Australia’s New Mortgage Rules May Level The Playing Field

Euromoney, July 2015

Australia’s big four banks will need to raise A$18 billion of new capital if a new recommendation is adopted by the national banking regulator, in a move that may provide a boost to the country’s second tier of banks.

The Financial System Inquiry, a report commissioned by the Australian Treasury and released for consultation at the end of 2014, recommends that the Australian Prudential Regulation Authority use higher average risk weightings for home lending. The market has been digesting the recommendations ever since. At the end of May Standard & Poor’s, having crunched the numbers, put out a detailed report suggesting that if APRA does implement the recommendation, the banks will need A$18 billion to maintain their tier 1 capital ratios at current levels.

While that’s a clear burden for Commonwealth Bank of Australia (whose former CEO David Murray chaired the inquiry), National Australia Bank, Westpac and ANZ, S&P’s main takeaway from it all was about who benefits: the second tier of banks such as Suncorp, Bendigo and Bank of Queensland.

Today, the major banks must hold an average risk weight of 18% of residential mortgages, and the other banks must hold 39%. The inquiry recommends that APRA require an average risk weighting of 27.5%, which would go some way towards making a more even competitive environment. “The recommendation will have a positive impact by creating a more level competitive residential mortgage loans playing field between the major banks and the three regional banks,” says Lisa Barrett, credit analyst at Standard & Poor’s.

Thinking it through, if the big banks had to raise all that extra capital, APRA itself reckons that those banks would probably have to lift the standard variable rate on their mortgages by 23 basis points to maintain their existing return on equity, while regional banks could maintain pricing. Looking at interest rates in the market today, that would in many cases make the big banks more expensive than the smaller ones.

“Under a scenario such as this, the major bank would have to reconsider its willingness and ability to grow its mortgage book at the current high rate of growth, based on the competitive pricing they have enjoyed to date,” the report says. So one of two things would have to happen: banks would either have to accept that mortgages are not going to be as profitable as they used to be, or they would have to raise rates and hope the business stays with them rather than fleeing to smaller competitors.

The mortgage question fits into a broader sense that Australia’s regional banks are well positioned to stand up and be counted in the country’s big four-dominated banking system – as reflected by Euromoney’s unprecedented decision to name Suncorp the best bank in Australia this year. With three of the big four facing questions over conduct, and the fourth (Westpac) underwhelming with its result, Australia’s regional banks are facing a brighter future than has been the case for some time.

Deutsche Bank analyst Karen Chidgey, for example, holds a buy recommendation on Suncorp. Speaking of the bank’s Optimisation programme for growth and efficiency, she writes: “Optimisation program benefits increase the probability that Suncorp will be able to reach its 10% return on equity target next year and sustain this over the medium term.”

Elsewhere, Bank of Queensland reported a 14% increase in statutory profit after tax in the first half of 2015, and Victoria-based Bendigo and Adelaide Bank – the fifth largest in the country – reported a 10.9% increase in cash earnings in its own first half. In comparison, Westpac’s cash earnings were up only 2% in its interim statement (prior to a derivative adjustment).

While the biggest bank, Commonwealth Bank of Australia, continues to perform well, it has spent much of the last year mired in a scandal around its financial planning division, through which thousands of customers lost large amounts of money – sometimes their life savings – as a result of inappropriate advice given by planners at the bank. ANZ has paid A$30 million of compensation to 8,500 clients after one of its product offerings – called Prime Access – was found to have charged customers for financial advice it did not give. And National Australia Bank fired a number of employees from its wealth division over misconduct concerns; its subsidiary Meritum was one of a number of institutions investigated by the securities regulator, ASIC, for its selling of complex financial products to ordinary investors.