Despite raising around $18 billion in capital last year, Australia's big four banks will need to boost their capital ratios again according to the banking regulator.
In an updated study released yesterday, the Australian Prudential Regulation Authority (APRA), the big four banks had increased their CET1 (Common Equity Tier 1) ratio from 11.7% as at June 2014, to 13.5% by December 2015.
Australia's big four Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) have also moved into the top quartile of global banks, compared to the bottom quartile in 2014. In addition, the banks' capital ratios also appear to have moved in line with the recommendations of the Financial System Inquiry.
But there's more work required according to the banking regulator, as international peer banks also continue to strengthen their capital ratios on an almost continuous basis.
"The major banks have undertaken significant capital raisings since the 2015 study, which has significantly improved their capital adequacy position relative to international peers. That said, the trend of international peer banks strengthening their capital ratios continues," APRA said.
That suggests that the banks will need to continue meeting ever higher capital buffers, although that could be a constantly moving target.
APRA also says that it "would be prudent for Australian ADIs (Authorised Deposit-taking Institution – or banks) to continue to plan for the likelihood of strengthened capital requirements in some areas."
The banks have several ways they can increase their capital ratios apart from capital raisings – which tend to be used as a last resort to raise large sums of capital. Those methods can include using underwritten dividend reinvestment plans (DRPs), reducing their payout ratios and cutting dividends.
However, shareholders should note that the more capital the banks require, the harder it will be for them to generate high returns on equity and hence earnings and dividends.
Foolish takeaway
A factor that is more likely to drive the banks' earnings will be the economic cycle and issues such as rising bad debts and falling house prices.
Over the short-to-medium term, I still see banks as unlikely to outperform the market (they make up a large part of it) with better opportunities out there.
