Moody’s Investors Service says that the Australian government’s response to the report of the Financial Inquiry (FSI) is overall credit-positive for the country’s banks as it would promote the resilience of the banking system.On 20 October 2015, the government delivered its response to the FSI, which had released its report in December 2014.”The government has agreed with the Inquiry’s key recommendations for the future positioning of Australia’s financial system, including those promoting the resilience of the country’s banking system,” says Ilya Serov, a Moody’s Vice President and Senior Credit Officer.”It has also agreed that steps should be taken to reduce any implicit government guarantee of Australian banks,” adds Serov. “On balance, we view the government’s response as credit-positive.””Ensuring that Australian banks have strong capital levels capital, as well as appropriate total loss-absorbing capacity and leverage ratios, is positive since such factors would strengthen the banks’ resilience to future crises and bolster investor confidence in the Australian banking system,” says Serov.Moody’s conclusions were contained in a just-released report, “Banking: Australian Government’s Adoption Of The Financial System Inquiry’s Recommendations Is Positive For Bank Credit Profiles”.Specific measures outlined by the government include additional steps by the Australian Prudential Regulation Authority (APRA) to ensure that the banks have ‘unquestionably strong’ capital ratios before end-2016, and that they have ‘appropriate total loss-absorbing capacity and leverage ratios’ beyond that horizon.So far this year, the major Australian banks have raised approximately AUD20 billion of capital, primarily in response to the increased residential mortgage risk weights announced by APRA, effective 1 July 2016. The increase in risk weights addressed a key recommendation of the FSI.
However, the government’s endorsement of the FSI’s view that Australian banks’ capital levels should be ‘unquestionably strong’ suggests the possibility of further changes to regulatory capital requirements; for example, via changes to the domestic systemically important bank (D-SIB) capital charge or further changes to risk weights. As such, we believe that the capital accumulation phase the banks entered into during 2015 is likely to be extended for the foreseeable future.In Moody’s view, following the capital raisings, the banks are now well-positioned to meet future increases in capital requirements through organic capital generation and usage of discounted or, if needed, underwritten dividend reinvestment plans (DRPs).The government’s response regarding bank resolution has emphasized the need to reduce any implicit government guarantee and the perception that some banks are too big to fail. The government has endorsed implementing a framework for minimum loss-absorbing and recapitalisation capacity ‘in line with emerging international practice’.In Moody’s view, this approach suggests that any changes to Australia’s bank resolution regime will be undertaken with a focus on loss-absorbing capacity and on strengthening policymakers’ crisis resolution powers, rather than on creating a statutory creditor bail-in regime.This position would align the government’s view with the proposals for Total Loss Absorbing Capacity (TLAC) put forward by the Financial Stability Board in 2014, and expected to be clarified further by end-2015.TLAC requirements apply to global systemically important banks and are not expected to directly apply to Australian banks. However, Australian banks may feel compelled to follow the emerging international standards and if a similar regime is implemented domestically, it would result in bank liability structures shifting to include higher levels of capital securities, subordinated debt, and potentially the creation of a new class of senior debt with contractual bail-in provisions.Increased TLAC requirements would be credit-positive for senior unsecured obligations on a fundamental basis, but could place pressure on the current uplift Moody’s incorporates into the ratings of Australia’s larger banks for potential government support, since they reduce the likelihood of bank resolution taking place by way of bail-out and instead imply a higher level of burden sharing with creditors.The credit effects of the specific policies ultimately adopted by APRA will therefore depend on the extent to which the positive effects on senior unsecured claims of increased loss absorption would offset the possible reduction in the support assumption in the banks’ senior debt ratings, especially given the government’s seeming focus on reducing the perception of implicit government support of Australian banks.However, given the dominance of the country’s major banks in the domestic financial system, and the important role they play in sourcing the foreign funding requirement of the Australian economy, Moody’s does not see as likely the total elimination of the government support assumption in the senior ratings of Australia’s major banks.The FSI is a government-mandated inquiry into Australia’s financial system. It delivered its final report in December 2014. The Inquiry focused on the broad principles governing the financial system with the view of promoting its resilience, efficiency and fairness. In particular, it concerned itself with ensuring the maintenance of investor confidence in the banking sector, in light of the important role it plays in sourcing Australia’s foreign funding needs and the high degree of concentration in the Australian banking system.
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