Capital Risk Analysis: Westpac and Bendigo and Adelaide Banks - Case Study Example

Capital Risk Analysis: Westpac and Bendigo & Adelaide Banks Student’s Name Student’s Affiliation Introduction Capital is perceived as being a prominent component in most of bank’s annual financial reports. This is ascertained to such factors as capital providing a permanent and limitless commitment of finances, it is established in order to freely absorb any possible losses to a given firm, it does not impose possible avoidable service charge against the earnings accrued within a given financial period and also, it is positioned behind the claims attributed to both depositors and creditors in the event of winding up a given firm (Boffey & Powell, 2014).This is basically to mean that capital risk ascertains to the mere assumption that the more capital a given bank possesses, the less risky it is for its activities to come down. APRA’s immediate perspective on capital is that of a substantial level of buffer that managing such risks as credit and market risks. APRA is provided within the Basel III accord where it exercises a fundamental prudence to make the underlying framework applicable within the entire Australian market as a whole. The framework requires that all Australian operating banks to acquire and utilize complex models for determining and evaluating such risks as credit, operational as well as interest rate risks in the course of taking them into the banking books (Lange, Saunders & Cornett, 2013). Significantly, APRA applies effective discretion in regards to the calculation of component of regulatory capital. In consequence, under APRA’s implementation of Basel III accord, all of the Australian banks are directed to sustain a minimum common equity tier 1 ratio of at least 4.5%, Tier 1 ratio of 6% and also, Total Regulatory Capital ratio of 8%. Therefore, the main purpose of this paper is to compare the capital risks of Westpac and Bendigo & Adelaide Banks in order to ascertain their respective aspects of commonality as well as differences that expound on their distinctive model of operations. Common Equity Tier 1 Capital Ratio Analysis For Westpac, the common equity tier 1 capital ratio increases from 8.4% to 9.1% in the periods between 2011 and 2012 while Bendigo and Adelaide Bank’s common equity tier 1 capital was positioned at a low of 7.82% in the financial year ending 2013 (Bendigo & Adelaide, 2014). However, it is important to realize that although there is a greater difference in the ratio percentages for this form of capital ratio, they are all placed over and above the standard ratio required by APRA of at least 4.5%. Significantly, Westpac Bank maintains a higher level of the ratio percentage in comparison to its immediate counterpart due to a number of reasons. First, the firm maintains a huge portfolio of share premium, common shares and retained earnings within the two financial years. For instance, Westpac’s common shares base increases by 2.5% in the two financial periods while that of Bendigo & Adelaide increases by about 2%. However, Bendigo & Adelaide bank maintains higher retained earnings for purposes of ensuring that they attain the capital minimum requirement set out under Basel III requirements. This is ascertained to the mere fact that while Westpac retained earnings increases by only a 10.3% margin in the two financial periods, Bendigo & Adelaide has increased its retained earnings by 34.2% within the same period. Calculations 1: Common Shares Westpac; (27,021-26,355)/26,355*100%= 2.5% Bendigo & Adelaide: (3,758-3,681.8)/3,681.8*100%= 2% Calculation 2: Retained earnings Westpac; (18,897-17,128) /17,128*100%= 10.3% Bendigo & Adelaide Bank: (398.1-296.5)/296.5*100%= 34. 2% It is important to understand that this ratio is also affected by either an increase or decrease in the amounts of other income since it forms a section of eligible items. Notably, Bendigo & Adelaide bank also strived to maintain a favorable common equity tier capital ratio through this item. The increase in other income item of the company is attributed to telecommunications revenues being recognized and disclosed within the comprehensive income statement for the first time since the firm acquired a 100% ownership in the company; Community Telco Australia Pty Ltd. Subsequently, the increase in the other income of the bank resulted from a substantial increase in the level of commission income enjoyed that related to such operational activities as insurance premiums as well as increases in product fees in regards to credit card, net transaction fees as well as foreign exchange commissions. Additional Tier 1 Capital Ratio Tier 1 capital ratio for Westpac increases slightly from 8.4% to 9.1% in the financial periods between 2012 and 2013 (Westpac Bank, 2014). On the other hand, Bendigo & Adelaide tier 1 capital ratio significantly from 8.39% to 9.25% within the same financial period (Bendigo & Adelaide, 2014). Under APRA’s requirements within Basel III accord, the standard average tier 1 capital ratios for Australian banks is set out at a minimum of 6%. This means that the two banks strived to maintain a sustainable tier 1 capital ratio for the two financial periods. This is attributed to the fact that while Bendigo & Adelaide bank ensured to maintain a null percentage increase in the amounts of its perpetual non-cumulative redeemable convertible preference shares as well as set up shares (Bendigo & Adelaide, 2014).Westpac, on the other hand achieved this ratio through a substantial increase in its treasury shares and RSP treasury shares it held within the two financial periods by 31.77%. Significantly, Westpac