” equity capital rather using more complex “gone concern” capital, such as hybrids and bonds that can be “bailed in” by regulators to become equity.
Sources said the inquiry believes that more equity and less leverage will reduce the risk of bank failures, whereas hybrids and bail-in bonds only allow governments to minimise the damage once disaster has struck.
The inquiry also has concerns that the loss-absorbing capital instruments, such as the bail-in bonds being considered by global regulators, create complexity and confusion about the rights of different funders compared with traditional debt and equity.
The big banks have been lobbying the inquiry to use loss-absorbing capital as a substitute for increasing equity, which they argue is too costly."
There are some positive signs. The so called “ring-fencing” laws that are popular in Britain and the US will probably not be needed because Australia's banks have tended not to get into the highly complex investment banking activities that created conflicts and which proved to be highly dangerous. They have had little need; they make fabulous profits from conventional mortgage lending. They may also be given a pass on paying for the government’s free guarantee of deposits, which was a response to the GFC.
But they do look likely to be asked to retain more capital. Given Australia's soaring property market, that may be a highly prudent move, providing a buffer against a sharp correction in house prices. But it may put pressure on the capital available for dividends:
"The Financial Review understands the Murray inquiry’s final report may call for an increase in the common equity tier-one capital buffer for the large banks from 1 per cent to 2 per cent or 3 per cent. It is also likely to recommend a minimum risk-weighting floor on home loans of 20 per cent.
Non-major banks now have minimum 35 per cent risk weightings applied to home loans, but the majors have no minimum, which has left them with much lower average risk-weightings of 18 per cent, according to APRA.
This means the majors hold less than half the capital, more than twice the leverage and can, in theory, generate double the returns of competitors.
Analysis published by Morgan Stanley and UBS suggests an increase in the majors’ too-big-to-fail equity buffer from 1 per cent to 2 per cent, combined with a new 20 per cent risk-weighting floor, would result in about a $24 billion deficiency in equity capital. The banks would, however, have until 2019 to implement the changes."