The bank sector safeguards to make Basel blush

Earlier this year the Basel Committee on Banking Supervision watered down the liquidity regime for banks it had proposed in 2010 to make them "more realistic". The Australian Prudential Regulation Authority, however, has decided that they reflect a different reality to that confronting our banks.

While the Basel Committee denied its decision to dilute its original proposals was in response to ferocious lobbying by the global bank lobby, one doesn’t have to be a cynic to believe the lobbying might have had some influence over the decision. Equally, given the distressed state of the eurozone and the fragile state of its banks, the impact of more stringent liquidity rules on an already recessed Europe would also have been a factor.

Australia has strong banks and, relative to Europe and the US, a relatively strong if slowing economy. APRA also has a reputation as a conservative (and successful) regulator, which today’s decision will enhance.

APRA could have done as the Basel Committee has done and effectively reduce the amount of liquidity the banks it regulates are required to hold and give them more time to build that liquidity. Instead it has stuck with its own 2011 stance on capital and liquidity which, even then, was more conservative/stringent than the original Basel committee proposals.

The Basel III liquidity rules require banks to hold sufficient high-quality liquid assets to withstand a 30-day period of acute stress. They also require banks to conform to a minimum net stable funding ratio to strengthen their funding profile and reduce the risk and/or magnitude of any "run".

Where the Basel Committee broadened the range of assets that would qualify as high-quality liquidity to include mortgage-backed securities, corporate debt and even some equities, APRA has decided it isn’t keen on following the committee’s lead. Only debt securities that are repo-eligible with the Reserve Bank for normal market operations or as collateral for the Reserve Bank's controversial Committed Liquidity Facility will qualify.

Where the Basel committee has allowed for a phase-in of the new regime, delaying its full introduction from the original target of 2015 to 2019, APRA will stick to January 1, 2015 for introduction of its requirements, without any phase-in.

The Basel Committee’s hand was to some degree forced by the condition of the eurozone banks, which under its original proposals would have been forced to raise up to about $2 trillion of extra liquidity in the form of what was then a quite narrow range of eligible assets that included government bonds – which events in Europe have demonstrated don’t necessarily meet most people’s definitions of high quality liquidity in an emergency.

APRA’s starting point is quite different. The banks it supervises are strongly capitalised, strongly profitable and generally already meet, with the help of the CLF, its new requirements. Their only obvious significant vulnerability is their continuing, albeit reduced, exposures to offshore wholesale debt markets and any disruption to them.

As APRA said in the discussion paper it issued today, by maintaining its requirements rather than picking up the revised Basel Committee rules it will "send a strong message about the soundness of the Australian banking system".

The big Australian banks would no doubt prefer the Basel Committee version. There is a significant cost associated with APRA’s conservatism. High-quality liquidity and extra capital is expensive. They will pay for access to the Reserve Bank's CLF regardless of whether or not they ever access it – and pay more if they do. They could be placed at a competitive disadvantage to other big banks.

If APRA’s stance maintains their position as arguably the strongest banking system within the global industry, however, those extra costs could be seen as both an insurance premium against another bout of global financial system turmoil and an investment in lower funding costs than they might otherwise face.

With share prices that (whether deliberately as a result of reduced risk premia or by yield-driven happenstance) could be said to reflect their reduced riskiness, their shareholders aren’t yet suffering because APRA has chosen a conservative approach.

The cost of that conservatism also provides a counter-argument to those advocating super-profit taxes on banks deemed too-big-too-fail.

In effect they are already paying a series of sizeable insurance premiums in the form of layers of extra and costly capital and liquidity requirements to reduce the likelihood of a failure occurring.