By Gareth Vaughan
ANZ New Zealand is far and away the country's biggest bank. As of September 30 last year it had total assets of $159 billion. As NZ's biggest home lender, these assets included about $76 billion of home loans.
So, under Reserve Bank enforced regulatory capital rules, how much capital is ANZ required to hold against these home loans?
Remember that, as explained in Part 1 of this series, ANZ uses the internal models approach meaning it's allowed to set its own models for measuring credit risk exposure and then get them approved by the Reserve Bank. Also introduced in Part 1 was the concept of risk-weighted assets (RWA), used to work out the minimum amount of regulatory capital a bank must hold. The capital requirement is based on a risk assessment for each type of bank asset.
ANZ's latest disclosure shows, at September 30, it had $76.168 billion of residential mortgages, $15.761 billion of risk weighted exposure and a minimum total capital requirement against these home loans of $1.261 billion. ANZ's risk weight on its housing lending was 19%.
The bank does hold more than its minimum capital requirement. At September 30 ANZ required minimum total capital of $4.487 billion to cover its total credit risk exposure, not just that to housing. However, the bank actually held total capital of $11.857 billion. In Part 3 of this series we'll look at regulatory capital ratios and the composition of bank capital.
In the meantime many bank customers may be surprised to learn that ANZ is technically able, under current bank regulatory capital rules, to hold just $1.261 billion of capital against $76 billion of home loans.
NZ's other big banks - ASB, BNZ and Westpac NZ - are also accredited by the Reserve Bank to use the internal models approach. The risk weightings used by the four differ from one another, with ANZ's risk weightings typically the lowest. The table below shows where the four stood as of their latest disclosure.
|Bank|| Housing loans/loans
| Risk weighted
| Minimum capital
|ANZ NZ||$76.168 billion||$15.761 billion||$1.261 billion||19%|
|ASB||$62.387 billion||$18.119 billion||$1.450 billion||27%|
|BNZ||$43.312 billion||$13.088 billion||$1.047 billion||30%|
|Westpac NZ||$56.219 billion||$16.562 billion||$1.325 billion||28%|
*ANZ, BNZ & Westpac figures above as of September 30, ASB as of June 30.
Again as noted in Part 1, other NZ banks must use what's known as the standardised approach where the banks have their credit risk exposure prescribed by the Reserve Bank. This includes NZ-owned banks active in the housing market being Kiwibank, TSB, SBS Bank and The Co-operative Bank.
Through the 2008 introduction of Basel II the minimum risk weight on housing loans under the standardised framework was reduced from 50%, which had applied to all banks up to that point, to 35%. And this is what the NZ-owned lenders work with today.
Thus, as of June 30, Kiwibank had $10.560 billion of home loans at a risk weighting of 35%. This gave risk weighed exposure of $3.696 billion, and a minimum capital requirement of $296 million. The bulk of the balance of Kiwibank's home lending - $5.337 billion, was on a risk weighting of 40%, giving risk weighted exposures of $2.135 billion, and a minimum capital requirement of $171 billion. Kiwibank had a further $1.059 of home lending at risk weights ranging from 50% to 100%, giving risk weighted credit exposures of $657 million, and a minimum capital requirement of $53 million.
Kiwibank's 3% plays ANZ's 1.65%
So all up that leaves Kiwibank with a shade under $17 billion of home loans, $6.488 billion of risk weighted exposure, and a minimum capital requirement of $520 million. That's capital equivalent to about 3.08% of the value of Kiwibank's home loans. ANZ's minimum capital requirement is equivalent to just 1.65% of its home loans.
Meanwhile, a more detailed break-down from The Co-operative Bank shows its home loans to owner-occupiers with loan-to-value ratios (LVRs) under 80% have a risk weight of 35%. At almost $1.6 billion, this includes the vast bulk of the bank's home loans.
Co-operative Bank's loans to owner-occupiers with LVRs between 80% and 90% have a risk weight of 50%, those at LVRs of 90% to 100% have a 75% risk weight, and the small volume with LVRs at 100% have a 100% risk weighting. Co-operative Bank's loans to property investors have a risk weighting of 40% for loans with LVRs below 80%, 70% for LVRs between 80% and 90%, 90% for LVRs between 90% and 100%, and 100% for LVRs of 100%.
Big four at 69% of standardised banks' residential mortgage RWA
As I reported in December, the Reserve Bank's consultation paper on its proposals to increase bank capital includes a probe of the big four banks' use of the internal models approach. This shows them with RWA equivalent to 69% of the standardised approach used by all other banks for residential mortgages. Across all types of lending combined, ANZ, ASB, BNZ and Westpac have credit risk RWAs of between 67% and 86% of the comparable standardised calculations, with an average of 76%, as shown in the Reserve Bank chart below.
Effectively what this means is the big four banks are able to hold less capital than if they used the standardised approach giving them a profitability advantage over their Kiwi competitors. Or put another way, the Aussie owned banks can use a smaller portion of equity funding for mortgages than standardised banks, which translates into a funding cost advantage. This is a factor in the significantly higher return on equity the Aussie-owned banks generate than their local rivals, as demonstrated in the Reserve Bank September quarter dashboard chart below.
Restraining, but keeping, the internal models approach
Last July the Reserve Bank unveiled a decision for the big four banks to be required to start reporting their RWA and associated credit ratios using both the internal models approach and the standardised approach. The regulator said credit risk models "need to be constrained more" given its experience with the internal models framework. Nonetheless it still appears to buy the argument, at least to some degree, that the internal models approach increases the sensitivity of capital requirements to key individual bank risks.
