New international banking won’t drive interest rates up

New international banking regulations, designed to improve banks' resilience in times of financial stress, will help to prevent another Global Financial Crisis (GFC), regulators have told a CEDA forum in Adelaide.

The audience heard that the first stage of the Basel III banking regulations would be introduced in Australia in late September.

Banking industry experts told the forum that regulatory changes:

• Were reinforcing structural changes in the banking sector caused by a reassessment of asset risk;
• Would protect the economy from riskier banking sector activities as the economy gets stronger;
• Would help to secure the international banking system in times of financial pressure; and
• Would not force up lending costs or limit access to credit.

A reassessment of Basel II banking regulations after the GFC found banks held insufficient capital readily convertible to cash which had forced governments and taxpayers to provide funds to prevent a large scale banking collapse.

Under the new Basel III rules, banks will be required to increase their ratio of core equity or truly liquid assets to 4.5 per cent of risk weighted assets, up from three per cent.

Australian Prudential Regulation Authority (APRA), General Manager Policy Development, Neil Grummitt said the Basel III regulations would require banks to have a buffer - a capital conservation fund of 2.5 per cent - that they could dip into in times of financial stress.

"Under Basel II if you had $100 in residential mortgages you only needed to have $1 of actual equity and under Basel III that will become $2.50. The benefit of hindsight is a wonderful thing but, Basel II allowed you to leverage your mortgage portfolio 100 to one, (so) are we surprised that mortgage lending became a significant part of the crisis?" Mr Grummitt said.

Banks will also need high quality liquid assets to withstand a one month stress test and there will be tougher standards about what can be classified as a liquid asset, he said.

He said APRA has estimated that two of the Basel liquidity measures will increase mortgage lending costs by between five to 10 basis points but overall, it estimates the additional costs will be negligible. Indeed the new regulations would be critical in maintaining Australia's access to foreign capital, the forum heard.

"It is certainly APRA's view that there is nothing in Basel III that will constrain the ability of banks to perform their primary function," he said.

"There are some things in Basel III which constrain banks from doing some of the things that, with the benefit of hindsight, we would say were pretty dumb."

Basel III would make the banking system more resilient, reduce the probability of institutional failure and reduce the impact of the failures, including economic malaise which unfairly affects subsequent generations, he said.

While the banking sector has suggested the new liquidity requirements would drive up borrowing costs and reduce their ability to provide capital, the forum heard that markets and a risk re-evaluation had caused a rise in banks' borrowing costs since the GST.

Reserve Bank of Australia (RBA), Assistant Governor, Guy Debelle said the market had determined that private sector debt instruments, previously held by banks as liquid assets, were riskier than government securities as many highly rated instruments had not been convertible to cash during the GFC. This had driven a wedge between interest rates on public and private debt, he said.

"In a macro sense, any costs are well worth paying, for a more stable financial system... It is important to remember that the Reserve Bank board is very conscious of the various ways credit has been repriced when it sets monetary policy," he said.

"In the current environment there is ample scope to lower the cash rate sufficiently to bring those other rates to where they need to be to achieve the overall stance in monetary policy," Dr Debelle said.

But as foreign investors, including central banks and pension funds, own about 75 per cent of the supply of Commonwealth Government Securities (CGS) on issue in Australia, local banks have little choice but to seek highly rated semi-government securities, cash and Reserve Bank deposits as tier one liquid assets, he said.

Dr Debelle said the RBA has developed a new liquidity instrument, providing a commitment to repurchase a broad range of high quality assets from banks at a 15 basis point fee in a bid to overcome the shortage of government-backed assets. This would effectively implement a user-pays system for Reserve Bank liquidly insurance and provide an incentive for banks to manage their liquidity, he said.

The RBA predicts that national growth will continue on trend - albeit at different rates across the country - despite evidence that the resources boom is peaking, he said.

Dr Debelle added that South Australia should not be overly concerned about the recent downgrade in its credit rating.

"There needs to be a fiscal framework in place but the government needs to be spending around infrastructure and yes, it sends some kind of message about the rating downgrade, but in the end what really matters is what it costs you to borrow and the State Government is borrowing roughly as low as it ever has been in history," he said.