December 8, 2014 / 4:03 AM / 3 years ago

Fitch: Australia FSI Report to Strengthen Banking System

(The following statement was released by the rating agency) SYDNEY/SINGAPORE, December 07 (Fitch) The recommendations contained in the final report of Australia's Financial System Inquiry, published 7 December 2014, should improve the resilience of the banking system to shocks, although the implicit government support for the system is likely to decline, says Fitch Ratings. Immediate rating action is unlikely despite the changes. Increased capital requirements, a higher average mortgage risk-weight for banks using the internal ratings based (IRB) approach to calculate regulatory capital, and improvements in the resolution framework, were all recommended by the inquiry. Australian bank capital holdings are likely to rise significantly if all recommendations are implemented. The report suggested a baseline target in the top quartile of internationally active banks, but stopped short of providing an explicit ratio. The aim would be to ensure Australian bank capital was viewed as "unquestionably strong" - given the system's reliance on offshore funding markets, its highly concentrated nature, and the similarity in the business models of most Australian banks. Importantly, this would apply to all banks rather than just those using IRB models. Common Equity Tier 1 (CET1) was the inquiry's preferred method of improving capital, although it left discretion for the Australian Prudential Regulation Authority (APRA) to focus on Tier 1 or total capital ratios if it felt these were more appropriate. The competitiveness of smaller deposit takers would improve at the expense of Australia's major banks, which hold 80% of system assets, if the recommendation for a higher average IRB risk-weight for mortgages is adopted. Nevertheless, a gap between the two methods is likely to remain to incentivise the banks to move toward the advanced models, and the improved risk management that ensues. The inquiry states that an average IRB risk-weight of 25%-30% would appear appropriate; and that it would require about 1pp of CET1 capital, or 40%-70% of their FY14 net profit, for the majors banks to achieve this. Fitch expects the banks to be given enough time to raise any capital required under these two recommendations through internal means, although equity market placements may be pursued to meet the targets sooner. The development of a stronger resolution framework is likely to result in the removal of our view of implicit support for the system, resulting in Support Ratings and Support Rating Floors migrating to '5' and 'No Floor', respectively. However, Fitch believes Australia will wait to see how global rules settle before finalising requirements. The report supports pursuing a total loss-absorbing capacity framework, in line with global moves, with loss-absorbing instruments and trigger points clearly defined. However, the inquiry notes the area is still developing and is complex, and avoids prescriptive recommendations such as the bail-in of senior creditors. Other recommendations included retaining the four pillars policy which prevents Australia's major banks from merging with each other; improved transparency of capital ratios relative to global minimums; improved crisis management powers for regulators, maintenance of the current deposit insurance and protection regimes; and the implementation of a leverage ratio as a backstop to deal with any inconsistencies in internal capital models. Fitch expects these measures to have a more limited impact on Australian banks relative to the three outlined above. The inquiry had no recommendations on liquidity, noting significant regulatory requirements are being put in place at the moment. It was also neutral as to the system's reliance on offshore funding markets, although this formed part of its recommendations on improving the resilience of the system. The Australian government has announced a round of consultation on the recommendations, which is expected to conclude by 31 March 2015, after which it will decide which recommendations to implement. Some of the measures could be implemented by APRA under its current powers - however, Fitch believes it will wait until the government consultation period has concluded before making any changes. Some of the more complex recommendations could be delayed until after the next Commonwealth election, currently scheduled for 2016. Fitch will comment further once the government has decided which recommendations to implement. Contacts: Tim Roche Senior Director Financial Institutions +61 2 8256 0310 Fitch Australia PTY Limited Level 15, 77 King Street Sydney, Australia Andrea Jaehne Director Financial Institutions +61 2 8256 0343 Justin Patrie Senior Director Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email:; Leni Vu, Sydney, Tel: +61 2 8256 0326, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S FREE WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Fitch Australia Pty Ltd holds an Australian financial services licence (AFS licence no. 337123) which authorises it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.

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