eliminated its convertible debentures as a section of its capital within the two financial periods in order to attain an effective tier 1 capital ratio. Percentage increase in Treasury shares and RP treasury shares for Westpac: (253-192)/192*100%= 31.77% Tier 2 Capital Ratio Tier 2 capital ratios for Bendigo & Adelaide bank decreases significantly from 2.02% to 1.46% in the financial periods between 2012 and 2013 (Bendigo & Adelaide, 2014). On the other hand, Westpac tier 2 capital ratios also decreases slightly from 1.6% to 1.4% within the same financial period (Westpac Bank, 2014). The rationale behind the decrease of this ratio for the two banks is all attributed to similar concern, which are operations subjected to limitations under APRA’s Basel III accord for that matter. Significantly, other aspects attributed to the decrease of the ratios for the two banks are associated with the requirement to reduce such eligible items as the convertible notes as well as a subordinated debt less a subsequent deduction of the firms’ own subordinated debt levels. Credit Risk Both Westpac and Bendigo and Adelaide banks identify credit risks as a form of uncertainty that is brought about by a financial loss for which a ban customer or counterparty for that matter fails to adhere and thus, pay-off their immediate financial commitments. For Bendigo& Adelaide, the total credit risk exposure increases between the two financial periods by 8.4 % (Bendigo & Adelaide, 2014). On the other hand, for Westpac Bank the credit risk exposure increases by about 4.9%within the 2012 and 2013 financial years (Westpac Bank, 2014). Calculations; Bendigo & Adelaide Bank Credit risk exposure; (60,622.6-55,939.8)/55,939.8*100%= 8.4% Westpac bank; (148,056 -141,082)/141,082 *100%= 4.9% Both of these banks experienced a substantial increase in their credit risk exposures due to a subsequent increase in the amounts offered as maximum credit risk exposures allowed for any given client or counterparty for that matter. However, there is an existing difference in regards to the manner for which these two banks offset the impairment assessment of assets. for instance, Bendigo & Adelaide bank ‘s main consideration for loan impairment is limited to whether payments for either the principal amount or interest rate is overdue by a period surpassing 90 or more days (Bendigo & Adelaide, 2014). The impairment assessment is also attributed to such factors as to whether or not there were immediate challenges in cash flow capabilities of counterparties, credit rating adjustments and also, in cases where there were direct infringements of the original terms of the loan agreement. On the other hand, for Westpac Bank, the impairment assessment is divided into three subgroups for purposes of classifying the level of client’s or counterparties to adhere and thus, pay for their immediate loan commitments (Westpac Bank, 2014). These impairment subgroups for the bank include; financial assets that perceived as neither being past due or impaired, those that are considered to be past due but are not impaired and also, financial assets that were 90 days past due date or have been defaulted but are fairly secured and not impaired for that matter. This difference arising from the manner for which the two banks measures credit risk exposures expounds on the degree of percentage differences that they face within the two financial periods (Westpac Bank, 2014). Market and Operational Risks Westpac Bank identifies market risk as a level of uncertainty that would adversely impact the company’s earnings due to such external forces as alterations witnessed within the market as foreign exchange rates, interest rates and commodity and equity prices for that matter. Notwithstanding, for this company, market risk includes interest rate risk that is positioned within its banking book. On the other hand, for Bendigo & Adelaide Bank, market risk is identified as being the uncertainty that a given fair value of future cash flows of the firm’s financial instruments will change in regards to such factors as interest rates, foreign exchange rates and equity prices (Valentine, Ford, Edwards, Sundmacher & Cropp, 2006). For Bendigo & Adelaide, the immediate shifts in profits are attributed to either a higher or lower level of interest costs from variable rate debt and also, cash resource balances for the two years (Bendigo & Adelaide, 2014). The movement witnessed in equity is also attributed to either an increase of decrease in the immediate fair values of derivative instruments that are depicted as cash flow hedges. This scenario evaluation postulates that the firm’s management fails to take any action needed for countering the movements witnessed in the aforementioned rates. In regards to foreign currency risks, the bank does not seem to suffer significant exposure given that most of its borrowings are conducted through Euro Medium Term Note Program as well as Euro Commercial Paper Program, which are completely hedged together (Bendigo & Adelaide, 2014). However, for Westpac Bank, foreign exchange risks seem to affect the overall market risk of the firm given that it decreases significantly within the two financial periods by about -36.4% hence affecting the total value of the overall market risk for the company(Westpac, 2014). While Bendigo & Adelaide Bank provides an elaborated preview of its operational risk framework, Westpac Bank fails to provide the same analysis altogether. For Bendigo & Adelaide Bank, the operational risks are identified as being uncertainties that might likely affect overall objectives that results from inadequate or failed internal