Implementation of Basel III in Australia and Its Impacts on the Banking Sector - Case Study Example

Basel III in Australia Institution: Student Name: Date: The implementation of Basel III in Australia Introduction The APRA (Australian Prudential Regulation Authority) in 2011 November made a release of a discussion paper referred to as Implementing Basel III liquidity reforms in Australia. It outlined its proposals with a target of strengthening the management framework of liquidity risk for the Australian deposit-taking institutions (ADIs). The paper discussed how the reforms announced by the Basel Committee will be brought to effect[Car13]. The reforms targeted to make the liquidity buffers stronger in the spirit of promoting a global banking system that is more resilient. By 2013 January, amendments were released by the committee to of the reforms’ key elements. The element was the LCR (Liquidity Coverage Ratio). APRA is positioned to end its consultations regarding the key elements of the framework of the Basel III liquidity. The package of consultation gives an outline of the proposed amendments of APRA to the 2011 proposals of the LCR’s implementation in Australia. It as well tackles the key issues that were raised in submissions together with the other interested parties and dialogue with the industry. The interested parties in this context reflect the early proposals of APRA that were not impacted by the recent revisions of the Basel Committee (Carr, 2013). Discussion The Basel Committee sets very high implementation priority in line with the standards of regulation that underpin the Framework of Basel[Bas14]. The advantages of the global reforms that were agreed upon are only accruable if the standards have been incorporated in the regulatory frameworks of the member countries, and they should be appropriately applied. The establishment of RCAP in 2011 by the Basel Committee was meant to monitor, evaluate and assess the implementation of the Basel Framework by the members. The assessment, therefore, has an aim of ensuring that individual member jurisdiction adopts the framework in a way that is not dividedly compatible with the spirit and letter of the Framework. The whole intention was that the transport and sound based prudent regulation requirements will help in strengthening the international system of banking. And at the same time, ensure a playing field that is level and improvement of the confidence of the market in regulatory ratios (Basel Committee, 2014). The RCAP Assessment Team made findings on the Basel risk-based capital standards domestic adoption in Australia and their consistency with the standards of the Basel Committee. Prof. Dr. Hilbers Paul, who came from the Bank of Netherlands (DNB), led the team that comprised of five technical experts. The assessment was through three stages: APRA self-assessment On- and off- site assessment stage The phase of the post-assessment review. The on and off-site stage included visiting Sydney where the Assessment Team involved the APRA in discussions together with five Australian deposit-taking institutions that were authorized and internationally active, one agency of credit rating and two audit firms. The discussions hence provided the Team with an overview that is comprehensive and of a deeper understanding of the Basel risk-based standards of capital implementation in Australia (Reserved Bank, 2015). The last phase was made up of a findings review that was technical of the team of assessment for a quality control mechanism that is substantive hence ensuring the assessment consistency. The Basel Committee Secretariat coordinated the works and interactions of the Assessment Team with the APRA. The Assessment Team learnt that the prudent regime of Australia complied with the Framework of Basel. According to the view of APRA, that rating is very appropriate. The conservative approach of APRA simple reality holds that an ADI that is active internationally in Australia has a tendency of facing a capital requirement that has at least one hundred basis points higher. This is in comparison to any given banking internationally that is subjected to the Basel Framework minimum requirements (APRA, 2013). Challenges Liquidity is domestically the main focus when viewing the challenges that Basel III comes with towards the Australian Banks (PWC, 2010). There is the conservative application of the APRA of the regulatory framework contemporarily. And the focus and emphasis put on domestic models trade indicating the Australian Banks. Basing on the feedbacks of clients, it is very clear that challenges have been clearly and significantly depicted ahead for the banks of Australia. The challenges have been categorised into: The board education challenge- there has been indications and suggestions by headlines that the banks were going to uphold the new rules very comfortably. On the other hand, the targets of the board may be revised upwards in order to raise capital. There are target levels that are new that should be considered and agreed upon both in the Basel III ending stage and in this stage of transition. The link that is missing, however, is the rising extent of the APRA new legal minima will establish specific PCRs of their banks. That was very fundamental in that the contemporary practice is setting the capital levels more than the PCR to be able to absorb stress and not risk regulatory breach at the same time[PWC10] The capital management-there is a transition process that is lengthy and complex together with measures that are new for instance the countercyclical buffer that presents challenges that are significant to the framework