E&Y Basel Committee Update

8/8/2019 E&Y Basel Committee Update

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Insights on Basel Committee Update Basel III

Outcomes of the Basel Committee meeting of the Group of Governors and

Heads of Supervision held on 12 September 2010

APRAs current prudential framework has ensured that the Australian banks have come through the recentturbulence in a strong position. As a result, Australian banks are well positioned compared to some of theirinternational peers to meet the end-state requirements to be implemented between 2013 and 2018.

There were no surprises in the Basel Committee on Banking Supervisions press release. In short, a positiveoutcome for APRA, as the current proposals are in-line to its preferred position in a number of areas as wellas being consistent with briefings and updates provided to the Industry.

While the immediate impacts are not as substantial as earlier proposals suggested, there are clearimplications for Australian banks in several key areas which must be carefully managed. As set out below inour summary.

September 2010

Financial services

regulatory update

While the immediate impacts are notas substantial as earlier proposalssuggested, there are clearimplications for Australian banks inseveral key areas which must becarefully managed.


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Ernst & Young Financial services regulatory update Page 2 of 5

1. Capital Ratios and Buffers

The minimum common equity ratio will increase to 4.5%and the total capital ratio will remain at 8%. The revisedminimum ratios will be twinned with two new buffers, which

are in addition to the above minima:

The Capital Conservation Buffer (CCB) is a buffer thatbanks will be expected to hold during the good times.This has been set at 2.5%, comprising common equity.In essence, this will create an effective common equityratio of 7% by the end of the transition period.

The Countercyclical Buffer (CB) can be imposed byAPRA under its national discretion to protect thebanking sector from periods of excess credit growth.The range has been set at 0 2.5% and can be madeup of common equity or other fully loss absorbingcapital. Operational aspects of its implementation areyet to be finalised.

In addition, there is scope for APRA to implement aSystemically Important surcharge to the T1 aspect of abanks Prudential Capital Requirement (PCR), where itconsiders it appropriate. This may impact the Big 4 banks.

Transition to the new requirements will commence fromJanuary 2013, with full implementation from January2018. The revised minimum common equity ratio of 4.5%will be fully implemented by January 2015 with the full

capital conservation buffer by January 2018.

During this transition period it is unclear whether excesscapital above a transitional minimums, but below the 7%end state requirement, would be available for release giventhe explicit requirement of prudent earnings retention.

Therefore, as at 1 January 2019, the Tier 1 requirementsfor Australian ADIs could range from 7% to 9.5% dependingon APRAs implementation of the Counter-Cyclical Buffer.For the majors the minimums could be even higher if APRAapply a Systemically Important surcharge.

Few details in relation to the leverage ratio have beenreleased. A minimum ratio of 3% will be tested during aparallel run period with the finalised leverage ratio to be inplace as a Pillar 1 requirement from January 2018.

2. Definition of Capital

Capital Deductions

Deductions now taken 50% from Tier 1 and Tier 2 willbecome 100% deductions from Tier 1 capital. Given thecorporate structures of many banks with subsidiaries this

will likely have a material impact on the T1 ratios.

Therefore, APRAs Level three conglomerate rules mayprovide an opportunity for more complex groups torestructure to a more capital efficient structure.

Eligible Capital

The aim of strengthening the loss absorbing capacity of Tier1 and Tier 2 capital remains firmly on the agenda althoughno final details have been included within the press release.There are a number of considerations for Australian ADIswith regard to eligible capital:

Will APRA maintain its conservative stance on thesenew instruments? Experience with Covered Bondssuggests that any instrument that may reduce orsubordinate depositors rights will not be viewedfavourably by APRA.

Transition to the new requirementswill commence from January 2013,with full implementation fromJanuary 2018.


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Assuming they are permitted there are a number ofquestions still to be resolved:

What will the market appetite, both domestic andinternational, be for these instruments?

What will be the premium attached to theseinstruments?

What will be the impact on the cost of capital?

Will these instruments even be relevant from arating agency perspective?

Grandfathering provisions have been announced withcapital instruments not qualifying as common equity, Tier 1or Tier 2 being phased out over a 10 year horizon from

January 2013. We do not expect this to impact AustralianADIs significantly given the maturity profile of existinginstruments.

3. Liquidity

Although specifics have not been released, the liquiditycoverage ratio will be introduced in January 2015, withobservation taking place from January 2011. The yet to bedefined net stable funding ratio is due to be implemented inJanuary 2018.

Australian banks are likely to be under some pressure to

meet the new requirements, with APRA expected tosignificantly raise the bar in this regard.

4. Strategic Direction

The changes to the minimum ratio are not l ikely toimmediately impact Australian banks (due to long transitionperiods) and local banks current T1 capital ratios. However,

this does not change the fact that there will be a moreconservative treatment applied in a number of areas.

From an Australian perspective, the current well capitalisedposition of the banks should not be viewed as directly

equating to excess capital to be used in buy-backsorsignificant acquisitions. It seems unlikely APRA wouldconsider a reduction of capital in the near term, only thento leave the bank in the position of having to raise capitalover the course of the transition period.

The full impacts of the changes to regulatory deductionsfrom capital need to be carefully considered. The overseasbanking subsidiaries of the major ADIs, particularly those inthe UK, US and New Zealand, may well see increased capitalrequirements imposed by local regulators with flow onimpacts to their parents.

At this point, we see merit in ADIs performing strategicreviews of their business lines to ensure that all assets areappropriately priced for both risk and return on capital.Banks will also need to re-assess the liquidity requirementsassociated with individual products and factor the cost ofholding additional liquid assets into a review of the productofferings.

On top of the changes in the capital ratios, an interestingaspect will be the impact of these buffers to APRAs PCRsetting process and banks in the preparation of their

ICAAPs.

From an Australian perspective, the

current well capitalised position of thebanks should not be viewed as directlyequating to excess capital to be used in

buy-backs or significant acquisitions.


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Appendix 1 Phase in arrangements (shading indicates transition periods)

- All dates are as of 1 January

2011 2012 2013 2014 2015 2016 2017 2018 2019

Leverage RatioSupervisory monitoring

Parallel run1 Jan 2013 1 Jan 2017

Disclosure starts 1 Jan 2015Migration to Pillar 1

Minimum Common EquityCapital Ratio 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Capital Conservation Buffer0.625% 1.25% 1.875% 2.5%

Minimum common equity pluscapital conservation buffer 3.5%

4.0% 4.5% 5.125% 5.75% 6.375% 7.0%

Phase in of deductions fromCET1(including amounts exceedingthe limit for DTAs, MSRs andfinancials)

20% 40% 60% 80% 100% 100%

Minimum Tier 1 Capital4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

Minimum Total Capital8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Minimum Total Capital plusconversation buffer

8.0% 8.0% 8.0% 8.625% 9.125% 9.875% 10.5%

Capital instruments that nolonger qualify as non Tier 1capital or Tier 2 capital

Phased out over 10 year horizon beginning 2013

Liquidity coverage ratio Observationperiodbegins

Introduceminimumstandard

Net stable funding ration Observationperiodbegins

Introduceminimumstandard


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For more information please contact

Steve Ferguson

Oceania Sector LeaderBanking and Capital MarketsTel: +61 2 9248 [email protected]

Andrew Harmer

PartnerFinancial Services Risk ManagementTel: +61 2 9248 [email protected]

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