From January 2016 Australia's four largest banks Australia and New Zealand Banking Group (ASX: ANZ), National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Commonwealth Bank of Australia (ASX: CBA) will be required to lift Common Equity Tier 1 (CET1) capital held from 7% to 8%.
Why? What is CET1?
The increase comes due to the release of the Basel III regulations which stipulate that Global Systematically Important Banks (G-SIBs) and Domestic Systemically Important Banks (D-SIBs) must increase their low-risk (CET1) capital above current levels. The idea is that banks would be more easily able to model risk as a function of the proportion of capital types held. A higher proportion of CET1 capital indicates a lower risk of default. An example of CET1 capital is ordinary shareholder equity.
Banks which are considered too big to fail from either a global or domestic perspective are required to hold more low-risk assets than their smaller peers. Australia's big four banks are not considered globally important, but are deemed domestically important by the local regulator, the Australian Prudential Regulation Authority (APRA).
What does this mean for the banks?
Well, that depends on who you talk to. The analysis I've read has mainly focused on the fact that all four banks already exceed the 8% threshold which is obviously positive looking forward. Some more in-depth analyses, such as that from the team at the Eureka Report, has looked at what sort of buffer the banks will choose to maintain.
The report considers it likely that Commonwealth and Westpac banks will target between 8.5% and 9%, while ANZ and NAB will target a range of 8.75% to 9.25%. Based on their estimates, Westpac is best placed to maintain its dividend payout ratio, followed by Commonwealth Bank, ANZ and then NAB. If dividend reinvestment plans are the preferred way of raising capital, the findings indicate that NAB is the only bank that will need to commence offering a discount to achieve the participation rate required. This will be mildly dilutive to existing shareholders.
Foolish takeaway
The new regulations for Australia's big four banks will impose a higher rate of low-risk capital held by January 2016. All four already hold the 8% of low-risk, high-quality capital required, but the question remains what buffer above 8% the banks will opt to maintain. Higher rates will require the banks to raise shareholder equity through dividend reinvestment plans or the unlikely event of a share placement. For the time being however, investors should be comfortable knowing that all four are well placed to adapt to the changes and should face few issues to satisfy the APRA requirements.
