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Morningstar | APRA Requires Three Australian Major Banks to Hold More Operational Risk Capital. No FVE Changes

The banking regulator, Australian Prudential Regulation Authority, or APRA, has forced three of the four major banks to hold, on a temporary basis, an additional AUD 500 million each in operational risk capital requirement. APRA’s initiative is in response to the culture, governance and accountability self-assessment process carried out by Australia and New Zealand Banking Group, National Australia Bank, and Westpac Banking Corporation. In short, APRA believes the three major banks need to improve management and oversight of nonfinancial risk and is a direct outcome from the Royal Commission findings. We are not surprised with APRA’s move to demand higher standards on culture, accountability, and governance.

APRA noted “the capital add-ons will apply until the banks have completed their planned remediation to strengthened risk management, and closed gaps identified in their self-assessments.” The major banks are well advanced on completing action plans, with most focus on board and executive governance, risk and compliance, customer, remuneration and accountability and culture. There is no change to our fair value estimates with ANZ Bank fairly valued and National Australia Bank and Westpac undervalued. APRA’s action to raise capital requirements further highlights reputational issues, although we believe most of issues have already been exposed during the Royal Commission process. But the AUD 500 million capital impost for each bank is more a slap on the wrist rather than anything serious.

The AUD 500 million requirement for each bank is to be applied through an increase in risk-weighted assets, effective from Sept. 30, 2019. The changes reduce the banks’ common equity Tier 1 capital ratios by an average of approximately 17 basis points. We do not consider APRA’s requirement to increase capital requirements for the three banks will overly complicate the path to achieving APRA’s common equity Tier 1 capital benchmark of 10.5% by Jan. 1, 2020.

Strengthening nonfinancial risk management is a welcome requirement to ensure long term sustainability of the major banks’ strong business franchises and profitable operating models. ANZ Bank’s common equity Tier 1 capital ratio is expected to decline by approximately 18 basis points. ANZ Bank’s key capital ratio was 11.50% at March 31, 2019. National Australia Bank’s common equity Tier 1 capital ratio is expected to decline by approximately 16 basis points. National Australia Bank’s key capital ratio was 10.40% at March 31, 2019. Westpac’s common equity Tier 1 capital ratio is expected to decline by approximately 16 basis points. Westpac’s key capital ratio was 10.64% at March 31, 2019.

National Australia Bank confirmed “work is already underway on all 26 actions identified and we have made material progress on a number of these.” National Australia Bank’s culture, governance and accountability self-assessment has been released publicly and the bank will provide an update report in November 2019.

Westpac noted around 20% of the recommendation in its culture, governance and accountability self-assessment have been implemented. The self-assessment was submitted to APRA in November 2018 and has been released in full on the bank’s website. ANZ Bank has not released its self-assessment to the public and has defended its decision, arguing the report was done on a confidential basis for APRA and not intended for general release. Commonwealth Bank was not included in APRA’s July 2019 initiative as the bank had been hit with a AUD 1 billion increase in its operational risk capital requirement in 2018 in response to shortcomings highlighted in APRA’s prudential inquiry.

Following the serious shortcomings identified in Commonwealth Bank’s 2018 prudential inquiry APRA required 36 financial institutions, including nine authorised deposit taking institutions to undertake and submit risk governance self-assessments. APRA highlighted the need to “strengthen non-financial risk management, ensure accountabilities are clear, cascaded and enforced, address long-standing weaknesses and enhance risk culture.”