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APRA chairman Wayne Byres has used his speeches to three Australian Financial Review Banking & Wealth Summits to set out ...

APRA chairman Wayne Byres has used his speeches to three Australian Financial Review Banking & Wealth Summits to set out his expectations for bank capital. Christopher Pearce

While the sharemarket’s stunning reaction to the new capital benchmarks could be read as an indication the banks got off lightly, it actually reflects their ability to read the tea leaves and accumulate capital well ahead of the Australian Prudential Regulation Authority’s regulatory minimums as it gently and consistently flagged its rising expectations.

When the major banks hit their new common equity capital (CET1) ratio of 10.5 per cent, they will have raised an additional $40 billion of equity since the financial system inquiry delivered its report. This has savaged returns on equity.

So it is remarkable that in statements to the Australian Securities Exchange on Wednesday, the banks went out of their way to applaud APRA’s direction on capital. National Australia Bank declared the higher equity buffers would “ensure the strength and stability of the Australian banks at what is an important time for the Australian economy”.

But it hasn’t always been this way.

When then Treasurer Joe Hockey commissioned former Commonwealth Bank boss David Murray to conduct the Financial System Inquiry, the banks thought it might help unwind the burden of regulation. They argued in their submissions that increased capital, particularly equity, was unnecessary because they were already highly capitalised relative to global peers and managed to escape the global financial crisis relatively unscathed. ANZ Banking Group’s former chief executive, Mike Smith, declared higher capital would threaten the flow of credit to the economy.

But Murray’s trip to the United States and Europe in mid-2014 ensured such arguments would not only fall on deaf ears but be comprehensively rejected. He saw first-hand the respect with which Australian regulation was held, and the heavy costs imposed on the world’s biggest economies when their financial firms failed in the GFC.

His final report was unequivocal in its direction: the implicit guarantee that taxpayers would bail out failing banks, which create moral hazard, needed to be minimised while the confidence of foreign investors in Australia’s banks needed to be maintained, given the economy relies on them to fund the $400 billion gap between domestic deposits and demand for lending.

Within months of the FSI’s release, it was clear Byres was ready to embrace it all the way.

At The Australian Financial Review Banking and Wealth Summit in April 2015, he said Murray’s report and reforms advocated by the Basel Committee on Banking Supervision “are undoubtedly going in the same direction, which will be leading to higher, tougher capital requirements”.

“The direction is clear…and the easiest way to deal with any change is to work at it gradually and get started early, and that is the sensible approach we will adopt,” Byres said.

For the banks, there were several bumps along the capital road. They were surprised by APRA’s announcement in July 2015 that the average risk weight on Australian residential mortgages would increase from 16 per cent to at least 25 per cent. That triggered multibillion- dollar capital raisings to lift equity levels quickly.

But since then their capital build has been constant, as Byres continued his jaw-boning the banks throughout 2016 and the first half of this year, leaving them with a clear impression the work on capital was not done.

Hence the relief for the banks and for investors on Wednesday when they finally realised the long and winding capital road was coming to an end. “The capital bears were unquestionably wrong,” said Credit Suisse analysts Jarrod Martin and James Ellis. Indeed, they said APRA’s new benchmarks highlight “a shift from capital raising risk to scope for capital management”. How the tide has turned.

APRA’s work, of course, is never done. A discussion paper on the capital framework for risk weightings is due later this year. Meanwhile, Byres said on Wednesday, “a strong capital position still needs to be complemented by sound governance and risk management within [banks], and ongoing proactive supervision by APRA.”

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