* FSI aims to level playing field for small banks
* Credit Suisse, Bell Potter upgrade regional banks
* ANZ, NAB seen as most vulnerable to new capital recommendations
By Swati Pandey
SYDNEY, Dec 8 (Reuters) - Australia's smaller banks stand to benefit from a government-backed financial sector review that has recommended the nation's big lenders set aside more capital for their main business of mortgages, in a move towards a level playing field.
The recommendation, if implemented, could help the smaller banks grab market share from the country's 'Big Four' major lenders for whom mortgages account for 40-60 percent of total loans.
It will also help make them more competitive by narrowing the gap between the majors and their smaller peers on the capital set aside against potential losses on mortgages.
Australia's major banks will need as much as A$48 billion ($39.68 billion) after the financial system inquiry (FSI) on Sunday called for stronger capital for them to become among the world's safest lenders.
Major banks currently, on average, keep aside 18 percent capital against potential losses on home loans compared with 39 percent for smaller peers, helping the big banks produce better shareholder returns. Under the proposed rules, though, the majors will have to set aside 25 percent to 30 percent capital.
"It is pleasing the inquiry has acknowledged the competitive gap enjoyed by the majors needs to be closed and would like to see action taken quickly to address this issue, before the dominance of the Big Four is further entrenched. If that happens, Australian consumers will ultimately be the losers," Jon Sutton, acting CEO of Bank of Queensland, said in a statement.
Recommendations by the inquiry, chaired by David Murray, former head of Commonwealth Bank of Australia, is open to consultation with regulators and industry until March 31.
Following the FSI report, brokerages including Credit Suisse and Bell Potter upgraded ratings on regional banks. Smaller banks Suncorp, Bendigo & Adelaide Bank and MEBank praised the inquiry's effort to try and level the playing field.
Big banks have already warned that raising capital requirements and mortgage risk weightings will lead to higher costs to consumers and smaller dividends for shareholders.
Credit Suisse downgraded Australia and New Zealand Banking Group while Morgan Stanley noted that ANZ and National Australia Bank, with the lowest tier-I ratios among the big banks, were the "most vulnerable."
"What Murray is trying to do is take away the lopsided nature of allocation of capital from the Big Four to the balance of the banking community," said Mark Bouris, executive chairman of Yellow Brick Road, a mortgage provider part-owned by Macquarie Group Ltd. (Editing by Muralikumar Anantharaman)