Big four mortgage portfolios have $19bn advantage

In its response, released earlier this month, APRA wrote: “For residential mortgages, IRB ADIs are currently subject to arrangements that are expected to generate, on average, a risk weight of at least 25 per cent; for standardised ADIs, the average risk weight is in the order of 39 per cent.”

Assuming a target common equity tier 1 (CET1) capital ratio of 9 per cent, APRA said that the difference in risk weights between the standardised and IRB approaches “equates to a reduction in CET1 capital requirements of approximately $19 billion (14 per cent), in aggregate, for the four major banks’ current Australian residential mortgage portfolios”.

APRA went on to outline that the difference in capital requirements will also impact ADIs’ profits and profitability, as an ADI with a higher risk weight will generate (all other things being equal), a higher profit in dollar terms, but a lower measure of profitability (e.g. return on equity).

The regulator added: “The implications of this difference will depend on the impact on an ADI’s overall cost of funding… [but a] simple but conservative example suggests a [pre-tax funding cost advantage] of around 14 basis points.”

However, APRA said that in practice, it is likely that the cost advantage is less than this (potentially around 11 basis points).

‘Major banks have a head start built into the rules of the game’

The APRA response has been welcomed by the Customer Owned Banking Association (COBA), an industry body for credit unions, building societies, mutual banks and friendly societies.

COBA CEO Mark Degotardi commented: “Common equity tier 1 regulatory capital is the most expensive form of funding and APRA allows the major banks to hold less of this form of funding against mortgages compared to their competitors.

“APRA has now confirmed that the difference in the regulatory capital rules equates to a reduction in common equity tier 1 capital requirements for the major banks of approximately $19 billion… and estimates that the pre-tax funding cost advantage for a major bank is approximately 14 basis points.”

Mr Degotardi added: “This estimate is based on conservative assumptions so changing the assumptions would deliver a much larger estimate of the funding cost advantage. 

“What it means is that in the mortgage market, the major banks have a head start built into the rules of the game.” 

The COBA CEO claimed that as APRA is the banking regulator, it is “significant that it has removed any doubt that major banks gain a funding cost advantage from the regulatory capital rules and also from implied government support being reflected in their credit ratings”. 

Mr Degotardi concluded: “COBA would like to see APRA acting with greater urgency in implementing reforms that add to banking system resilience and reduce the advantages major banks have over their smaller competitors. 

“Customer owned banking institutions — mutual banks, credit unions and building societies — are eager to build on their 4-million strong customer base, but we need a fairer regulatory framework.”

Mr Degotardi called on APRA to implement the top three recommendations that the Financial System Inquiry put forward in 2014: make regulatory capital for major banks ‘unquestionably strong’, narrow the gap in mortgage risk weight between banking institutions, and reduce the effect of the implicit ‘too big to fail’ guarantee for the major banks. 

[Related: Customer-owned banking reaches $100bn in assets]