Since the financial crisis, prudential regulators have focused on shoring up the banks and, by extension, the broader system.
The banks, particularly those of systemic significance, have experienced massive increases in the amount of capital and high-quality liquidity (cash or other liquid and safe assets) they are required to hold while also experiencing a tightening of lending standards.
APRA has, for instance, set its minimum core capital requirement – the common equity tier one capital adequacy (CET1) ratio – at 10.5 per cent, while planning to raise the banks’ minimum total loss absorbing capacity (equity and other capital that ranks behind depositors and other bank creditors) by three percentage points by 2024.
APRA has also responded to a proposal by its New Zealand counterpart to double the amount of capital the majors hold within their NZ subsidiaries over the next five years – which could equate to $12 billion of extra capital – by saying that it will require banks with large NZ subsidiaries to hold even more capital within Australia to protect Australian depositors.
APRA and its peers offshore also require banks to hold enough cash and near-cash to cover 100 per cent of the estimated net cash outflows they would experience over a 30-day period during any “run” on their deposits and other funding.
The four big Australian banks have CET1 ratios, on average, of about 10.8 per cent and liquidity coverage ratios of about 130 per cent.
After being momentarily frozen out of offshore funding markets during the crisis, the banks have also been encouraged by APRA to fund themselves with a greater proportion of deposits. They are now all more than 60 per cent funded by deposits.
There are costs to holding more capital and liquidity, particularly in the ultra-low interest environment in which they now operate. The most obvious is that the banks generate lower returns on their shareholders’ capital and less income from low-interest and no-interest deposits.
Since the crisis, the major banks’ average return on equity has dropped from just under 20 per cent to 11 per cent and their average net interest margin has been compressed from around 2.25 per cent to 1.94 per cent – the first time in memory it has been below 2 per cent.
Taken together, the tougher capital, liquidity and funding requirements have made the banks and the system safer. But, combined with the low-interest rate environment and changes to the risk weightings for some forms of lending, like home loans, they have also reduced returns from lending.
One of the puzzling aspects of the “repo” market seizure in the US in September, discussed previously, was the inaction of JPMorgan, probably the most liquid of the US banks.
JPMorgan could have made safe, quick and high-returning profits had it supplied liquidity to that market but its CEO, Jamie Dimon, has said that the post-crisis liquidity rules meant he couldn’t deploy the bank’s excess liquidity.
The post-crisis regime has had a peculiar effect on JPMorgan’s balance sheet. It has invested its $US130 billion ($190 billion) of excess cash in long-dated Treasury bonds while selling off big parcels of its loans and returning cash to shareholders.
That’s apparently because the prudential regime makes it more profitable to sell loans, buy bonds and return excess capital to shareholders than to lend and do what banks need to do if financial systems and economies are to function properly.
In this market, apart from a general APRA approach that demands the majors should be “unquestionably strong”, we’ve also experienced the fallout from the Hayne royal commission.
Separate to the massive costs of remediation, there is the uncertainty generated by the Australian Securities and Investments Commission’s view of what constitutes “responsible lending”, despite an emphatic court ruling (which it is appealing) against it.
That’s having a chilling effect on small business and home lending.
In Wayne Byres’ “zero-risk” speech mentioned above, the APRA chairman stressed the regulator wasn’t tasked with ensuring that nothing could go wrong but that it needed to balance stability with other objectives.
Former Commonwealth Bank chief executive David Murray said some years ago the impact of post-crisis banking reforms on already-weak economies had been contradictory.
“If the banking system is the gearbox of the economy, then Basel III (the global reforms) stripped out over-drive and top gear at the wrong moment,” he said.
At the moment, with demand for credit weakened by a slowing economy, perhaps it doesn’t matter if the banks’ capacity to lend has been constrained.
There is, however, as Murray was suggesting, a “chicken or the egg” question as to whether the economy would be somewhat stronger if our “unquestionably strong” banks weren’t experiencing increasing prudential and other demands even as their returns from lending continue to diminish.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.