Basel III: an Australian perspective on a global challenge

The challenges of Basel III for Australian Banks

Domestically, liquidity is the key focus, and in particular the final definition of eligible liquid assets.

With APRA's conservative application of the current regulatory framework and with less emphasis placed on trading within the domestic models, it is a widely held belief that Australian Banks will weather the changes to capital adequacy well.

And where Basel III presents a much bigger challenge for the US and European Banks, this may in turn present opportunities for our domestic players.

However, speaking to our clients at the sharp end of capital management, it is clear that there are significant challenges ahead for Australian banks.

The board education challenge

Despite headlines indicating banks will comfortably meet the new rules, board targets may well be revised upwards in capital raising. While new target levels of capital need to be agreed both in this transition phase and Basel III end state, the missing link is how far above the new legal minima APRA will set their bank specific PCRs. This is crucial as current practice is to set capital levels above PCR to absorb stress without the risk of regulatory breach.

The capital management

A complex and lengthy transition process as well as new measures such as the countercyclical buffer present significant challenges to capital management framework. Capital plans over 3-5 years not only need to consider additional capital planning risk, but the risk of a regulatory minima being increased if an "asset bubble" is declared in a given jurisdiction.

Our concern is that the countercyclical buffer measure may be procyclical as impacted banks raise addition capital in a market where their own debt and equity will attract higher capital charges for investors.

The investor relations challenge

Transition arrangements will inevitably create complexity for investor communications - banks will at some point, need to disclose their capital positions against the current rules and of the Basel III end state.

Comparisons will be sought and the current APRA vs FSA comparisons published by Australian Banks will become more complex.

The challenge will be to convince investors that potentially lower sector Return On Equities (ROEs) will be compensated for by increased bank safety.

Public stakeholder challenge

The challenge will be to effectively communicate the need for reform to mitigate future costs to the public purse. However, reform to create a safer banking system needs to be paid for and while privately many public stakeholders recognise this, public rhetoric suggests the opposite.

System and infrastructure challenge

This is one of the most significant challenges - a lack of timely and granular information to enable senior management to respond to the GFC was a key issue at the height of the crisis. One of the less publicised principles of the reform agenda is the drive to address this with more granular, timely and relevant reporting and analysis.

What next for Australian banks?

• Capital planning, risk management and investor relations will need to continue to be more integrated and forward looking.
• Developing appropriate and analytical tools and the right internal organisation will be critical to success.
• Infrastructure alignment and investment - at a time of major spend by all of the Australian majors on core systems. APRA has already flagged that this industry-wide project risk is prominent on the supervisory radar.
• Educating the board needs to begin now - a roadmap demonstrating the complexity of the next 5-10 years alongside how and when capital target levels will be redefined will prove highly valuable.
• APRA needs to be engaged now - we see a risk in the new regime of double counting and "buffer on buffer". The dual role of testing by APRA to inform the PCR and by banks to set their internal target capital levels above the PCR is one example. Open communications by banks will assist APRA in assessing system-wide impacts.