Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 119

What happened to our gold-plated bank capital position?

APRA released a paper last week which gave some clarity to the question of just how well capitalised the Australian major banks are (but no clarity on where they need to get to). Despite the major banks claiming for the past five years that they are the best capitalised banks in the world, it seems they are not even in the top quartile. There is no agreement as to how much extra capital needs to be raised, but in one sense it doesn’t matter. Earnings Per Share and Returns on Equity may well be unchanged as banks will continue to practice regulatory arbitrage and the oligopoly will allow them to increase fees without much fuss. Still, it will be unarguably a better outcome for hybrid and debt holders.

Recap on what the fuss was all about

There’s been an ongoing discussion about how much capital banks should have. Although the Basel regulations are meant to standardise capital, each national regulator does its own renovations, so it’s not easy to compare capital levels between banks of different domiciles. The most important capital level is common equity (or CET1) and the minimum level for the four major Australian banks is 7% of risk weighted assets. Differences between regulators are myriad. For example, in contrast to other regulators, APRA says that banks need to put aside risk for any interest rate bets they take on their deposit book and APRA won’t allow banks to claim past tax losses as an asset (because this reduces the amount of tax paid in the future). This means that Australian bank capital levels would be naturally lower than their overseas counterparts. On the other hand, Australian banks set aside far less capital for housing risk than overseas banks which has the opposite effect of overstating domestic bank capital levels.

In a Media Release announcing the changes to residential mortgage risk weighting, APRA said, "This change will mean that, for ADIs accredited to use the IRB approach, the average risk weight on Australian residential mortgage exposures will increase from approximately 16 per cent to at least 25 per cent." IRB is 'Internal Ratings-Based', which allowed the major banks to use their internal models and assign low risk weights.

APRA’s report used some confidential data available to the Basel Committee. APRA came to the conclusion as at June 2014, that Australian bank equity capital levels were around the middle of the second quartile and 0.7% lower than the global first quartile level. So, for example, if the Australian banks capital levels (under APRA rules) are 8%, the top quartile of the world would be 8.7% (under APRA rules) or if Australian banks were judged on the Basel survey and the top quartile of banks had 11% CET1 levels, Australian banks would have 10.3% CET1 levels.

Second quartile is news for Australian bank CFOs

One of the most enduring attempts at agenda-setting by the banks is claiming they have the best capital levels in the world. Figure 1 below from the CBA February 2015 results is typical and gives the impression that on a comparative basis, CBA has a gold-plated capital structure. It purports to show what CBA’s CET1 capital levels would be under the various regulatory regimes operative in the UK, Europe and Canada.

Figure 1: CBA capital levels compared with banks in other countries, according to CBA

Unfortunately, the APRA paper calculated that the banks were middle second quartile. It’s hard to understand how the Australian banks can justify their claims on capitalisation and relative safety. APRA baulked a little as to whether the middle top quartile is an appropriate target, probably because global banks continue to grow capital and there are a number of large global banks who have to hold additional capital because they are Globally Systemically Important Banks or GSIBs.

How much additional capital is required?

No one actually knows how much extra capital is required, as it’s a combination of factors:

  • An expectation that Basel 3 will soon be replaced by Basel 4
  • Global banks continue to increase their capital levels
  • Small changes in assumptions or bank structures can change nominal capital levels and regulatory capital adequacy materially
  • APRA continuing its Delphic-ness by not telling anyone what might be an appropriate CET1 capital level. Even the analysts are confused. From a survey of five of the major analysts there was a range of $8 billion to $20 billion additional capital needed
  • The extra capital needed to support the rise in risk weights on residential mortgages.

A few months ago we estimated that the banks needed to raise $20 billion if their mortgage risks were raised to international standards. They have since raised $8 billion, so our simple estimate is now $12 billion to $14 billion.

What do the banks do and does it matter?

There is no problem with the banks meeting whatever new targets APRA decides on. There is still a lot of cash floating around in Australia and the only issue is at what price the new equity is raised. Banks have been optimising their regulatory capital since 1994 when Westpac started buying back shares (between 1994 and 2004, the total number of shares decreased by 2%, but assets increased 161% and EPS 260%: that’s gold medal-winning regulatory arbitrage). They’ll do it again and may sell divisions or assets that don’t cut it in the new regulatory environment if it will produce a better EPS outcome. It’s an extremely effective oligopoly and if they have to issue more shares, which are potentially dilutive to RoE, EPS or DPS, they just put up interest rates and fees.

Although it’s not reflected in market prices, hybrids are now approximately $20 billion to $30 billion safer than they were three months ago. There might be a bit more supply over the next few years as banks attempt to push up their total capital levels, but we think that will be price-driven and at the moment raising hybrid capital is historically very expensive.

On a tangent, we are continuing to develop the view that while capital levels are important in protecting hybrid holders up to a certain point, at some stage the profitability of the bank becomes more important. It explains why the US banking system was able to move from ‘insolvency in 2010’ to repurchasing stock in 2013. Australian banks are wonderfully profitable, so the profit-generating capability becomes more and more important. For example, in 2007 banking system profits were $20 billion while in 2015, it will be more like $34 billion. It’s pretty easy to recapitalise when you are making that much money each year.


Campbell Dawson is an Executive Director at Elstree Investment Management, a boutique fixed income fund manager. See This article is for general education purposes and does not consider the circumstances of any individual.



Leave a Comment:



Bank capital in a post-FSI world

Among key trends in Australian banks, one factor stands out

Are Australian bank boards fit for purpose?


Most viewed in recent weeks

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Welcome to Firstlinks Edition 467

Fund manager reports for last financial year are drifting into client mailboxes, and many of the results are disappointing. With some funds giving back their 2021 gains, why did they not reduce their exposure to hot stocks when faced with rising inflation and rates?

  • 21 July 2022

Welcome to Firstlinks Edition 466 with weekend update

Heard the word, cakeism? As in, 'having your cake and eating it too'. The Reserve Bank wants to simultaneously fight inflation by taking away spending power, while not driving the economy into a recession. If you want to help, stop buying stuff.

  • 14 July 2022

Welcome to Firstlinks Edition 465 with weekend update

Many thanks for the thousands of revealing comments in our survey on retirement experiences. We discuss the full results. And with the ASX200 down 10%, the US S&P500 off 20% and bond prices tanking, each investor faces the new financial year deciding whether to sit, sell or invest more.

  • 7 July 2022

Latest Updates


The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.


Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.


The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.


The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.