skip navigation
Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

ECONOMY
July 16, 2019

Australia’s Regulatory Capital Requirements Increased for Banks

By Sean Rogan

Stay up to date on timely topics and market events. Subscribe to our Blog now.

On the 9th July 2019, the Australian Prudential Regulation Authority (APRA) released its final decision on the form of capital that will make up part of the Total Loss Absorbing Capital (TLAC) for its domestic systemically important banks (D-SIBs), which comprise the four major Australian banks. Following a consultation period, APRA made some modifications to its original proposal, but has decided to stay with the current Tier 2 instrument to fulfil the additional capital requirement.

APRA have reduced the quantum of additional capital required from a previous level of 4%-5% of risk-weighted assets (RWA) to 3% and extended the period for the capital build to the 1st January 2024. APRA has indicated that the remaining 2% of additional capital required for its TLAC target can be considered at a later date. In essence, a typical capital structure for an Australian D-SIB will look like the following:

Exhibit 1: Typical Capital Structure for an Australian D-SIB
Typical Capital Structure for an Australian D-SIB
Source: APRA. Note that APRA currently requires the major banks to maintain a minimum 10.5% CET1 by 1st January 2020, to be considered unquestionably strong.
^ Capital conservation buffer.
* Capital surplus of 3.5% is generally higher than the level D-SIBs may normally maintain, as they have acted in anticipation of changes to the capital adequacy framework as a result of the ‘unquestionably strong’ capital benchmarks. APRA expects the D-SIBs to continue to maintain a normal capital surplus in excess of regulatory capital requirements once such changes are implemented.
Select the image to expand the view.

The decision to stay with Tier 2 seems partially driven off the fact that APRA has no authority to introduce a senior non-preferred or a Tier 3 security, the establishment of which would require the government to pass legislation to enable the Banking Act to be modified. An additional concern for APRA was the potential ratings implication for the current senior unsecured ratings, where the rating agencies have typically reduced implied government support when senior non-preferred securities have been introduced into the capital structure.

To this point, post APRA’s announcement S&P placed all four major banks back on Stable outlook. S&P require that the important principles underlying APRA's plan remain unchanged compared with the proposal it announced in November 2018. The main difference is that APRA has set the target additional amount of loss-absorbing capacity by Jan. 1, 2024, to a reduced 3% of regulatory RWA compared with 4%-5% in the previous proposal. S&P expect that the banks would predominantly use Tier 2 capital instruments to strengthen their loss-absorbing capacity. Increased loss-absorbing capacity could lessen the need for the Australian government to provide financial assistance to banks in a stress scenario and thus lessen the financial burden on taxpayers. Nevertheless, S&P believe that this plan does not introduce any policy or process impediments to the government bailing out a D-SIB, in the unlikely event this was required. Nor does it suggest any diminution in the Australian authorities’ willingness to do so.

Currently S&P provide three notches of sovereign support to the Senior Unsecured ratings of the banks. Post the announcement this has remained unchanged. Moody’s currently prescribes two notches of Sovereign Support to the Senior Unsecured Rating.

From a market perspective, on current RWA, the banks will need to issue an additional AUD 50 billion in Tier 2 by the 1st January 2024. This is more than double the current outstanding of approximately AUD 40 billion to a total of AUD 90 billion. In round numbers, each bank will be required to do a AUD 3 billion Tier 2 deal each year in addition to refinancing their existing securities.

This is unprecedented volume; however, in current market conditions it does not seem unrealistic. Tier 2 remains reasonably rated with S&P at BBB, Moody’s at Baa1 and Fitch at A-.

The additional volume of Tier 2 will see a commensurate reduction in Senior Unsecured issuance, all things being equal. Post the announcement, Tier 2 initially moved out 20 bps, but it has since recovered those losses. Also post the announcement, 5-year senior bank notes have moved in 6-8 bps to 70 bps, reaching a new post-GFC tight.

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.