"On balance, the Reserve Bank prefers an approach that retains IRB [or internal] models in the New Zealand framework, while putting in place restraints on IRB modelling to mitigate the disadvantages of internal modelling [being] competitive neutrality and the opaqueness of internal models," the Reserve Bank said.
"The recent example of the Global Financial Crisis (GFC) also provided strong evidence that in times of stress, market participants and other stakeholders quickly demand simplicity and clarity about the measurement of capital, which is a clear advantage the standardised framework has over the IRB [or internal models] approach."
'Difficult for an external observer to know... whether they are reasonable'
As its capital review has unfolded since March 2017, it has been clear the Reserve Bank has concerns with the internal models approach. In December 2017 it said; "Although banks disclose some information about model outcomes it is difficult for an external observer to know how these were arrived at or whether they are reasonable."
The regulator noted the four banks have different internal definitions of things as simple as the loan origination date for a home loan, making it "difficult to provide consistent data for benchmarking exercises [between banks] as well as to analyse existing portfolios."
"In most cases the variables used in banks’ internal models are readily available but in a significant number of cases important data is implausible, missing, truncated, or inferred from relationships with other variables rather than provided in raw form," the Reserve Bank said.
The banks themselves have also had problems with their internal models, as demonstrated by these interest.co.nz headlines;
And in its latest disclosure statement ANZ notes non-compliance with conditions of its banking registration due to "commitments jointly held" with its Aussie parent "in the risk weighted exposures for the Banking Group for capital adequacy purposes." Rectifying this saw ANZ's Tier 1 capital ratio decrease by 13 basis points to 14.4%, with a $58 million increase in its minimum capital requirement also needed.
A leveller playing field
On a different tack the Reserve Bank believes the staff, systems and compliance costs for the big four banks of running their internal models eats into the risk weighting gap between them and the standardised banks. Thus it argues its proposals detailed in December will largely level the playing field for the NZ owned banks against their Aussie owned rivals. The proposals would see ANZ, ASB, BNZ and Westpac increase the assets they use to determine the minimum amount of regulatory capital they hold to the equivalent of 90% of what's held by other NZ banks, up from about 76% now.
The proposed changes would increase the total RWA value required by the four Aussie owned banks from $251 billion, where they were at March 31 last year, to $290 billion. Note, as of September 30 the big four banks had combined total assets of $447.038 billion and Tier 1 capital, which consists of the likes of paid-up ordinary shares, retained earnings and preferred shares, of $34.247 billion.
As I also reported last year, The Co-operative Bank, SBS Bank and TSB all lobbied for the Reserve Bank to standardise the measurement of risk weighted exposures across all banks, saying this would ensure a level playing field across the banking sector. Kiwibank shareholders the New Zealand Superannuation Fund and Accident Compensation Corporation, have also raised the concept of levelling the capital playing field with the big four banks. And rural lender Rabobank called for a more detailed look at the differences between internal models and standardised approaches in a submission to the Reserve Bank.
The Basel II impact
The introduction of Basel II in 2008 enabled banks to reduce capital. This is demonstrated by the 2017 Reserve Bank chart below, which highlights a drastic drop in RWA to total assets after Basel II was applied. The post-GFC Basel III subsequently led to a minor increase.
Interestingly, a 2001 submission from then-Reserve Bank Governor Don Brash to the Basel Committee described a 50% risk weighting on residential mortgages as "very conservative" given the "low risk" nature of this form of lending, and that it's secured by residential properties.
With neither the Reserve Bank nor Basel Committee rejecting the internal models approach outright, they are accepting that banks looking at their own data and analysing their risks and own capital needs is a good thing. Nonetheless by reining the internal models approach in, regulators are trying to put the genie back in the bottle to some degree.
The Reserve Bank's proposals to increase bank capital requirements released just before Christmas do not propose to change risk weights used by standardised banks. Thus the 35% minimum for housing loans will stay, remembering this was set at 50% before 2008.
The regulator wants a leveller playing field both among the internal models banks, and between internal models and standardised banks. Thus if standardised banks' home loan risk weights average out at 38%, the Reserve Bank wants banks using internal models to be between about 33% and 36%. This means a significant increase in risk weights used by ANZ in particular.
An international comparison
A March 2017 speech from then-Deputy Governor and Head of Financial Stability Grant Spencer kicking off the Reserve Bank's capital review, featured the table below comparing housing loan risk weights in a range of countries with NZ's the highest. Note, the Australian Prudential Regulation Authority has had Australian banks using the internal models approach lift the risk weights on their housing loans to an average of at least 25%.
The table below, also comparing a range of international mortgage risk weights, comes from a 2017 PwC report commissioned by bank lobby group the New Zealand Bankers' Association. (Note RCAP stands for the Regulatory Consistency Assessment Programme of the Basel Committee for Banking Supervision, or BCBS).
PwC also adjusted the big four NZ banks' risk weights to make them more internationally comparable. This shows them at or below the RCAP median of 17%, below. PwC notes the only countries with materially higher risk weights are either those with a history of significant losses or, in the case of Australia, as a result of specific regulatory supervisor overlays.
In Part 3 of this series we'll look at how the owners of NZ's big four banks have fared over the past decade, and how the Reserve Bank's proposal to increase bank capital requirements could impact this, and what it may mean for bank customers. We'll also look at a couple of other key aspects of the Reserve Bank's proposed changes to bank capital requirements.
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