Higher capital buffers are the key changes to the bank capital framework detailed in an information paper released by the Australian Prudential Regulation Authority yesterday.
There are also changes to the level of capital required to be held for different types of loans. APRA has increased the capital requirement for residential mortgages and reduced them for SME lending.
After four years of consultation APRA has finalised its new bank capital prudential framework, which will take effect on 1 January 2023.
The regulator said the new framework “provides the foundations for an unquestionably strong financial system in the years ahead”.
For banks using the standardised approach to credit risk, minimum capital of 8 per cent will be made up of a 4.5 per cent common equity tier 1 minimum, a 2.5 per cent capital conservation buffer and a 1 per cent countercyclical capital buffer.
For banks using internal models, minimum capital of 9.25 per cent will be made up of a 4.5 per cent CET 1 minimum, a 3.75 per cent capital conservation buffer and a 1 per cent countercyclical capital buffer.
The major banks will have the addition of a 1 per cent domestically systemically important bank (D-SIB) buffer, taking their minimum capital to 10.25 per cent.
Under the pre-2023 framework, regulatory buffers are 2.5 per cent of all banks except 3.5 per cent for the major banks.
The unquestionably strong benchmark is an increase in average minimum capital of 50 basis points for standardised banks and 150 bps for advanced banks. APRA said it expects the major banks to operate with capital ratios above 11 per cent.
It said the greater use of buffers to strengthen capital would provide greater flexibility. The buffers will be useable during periods of stress.
The other key design feature is to allocate higher capital requirements for higher risk lending.
APRA has increased capital for residential mortgages relative to other asset classes, given the high concentration in this asset, and created greater distinction between higher and lower risk mortgage lending.
Loans to owner-occupiers paying principal and interest are low risk, while investor loan and intertest-only loans are higher risk. Mortgages with both an interest-only period of five years or more and a loan-to-valuation ratio above 80 per cent are classified as non-standard loans and require a risk weight of 100 per cent.
Capital requirements for lending to SMEs have been reduced, with lower risk weights under the standardised approach. The threshold for defining retail SME has been raised from A$1 million to $1.5 million in loan size.
APRA believes the new framework will enhance competition by increasing minimum capital requirements for advanced banks more than standardised banks and reducing capital requirements for lower risk mortgage lending by banks on the standardised approach.