The build-up in capital adequacy by Australian banks in anticipation of new regulatory requirements is having a much bigger impact on the returns of regional banks than on the majors, a new report shows.A KPMG study of the financial performance of regional banks over the past year, released yesterday, shows a significant fall in the average return on equity of the four regionals in the survey - Bendigo and Adelaide Bank, Suncorp, Bank of Queensland and ME Bank. The average ROE for the four banks fell from 7.2 per cent in the 2009/10 financial year to 6.7 per cent in 2010/11. Bendigo and Adelaide was the top performer, with an ROE of 9.1 per cent, while Suncorp could manage only 3.2 per cent.Average regional bank ROE fell from a peak of 15 per cent in 2007/08, as the financial crisis hit, and has not recovered since then.The big banks have fared better. Average Big Four ROE fell from close to 20 per cent in 2007/08 to below 15 per cent a year later but has since recovered, reaching 15.9 per cent in 2009/10 and 16.7 per cent in 2010/11.The KPMG report said: "The regionals maintain healthy capital bases and capital ratios. However, one result of holding this additional capital is that they are experiencing a drag on ROE."Despite sacrificing returns for capital growth, all the regional banks experienced a fall in their capital adequacy over the past year. The average capital adequacy ratio fell from 13.2 to 12.5 per cent.KPMG said the regional banks' ROE levels were not sustainable long term. The banks need to work out how to get them up to higher levels.