Macquarie Group (ASX: MQG) shares are flat today after the investment bank and asset manager admitted that the prudential regulator APRA is unhappy about how it has been reporting its intra-bank funding agreements with regard to its capital adequacy reporting.
By way of brief background, Macquarie has since 2007 been split into two separate legal entities of Macquarie Group and Macquarie Bank.
Previous management split the group's core banking and asset management or capital-market facing operations because it could help 'minimise' regulations that demanded it carry more capital in reserve as a bank or authorised deposit taking (ADI) entity.
In theory under the Basel Banking Supervisory and APRA rules Macquarie Group as a whole must comply with minimum capital adequacy requirements or be "unquestionably strong".
However, by splitting out the bank from the investment group the investment group could operate with less stringent capital adequacy requirements.
The principal risk regulators such as APRA are concerned with is that deposit-taking banking operations like Macquarie maintain minimum amounts of liquidity (cash on hand, short term finding lines, etc,) to make sure there could never be a 'run on the banks' as was seen in Europe and the US during the GFC or 'liquidity crisis' of 2007.
This is where depositors lose faith in a bank's solvency and all try to retrieve their deposits or other lines of credit at the same time out of fear the bank may go bust.
One way Macquarie has boosted its bank's liquidity position is by demonstrating it can fund itself intra-group from Macquarie Group.
As it notes in today's announcement: "MGL raises long-term funding and places surplus funds with MBL, in the form of intra-group loans. Over the past year, these loans have represented around 10-15% of MBL's total funding and have been included in the calculation of MBL's Liquidity Coverage Ratio (LCR) according to their contractual tenor."
However, it seems APRA is unhappy that a clause in the agreement between the two groups meant term funding could "fall short of the LCR (liquidity coverage ratio) of 30 days".
As a result Macquarie is being forced to update its funding agreement and also has to restate its past funding and liquidity coverage ratios.
APRA also warned in its announcement that: "Supervisors are considering a range of further options, including the imposition of higher funding and liquidity requirements on these ADIs."
Although it won't admit it publicly, Macquarie is in a constant battle to minimise its capital adequacy backing, while keeping regulators happy.
This is because the more idle capital a bank is forced to keep in reserve the lower its return on equity and profitability. In effect the capital cannot be lent out or invested for profitable returns, which drags down performance.
Notably, Macquarie was also was the first major bank including the big four of Commonwealth Bank of Australia (ASX: CBA) and co. to convince APRA to let it calculate capital adequacy as an "advanced" entity under the Basel II requirements.
While this received little attention in the local media it was a coup for the bankers as "advanced" accreditation actually gives a bank more leeway in calculating the potential impact of operational losses.
In effect it has wider permissions to work out how much capital it requires and generally "advanced" accreditation banks will end up carrying less capital in reserve partly because they have more license to use different methodologies in calculating it.
Overall though the key takeaway for investors today is that APRA may revisit liquidity requirements on ADIs including Macquarie in light of its recent findings on funding arrangements.
Any revisitation is not likely to be material for Macquarie as existing legal frameworks will not be superseded, but is still something to watch given the implications.
