The Commonwealth Bank of Australia (ASX: CBA) share price is rising after the major bank responded to the Reserve Bank of New Zealand (RBNZ) capital requirements announcement.
CBA is represented in New Zealand by ASB Bank. RBNZ has confirmed that the risk-weighted assets (RWA) of internal ratings based banks like ASB will increase to approximately 90% of that required under a standardised approach.
The New Zealand Reserve Bank deemed for systemically important banks, including ASB, the Tier 1 capital requirement will increase to 16% of RWA, 13.5% of which must be in the form of CET1 capital.
Tier 2 capital will remain in the framework, and can comprise 2% of the minimum total capital ratio of 18%.
However, existing additional Tier 1 and Tier 2 contingent instruments issued by New Zealand banks will no longer be eligible under RBNZ's new capital criteria and will be phased out over the transition period.
How long does CBA and ASB have?
The RBNZ has announced a 7-year transition period for banks to meet the new requirements, starting from July 2020.
How will it affect CBA?
CBA said it's well positioned to meet the new capital requirements over the implementation period.
At 30 September 2019 CBA's Level 1 CET1 ratio was 11%, based on CET1 capital of $47.4 billion and RWA of $432.2 billion.
On a pro-forma basis and assuming current balance sheet size and composition, ASB will need an additional NZ$3 billion in Tier 1 capital, of which NZ$2.5 billion must be in CET1 capital by 1 July 2027.
Under APRA's proposed revisions to APRS111, an equity injection of this additional capital into ASB over the transition period would eventually result in a reduction in CBA's level 1 CET1 ratio of approximately 30 basis points (0.30%).
CBA's Level 2 CET1 ratio at 30 September 2019 was 10.6% and will not be affected by these requirements.
The RBNZ and CBA has said that a significant increase in capital ultimately increases the cost of providing loans to customers.
It's likely that CBA will compensate for this higher cost by charging borrowers a higher interest rate.
Foolish takeaway
CBA is currently trading at under 16x FY21's estimated earnings with a grossed-up dividend yield of 7.8%.
If CBA can maintain this dividend for the foreseeable future then it could be the best big ASX bank to own. But, there are a lot of pressures of CBA's profit in the short-term and the long-term.
