APRA to strengthen bank capital requirements and liquidity standards

The Australian Prudential Regulation Authority (APRA) is proposing several changes to strengthen bank capital requirements and liquidity standards in response to the global banking turmoil earlier in 2024. Here are the key proposed changes:

Valuing liquid assets at market value

APRA is proposing to require banks subject to the Minimum Liquidity Holdings (MLH) regime to value their liquid assets at market value and adjust for movements in market prices regularly. This is to ensure liquid assets can absorb stress as intended, after some banks faced unrealised losses on liquid assets during the 2024 banking turmoil.

APRA also proposes deducting any unrealised losses on liquid assets from banks’ capital for all banks.

Formalising access to exceptional liquidity assistance

APRA plans to formalise requirements for banks to access exceptional liquidity assistance from the Reserve Bank of Australia, including specifying the information APRA would request from a bank in such an event. This aims to ensure banks are prepared to access emergency liquidity if needed during a crisis.

Strengthening composition of liquid assets

To reduce contagion risk, APRA proposes removing bank securities from eligible liquid assets under the MLH regime. This prevents stress at one bank from having an outsized impact on other banks.

Reinforcing interest rate risk management

Following the banking turmoil partly caused by failures in managing interest rate risk, APRA is updating its prudential standard APS 117 on interest rate risk in the banking book (IRRBB). The changes reaffirm that all banks must manage IRRBB appropriately, and APRA may require additional capital if it deems a bank’s IRRBB management is inadequate.

These changes aim to strengthen resilience, APRA has calibrated them to avoid materially increasing capital charges for larger banks. For smaller banks under the MLH regime, the focus is on improving risk management practices rather than raising capital levels significantly.

A new framework

The new bank capital framework from the Australian Prudential Regulation Authority (APRA) is expected to have some impact on the profitability of Australian banks, though the overall effect is not seen as overly significant.

The new framework does not require Australian banks to raise additional capital since they already meet the “unquestionably strong” capital benchmarks set by APRA previously. This helps avoid a major drag on profitability from having to raise large amounts of new capital.

However, the framework adjusts risk weights to better align capital requirements with underlying risks. This means higher risk weights and more capital required for higher-risk lending like investor and interest-only mortgages, while lowering capital for lower-risk loans like some business lending.

APRA estimates this will result in around a 5 basis point increase in average mortgage pricing for banks using advanced internal models versus those on the standardised approach . This modest mortgage repricing could slightly boost net interest margins and profitability.

The major banks will need to increase their total capital by around 4.5 percentage points by 2026 through instruments like Additional Tier 1 and Tier 2 capital . This could put some pressure on profitability from the cost of raising and maintaining this extra capital buffer.

Smaller banks get some capital relief under the simplified requirements, which avoids an unnecessary regulatory burden that could have impacted their profitability.

Overall, while there may be some offsetting impacts, most analysts don’t expect the new framework to materially increase capital charges or significantly dent the strong profitability of the major Australian banks. The changes aim to reinforce resilience without overly burdening the banking system.

In summary, the capital reforms are relatively modest adjustments that better align capital to risk without requiring Australian banks to dramatically increase capital levels from their already strong position. This should allow them to maintain healthy profitability while enhancing financial stability.