By its own admission, Australias financial services regulator, the Australian Prudential Regulation Authority (APRA), is unlikely to be at the top of most local banks Christmas card lists. As it has conceded on more than one occasion, APRA recognises that part of its job is to make sure that the punch bowl is removed before the party gets going.
There is nothing unusual about financial regulators being regarded as party-poopers. But when it was originally set up, towards the end of the 1990s, Australias regulator probably had more reason to keep a watchful eye on the punch bowl than its counterparts in many advanced economies.
As John Manning, senior fixed income manager at Aberdeen Asset Management in Sydney points out, its easy enough to forget, more than 20 years afterwards, that in the recession of the early 1990s Australias banking industry was close to collapse. "We almost lost two of our major banks in the recession of 1991," he says.
For the Australian banking sector, that recession was indeed traumatic. According to the Reserve Bank of Australia, pre-tax losses at the banks in 1990, 1991 and 1992 exceeded A$9bn, or more than 2.25% of GDP. Over the same period, about a third of the industrys aggregated shareholder funds in 1989 were wiped out.
"Deregulation in the mid-1980s intensified competition and the desire by institutions to grow their balance sheets rapidly," the RBA explains. "This took place in an environment in which asset prices, particularly commercial property prices, were increasing quickly, and credit assessment procedures in many financial institutions had not adjusted to the new liberalised environment."
"The result was extremely strong credit growth secured against increasingly overvalued commercial property," the RBA adds. "In 1989, the combination of high interest rates and a softening of the commercial property market exposed the poor credit quality of some of the most risky loans. Then, as the economy went into recession and the decline in property prices accelerated, more broadly-based credit quality problems became evident; by mid-1992, the ratio of non-performing loans to total loans had increased to 6%."
This legacy explains why, ever since the upheavals of the early 1990s, caution has been more deeply engrained on the psyche of Australias banks and its regulator than in most developed economies. It may explain why there was no such thing as an Australian subprime market, why there are no G-SIFIs in Australia, and why more than 90% of its banks loan books are in Australia and New Zealand.
It may also partly explain why APRA was long regarded (erroneously) as party pooper-in chief in its attitude to covered bonds in Australia. As recently as last year, Australia stood out as being one of the few developed economies that had yet to permit the issuance of covered bonds. That, however, was a function of Australias Banking Act of 1959, which provided that depositors ranked above all other claims on authorised deposit-taking institutions (ADIs), rather than the result of mulish conservatism at APRA.
The amendment to that law, which became effective on October 17, 2011, allowed for the issuance of covered bonds in Australia, although bankers point out that the new law unmistakably has APRAs conservative fingerprints on it, with banks limited to issuing 8% of their Australian assets in covered bonds. This is higher than the Canadian limit of 4% but below New Zealands (of 10%).
In settling on an 8% cap, APRA had one eye on creeping encumbrance of balance sheets in Europe.
"APRA felt there was a balance to be struck between allowing covered bonds as a new source of funding while guarding against a situation where various classes of creditors might be unfairly favoured over others," says one market participant.
1990s crisis legacy
The legacy of the early 1990s perhaps also explains why APRAs chairman, John Laker, has sometimes seemed exaggeratedly jumpy about any plans Australian banks may have to expand aggressively overseas. As he cautioned in a recent speech: "Expansion into new markets and products... needs to be supported by rigorous planning and enhancements in risk management. Without this, an ADI can become exposed to volatile economic and market conditions in offshore markets, potential deterioration in credit quality and an increase in strategic and reputational risk."
"In offshore markets," Laker added, "ADIs face competition from both local and other international banks, regulatory hurdles such as limits on foreign ownership, and economic, cultural and legal differences, all of which can complicate strategic objectives.
"For these reasons, APRA supervisors will be alert to the risks associated with major shifts in strategy that take an ADI beyond its existing core markets and competencies."
These remarks were widely interpreted as a thinly-disguised and none-too-approving observation on the Asian ambitions of ANZ. Although other Australian banks are also making low-key inroads into Asia, the Melbourne-based ANZ is widely regarded as Australias most internationally-minded ADI. It declared five years ago that it was aiming to lift the Asian contribution to group profits from 7% to 20% by 2012. To date, that expansion has been self-funded, with its Asian operations having an exceptionally low loan to deposit (LTD) ratio of 60%, which compares with a ratio of 156% in Australia.
For his part, ANZs chief executive, Mike Smith, has made little secret of his view that APRAs conservatism has made it unnecessarily proactive in following the Basel III capital requirements. In May, this led to an animated exchange between Western Australian Liberal Senator Mathias Cormann and APRAs Laker at a Senate Economics Legislation Committee meeting in Canberra. Cormann reported that he had been told by "one very senior managing director of a big financial institution" (widely taken to be ANZ) that Australias banks were disadvantaged by the implementation of Basel III.
"Every provider in this space tells me that, in their view, APRA is too far ahead of the curve, that it comes at a cost in terms of our international competitiveness, and that somehow we are trying to be world leaders," Cormann said. "Of course, by being ahead of the pack internationally, we are imposing costs on our banking sector that are not having to be carried by banks in other parts of the world."
APRA has countered that far from being ahead of any curve on Basel, it has required Australian banks to meet the minimum capital requirements by January 1 2013 (rather than over a two-year period beginning on that date), precisely because in many ways local ADIs are already compliant with Basel III.
As Laker said when pushed on this issue in May: "The Basel Committee has established quite a generous timetable for transition to Basel III. On both capital and liquidity, the timetables differ, but it is a generous timetable. The Basel committee also said that where a jurisdiction is able to move more quickly than that timetable, they should do so. And we are doing so. We are certainly not alone. A number of other countries are also working on an accelerated timetable. But the important point... is that the Australian deposit-taking institutions... have already passed the 2013 target."
Laker acknowledged that moving more quickly on Basel came at a cost, but that none of these costs had been imposed on the banking sector by APRA. "The banks raised capital of their own volition during the crisis," he said. "They were not required by APRA to raise capital. They are historically at their highest level of capital because the market is demanding it of our major institutions."
Level two toughness
Perhaps. But if APRA is seen as having whipped the punch bowl away too early in its approach to the Basel III rules on capital, some have also argued that the regulator has been over-zealous in its interpretation of the liquidity coverage ratio (LCR) requirement. That over-zealousness, they say, has had a damaging impact on the Kangaroo market by ruling in February 2011 that no securities would qualify as level two assets for LCR purposes, and that the only assets qualifying as level one assets would be cash, and Australian government and semi-government bonds. In other words, supranationals historically the anchor issuers in the Kangaroo market would not be eligible.
If a number of issuers and investors have been surprised, or felt disappointed and even mildly insulted by this decision, APRA is unapologetic. Its view is that in assessing eligibility for level one or two status, its responsibility is not to act as a judge in a popularity contest, nor to provide a credit risk opinion.Instead, it insists that its role as a regulator is to act as a dispassionate observer of the industry and of market liquidity. APRA has pointed out that it has studied a number of measures, including volumes outstanding, turnover, repo market activity and the depth of the market. On none of those measures is APRA sufficiently confident that in a distressed situation it would be possible for an Australian bank to sell or repo Kangaroo bonds for cash to a third party preferably a third party outside the local banking sector.