NAB says bank strength needs to be measured broadly

The measure of bank strength favoured by the financial system inquiry – capital levels – is too narrow, and assessing capital by reference to offshore banks will create “uncertainty and unintended consequences”, National Australia Bank has told Treasury.

The more capital a bank holds, the less leveraged it is, which creates a larger buffer between losses sustained in a crisis and the bank’s bond holders or depositors. Financial system inquiry chairman, David Murray said boosting this buffer would help Australian banks maintain support from offshore investors who fund the gap between deposits and loans. Banks generally resist holding higher levels of capital because it reduces their return on equity unless costs can be passed on to customers.

NAB said in a submission to Treasury on the inquiry that it supports Australia’s banks having capital that makes them “unquestionably strong”, and noted international investors already see this as the case. However, “by focusing on one capital ratio alone, the FSI recommends a measure of strength that is too narrowly defined”, NAB said.

Instead, strength should also be measured by looking at bank-specific factors – including the funding profile, liquidity, risk management, governance, and specific risk exposures – along with system issues including the level of central bank support and prudential supervision. “The characteristics that define an ‘unquestionably strong’ financial system are broader than just capital alone and a range of other attributes should also be considered by regulators when determining appropriate prudential standards,” NAB said.

NAB has also rejected Mr Murray’s call for “unquestionably strong” to be measured in relative terms of being in the top quartile of “internationally active” banks. It described this as an “arbitrary measure” and suggested a better alternative would be for the Australian Prudential Regulation Authority to set an absolute minimum capital requirement (rather than a relative one) and to review this on an ongoing basis.

Risk weightings review
With the Basel Committee on Banking Supervision currently reviewing the way in which banks assign “risk weightings” to assets to determine how much capital is carried, a process being described as Basel 4, NAB said changes to Australia’s regulatory framework “must be compatible with international regulatory developments. As such, they should not run ahead of the BCBS agenda, which is likely to result in material changes to capital standards for banks globally.”

With the regional banks on Tuesday calling for Mr Murray’s call for the big banks’ mortgage risk weights to be increased to happen “without delay”, NAB said it disagreed that higher mortgage risk weights are required. It said competition was not being inhibited by the the current differential. If the weightings are increased, NAB said they should be limited to new loans, given application to the whole book “may create capacity problems with capital issuance”.

NAB said it generally supported the creation of a regime for “loss absorbing capacity” but called for a “sufficiently long time frame” to minimise market disruption. A leverage ratio should remain a backstop measure, NAB said.

On superannuation, NAB agreed with Mr Murray that the objectives of the superannuation system be defined in law, which NAB said “should lead to greater policy stability” and provide a framework against which tax policy and other superannuation policy can be assessed.