Bank Capital Adequacy in Australia

Topics: Capital requirement, Capital adequacy ratio, Basel II Pages: 28 (8383 words) Published: August 2, 2013
WP/12/25

Bank Capital Adequacy in Australia
Byung Kyoon Jang and Niamh Sheridan

© International Monetary Fund

IMF Working Paper Asia and Pacific Department Bank Capital Adequacy in Australia Prepared by Byung Kyoon Jang and Niamh Sheridan1 Authorized for distribution by Ray Brooks January 2012 Abstract This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The paper finds that, given Australia’s conservative approach in implementing the Basel II framework, Australian banks’ headline capital ratios underestimate their capital strengths. Given their high capital quality and the progress in their funding profiles since the global financial crisis, the Australian banks are making good progress toward meeting the Basel III requirements, including the new liquidity standards. Stress tests calibrated on the Irish crisis experience show that the banks could withstand sizable shocks to their exposure to residential mortgages. However, combining residential mortgage shocks with corporate losses expected at the peak of the global financial crisis would put more pressure on Australian banks’ capital. Therefore, it would be useful to consider the merits of higher capital requirements for systemically important domestic banks. JEL Classification Numbers: G20, G21, G28, F32 Keywords: Australia, Canada, Basel II, Basel III, capital, loss given default, probability of default, stress tests Author’s E-Mail Address: bjang@imf.org, nsheridan@imf.org The authors would like to thank the Reserve Bank of Australia, the Australian Prudential Regulation Authority, and the Australian Treasury for their valuable comments on earlier drafts of this paper. We benefited greatly from comments and suggestions from Ray Brooks, Nancy Rawlings, Kate Seal, Liliana Schumacher, and Nicolas Blancher. Kessia De Leo and Solomon Stavis provided excellent assistance. 1

2   I. II. III. IV. V. Contents Page

Introduction ...................................................................................................................... 3 Features of the Australian Banking System ..................................................................... 3 Basel II Implementation and Capital Ratios .................................................................... 6 Basel III and Australian Banks ...................................................................................... 11 How Vulnerable are Australian Banks to Shocks to Residential Mortgages? ............... 13

Figures 1. Assets of Four Major Banks for Selected Countries, 2010 .............................................. 4 2. Banking Sector Assets for Selected Countries ................................................................. 4 3. Bank Nonperforming Loans to Total Loans .................................................................... 6 4. Bank Nonperforming Loans to Total Loans .................................................................... 6 5. Indebted Households, 2009 .............................................................................................. 6 6. Total Short-Term External Debt ...................................................................................... 6 7. Loss Given Default on Residential Mortgages ................................................................ 6 8. Total Regulatory Capital Ratio, 2010 .............................................................................. 7 9. Tier 1 Regulatory Capital Ratio, 2010 ............................................................................. 7 10. Tangible Common Equity to Risk Weighted Assets, 2010.............................................. 7 11. Tangible Common Equity to Tangible Assets, 2010...

References: Australian Bankers’ Association Inc., 2009, Comparison of Regulatory Capital Frameworks: APRA and the UK FSA, June. Australian Prudential Regulation Authority (APRA), 2010a, Insight, Issue 2. ____________, 2010b, Supervisory Oversight and Response System, November. ____________, 2010c, Probability and Impact Rating System, November. ____________, 2011a, Implementing Basel III Capital Reforms in Australia, September. ____________, 2011b, The RBA Committed Liquidity Facility, Media Release, November. ____________, 2011c, Implementing Basel III Liquidity Reforms in Australia, November. Basel Committee on Banking Supervision (BCBS), 2006, International Convergence of Capital Measurement and Capital Standards: A Revised Framework. ____________, 2009, Strengthening the Resilience of the Banking Sector, December. ____________, 2011, Global Systemically Important Banks: Assessment Methodology and the Additional Loss Absorbency Requirement, November. Bologna, Pierluigi, 2010, “Australian Banking System Resilience: What Should be Expected Looking Forward? An International Perspective,” IMF Working Paper No. 10/228 (Washington: International Monetary Fund). Davis, Kevin, 2011, The Australian Financial System in the 2000s, paper presented at the Reserve Bank of Australia, Annual Research Conference, August. Debelle, Guy, 2011, Collateral, Funding and Liquidity, Address to Conference on Systemic risk, Basel III, Financial Stability and Regulations, June. European Banking Authority, 2011, 2011 EU-Wide Stress Test: Methodological Note, March. Financil Stability Board, 2010, Intensity and Effectiveness of SIFI Supervision: Recommendations for Enhanced Supervision, November. ____________, 2011, Peer Review of Australia, September. International Monetary Fund, 2010, Australia: Basel II Implementation Assessment, IMF Country Report No. 10/107, May.
19 Kiff, John, 2010, “Canada’s Housing Finance System: Policy Backdrop,” in Canada: Selected Issues Paper, IMF Country Report No. 10/378 (Washington: International Monetary Fund). Laker, J.F., 2010, The Australian Banking System Under Stress?, Australian Business Economists, Sydney, June 9. Reserve Bank of Australia, 2010a, Financial Stability Review, March. ____________, 2010b, Australian Implementation of Global Liquidity Standards, Joint Media Release, December. Takats, E., and P. Tumbarello, 2009, “Australian Bank and Corporate Sector Vulnerabilities—An International Perspective,” IMF Working Paper No. 09/223 (Washington: International Monetary Fund).
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