level processes and people systems. The bank has risk being overseen by its Board Risk Committee. In the course of managing this form of risk, the management takes into consideration the fact that there is a correlation with such other risks as strategic, reputation and contagion risks. Some of the notable factors that are perceived as being able to affect the firm’s immediate level of operation are listed as globalization as well as global impacts like investor sentiments, economic factors like interest rate developments as well as changes witnessed in government policies and regulations. Other factors mentioned include; demographical factors, technological aspects as well as financial convergence and also, competitive landscape availed to conduct operations (Viney, 2012). To sum up the analysis above, it can be ascertained that both of these banks have taken stringent measures to mitigate and therefore, prevent their capital risk from falling below the expectations set by the APRA requirements under Basel III accord. The tier 1, common equity tier 1 and tier 2 capital ratios for all of these banks fall way above the minimum requirements set by the APRA requirements. This means the two banks are committed to adhere to the changes being affected by the implementation of newer requirements set within the Basel III accord for that matter. In regards to credit risk, for Bendigo& Adelaide, the total credit risk exposure increases between the two financial periods by 8.4 %. On the other hand, for Westpac Bank the credit risk exposure increases by about 4.9%within the 2012 and 2013 financial years. This means that even though the firm’s stringent measure to eliminate the effects of this risk altogether still there are client’s and counterparties that fail to commit into repaying their obligations whenever they fall due. Both of these banks have taken the initiative of creating an internal Board Risk Committee whose mandate rests with overseeing and monitoring the level of risks being experienced within the two financial periods. In regards to both market and operational risks, the two firms exhibit different approaches of identifying and thus, defining market and operational risks. In regards to APRA requirements under Basel III accord, both of these firms have strived to maintain standard tier capital ratios for the two financial periods. Significantly, they have both ensured that they effectively manage their respective capital balances in order to balance the existing requirements that pertain to the various stakeholders of the banks that include; regulators and also, their immediate shareholders (KPMG, 2013). This has been attained through these banks efforts to optimize their respective mixes of capital, while at the same time ensuring to maintain an adequate capital ratio framework throughout the two financial periods between 2012 and 2013. The capital position for both of these banks are monitored on a continuous basis approach and thereafter, reported on a monthly to the ALCO (KPMG, 2013). However, in regards to operational risks, Bendigo & Adelaide unlike Westpac identifies such areas of operations as; retail banking, third party banking and also, rural banking as required under the APRA requirements. The amount of residual capital, for both of these bans, that are considered to be eligible for purposes of inclusion as tier 1 capital have been subjected to an APRA prescribed limit of 25 per cent of the overall tier 1 capital with the excesses of these amounts being transferred to the tier 2 capital. Furthermore, the banks have ensured to adhere to the APRA regulation that requires surplus, which is net of tax, within the bank’s immediate defined benefit superannuation funds that is included within the shareholders’ equities are lessened from tier 1 capital. It is important to understand that APRA engages in the supervision of approved trustees of the aforementioned superannuation funds and also, expects them to maintain net tangible assets of a minimum of $5million amount (KPMG, 2013). Both Westpac and Bendigo & Adelaide banks have been able to maintain a net intangible asset that is positioned way above the $5million mark set as a requirement. Therefore, despite the mere differences witnessed in the presentation and accounting of the different capital risks for both of the banks, it can be fairly ascertained that they have both ensured to maintain a consistent implementation of APRA requirements that well formulated within Basel III accord. References Boffey, R & Powell, R. (2014).Financial institutions management. Class Notes Presented within Faculty of Business and Law, Edith Cowan University. Bendigo & Adelaide. (2014). 2013 annual report. Retrieved from http://www.bendigoadelaide.com.au/public/shareholders/annual_reports.asp Gup, B. E., Avram, K., Beal, D., Lambert, R. & Kolari, J. W. (2007). Commercial banking: The management of risk. Milton: Wiley. KPMG. (2013). APRA conglomerates policy and risk management requirements. Retrieved from https://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/Documents/apra-conglomerates-policy-risk-management-requirements-may-2013-v3.pdf Lange, H., Saunders, A., & Cornett, M. M. J. (2013). Financial Institutions Management. North Ryde, N.S.W.: McGraw-Hill Australia. Valentine, T., Ford, G., Edwards, V., Sundmacher, M, & Cropp, R. (2006). Financial markets and institutions in Australia (2nd Ed.). Sydney: Pearson Education Australia. Viney, C. (2012). Financial institutions, instruments and markets (7th Ed,). Sydney: The McGraw Hill Companies, Inc. Westpac Bank. (2014). 2013 annual report. Retrieved from http://www.westpac.com.au/ Read More