Australia’s response to financial system inquiry

The Australian government’s response to the financial system inquiry could drive up interest rates at New Zealand’s biggest lenders as their Australian parent banks seek higher returns because of the requirement that they hold more capital.

The Australian federal government has largely accepted the recommendations of the inquiry set up in late 2013 to conduct “a root and branch examination” of Australia’s financial system chaired by former Commonwealth Bank chief executive David Murray. As well as agreeing to improve the resilience of the financial system, the coalition will take up advice to make Australia’s pension system more efficient, stimulate financial system innovation, ensure consumers of financial products such as credit and debit cards are treated fairly, and strengthen regulators.

Although their New Zealand operations come under the jurisdiction of the Reserve Bank in Wellington, it is likely some of the impact of changes in Australia will be exported across the Tasman, says David Tripe, associate head of Massey University’s School of Economics & Finance.

“It would be a reasonable assumption, if banks need to hold more capital, they are likely to up their returns a bit too across the business,” Tripe said. “That in general is likely to push up interest rates, although not by a huge amount.”

Australian Treasurer Scott Morrison said this week that while Australia’s financial system was “strong, stable and well regulated,” it did have potential vulnerabilities. Banks sourced much of their funding offshore and accounted for almost 90% of domestic credit for local firms and households. Home loans made up 60-70% of total lending, which “creates some concentration of risk in the system” and meant Australia needed a stronger regulatory framework than other countries.

In July, the Australian Prudential Regulation Authority (APRA) lifted the average mortgage risk weight on residential mortgages for the big four lenders to 25% from about 16%, a move it estimated would require Australia & New Zealand Banking Group (ANZ), Commonwealth Bank (CBA), National Australia Bank (NAB) and Westpac Banking Corp to increase their overall capital by 80 basis points. APRA ultimately wants the banks to lift their capital by 200 basis points to ensure they rank among the world’s most secure, a target that may imply $A30 billion of extra capital.

The banks haven’t waited for the government response to the inquiry to increase their capital. This month, Westpac announced it had raised $A3.5 billion discounted rights offer that would lift its common equity Tier-1 ratio by about 100 basis points to more than 14%, which the lender said would put it in the top quartile of banks globally. CBA raised $A5 billion in an entitlement offer in August that followed NAB’s $A5.5 billion share sale and ANZ’s $A3 billion. Funds raised are also for other classes of capital to meet the Basel III requirements of the Basel Committee on Banking Supervision.

Westpac had earlier raised $A2 billion from a dividend reinvestment plan and $A500 million from the partial sale of BTIM toward its target of $A6 billion raised this year, and this month became the first of the big four banks to raise home loan rates to protect its margins in the face of increased capital. From November 20, Westpac will hike its variable home loan and residential property loan rates by 20 basis points, saying the lift in mortgage risk weights amounted to an increase of more than 50% in the amount of capital required to be held against mortgages.

In July, Westpac chief financial officer Peter King said the cost of holding more capital “will inevitably be borne by customers and shareholders.”

NZ Bankers’ Association chief executive Kirk Hope said the requirement for more capital does in theory imply higher interest rates but, in reality, in the New Zealand market, competition in the lending market is weighing on interest rates.