G20: a brave, bold balanced agenda for banking reform
The G20 this weekend is expected to give its blessing to proposals made by the Financial Stability Board (FSB) for further capital requirements for the world’s largest 30 banks – the ‘global systemically important banks’. In its ongoing efforts to prevent any repeat of the ‘too big to fail’ scenarios of the GFC, the FSB has called for an extra financial buffer on top of the existing Basel 3 capital requirements. The so-called ‘total loss absorption capacity’ (TLAC) of these lenders would be in a range of 16-20% of their risk-weighted assets.
While none of this directly affects Australia’s major banks, it seems likely to sway the direction of regulatory thinking here. And the timing, just ahead of the final report from David Murray’s Financial System Inquiry, will give comfort to the FSI if it opts for requiring Australia majors to hold more capital. Mike Smith, CEO of ANZ , has already said he believes the TLAC concept will become commonplace here.
It is quite understandable, with the GFC still so fresh in people’s minds that the G20 would place emphasis on increasing the safety, soundness and resilience of the financial system. But there comes a point where the costs of moving ever further in this direction – the higher costs and reduced availability of financial products and services, the localisation and fragmentation that arise from the inconsistent implementation of regulatory reforms across jurisdictions, and the continuing uncertainty over the end point – outweigh the benefits of reducing the probability of another financial crisis. A completely safe financial sector would be of little economic and social value.
Many believe this tipping point has already been passed, in particular in Europe. And in Australia, where the GFC did not hit with the same impact as elsewhere, partly due to heavier capital requirements here, that view is even more persuasive.
For while, Australia’s banks are still generating impressive profits, KPMG’s recent Major Banks Report revealed rising pressures on the majors’ ability to continue generating such high returns, which reflects the impact of significantly increased regulatory capital requirements. The major banks reported an average Return on Equity (ROE) of 15.6 percent for the 2014 full year, compared with 15.9 percent in 2013. And this contrasts sharply with the ROE of 18.5 percent a decade ago.
It should not be forgotten that it is the sustained levels of strong bank profitability that have underpinned the strengthening in the majors’ capital position, with their aggregate Common Equity Tier 1 (CET1) capital ratio rising by 38 basis points over 2014, to 8.93 percent of risk-weighted assets (RWAs), largely reflecting the accumulation of retained earnings. With the increasing regulatory burden, this is critical to the majors’ ability to balance capital adequacy with the efficient and flexible use of their capital to satisfy investor expectations for higher returns on equity. Balancing the competing demands of various stakeholders is no easy task.
We would like to see policymakers both internationally and at home focus more on the cumulative impact of regulation on the financial sector and on the wider jobs and growth agenda. We would support:
Re-evaluating the cost benefit analysis of some regulatory reforms;
Prioritising the remaining initiatives, and providing greater certainty on the substance and timing of these remaining initiatives
We would have preferred the G20 (and we hope the FSI takes note) to focus more on the role the financial services industry can play in creating jobs and stimulating economic growth.
Of course, banks must play their part and intensify their efforts to introduce cultural and behavioural change, so that regulators feel more comfortable in taking a step back. We need a new relationship between the financial services sector and regulators which delivers increased stability while stimulating economic growth.