of capital management. The over 3-5 years capital plan needs to consider the risks of additional capital planning. In the same manner, they need to consider the improvement of the regulatory minima regulatory risk being improved if a given jurisdiction declares an “asset bubble”. The focus of capital management is that the measurement of the countercyclical buffer could be pro-cyclical as influenced by the raise of banks’ additional capital in markets. The equity and debt tend to attract capital charges that are high for investors. The relations challenge- the communications of the investors’ complexity is created by the transition arrangements. At one point, banks will have a need of the disclosing the capital positions they hold against the contemporary rules and of the end state of Basel III. The will be sorting of the comparisons and the contemporary FSA vs. APRA comparisons published by the Banks of Australia could be very complex. The outstanding challenge, however, will be convincing investors that ROEs (Return On Equities) that are potentially lower will be considered and compensated for if the safety banks increase[APR13]. The public stakeholder challenge -here the challenge is effectively communicating why a reform is required so as to pursue the public. Nevertheless, the reforms of creating a banking system that are safer need should be paid for. Such much as several public stakeholders privately recognise this; the suggestions made by the public rhetoric are entirely opposite. System and infrastructure challenge- this is precisely among the challenges that are most significant. A lack of information that is granular and timely to trigger the response of top management to the GFC is a very fundamental issue[Bas14]. Investor relations, risk management and capital planning need to continue to be more forward-looking and integrated[APR13]. Developing analytical and appropriate tools and an internal organization that is right will very fundamental to success. Infrastructure investment and alignment should be considered by the banks in Australia during major spending times by every Australian major on the core systems. APRA has flagged readily that the industry-wide project risk is very outstanding in the radar of supervisory. To educate the board requires an immediate start that demonstrates a roadmap showing the next 5-10 years complexity alongside when and how the levels of the capital target can be refined and will prove to be highly valuable. Global bank treasurers received New Year excitements when the committee of Basel amended the ratio of liquidity coverage that was a very fundamental Basel III element. However, most local banks are still trying to wait in case APRA passes on the ‘’rate cut’ of LCR- and there, therefore, might be some sting in the tail. The LCR is often like the Basel III package of reform cornerstone. The fact that the standard of global liquidity lacked was a depiction of a big hole in the landscape regulatory. LCR was therefore part of the response of the Basel Committee that was designed to make the banks in any crisis bullet proof. The Basel Committee in 2013 endorsed several proposed changes to the LCR calculations as well as its introduction’s timing. Banks, therefore as a result will be in a perfect position of holding a volume of liquid assets. The assets are more expensive than those set out in the 2010 text of Basel III - but still more than today in a significant manner[APR13]. The Regulatory changes and banks' responses in the implementation of Basel III in Australia There are various modifications that have been implemented since the introduction of the Basel III in Australian banks[Lae03]. Taking the outflow of cash, run-offs of deposits- the deposits rates are estimated to have been withdrawn from various banks during a crisis. The banks hence have experienced a downward revision. For instance, some particular deposits experienced their runoffs reduced to three per cent from five per cent. About $ 584 billion household deposits exist across the banking system of Australia this is as per the monthly banking statistics of APRA in 2012. While not everyone or every bank could meet the criteria of eligibility for the lower factor of runoff, the change alone is able to make a representation of a HQLA holdings reduction of billions of dollars (Collins, Shackelford & Wahlen, 1995). The equation’s other side focuses on the HQLAs criteria that have loosened hence permitting a wider asset pool to qualify. This, therefore, alleviates pressures in the market that are associated with banks pursuing a pool of qualifying assets that has been narrowly defined. The LCR changes are undoubtedly a representation of the “lowering of the bar”. Banks have been further given much time for “clearing the bar”[Bea95]. The LCR was phased in January 2015, but it will take time; until 2019 that HQLA bank reserves have to cover entirely the funds outflow that has been assumed. The question that arises, however, is why the changes are necessary. The banking reality is reflected where there is liquidity and where it remains at a premium. The global conditions make it unlikely for the future that is foreseeable to comply with the original rules. When the bars are set very high, implementing them is very problematic for not only the banks but also the regulators. Lower liquidity bar for regulators that is consistently applied for most is better than none. The local market’s implications are not very clear. While writing time, APRA had not made a response publically to the changes of the Basel Committee with the basis of its draft rules on the 2010 version of the Basel III (Moyer, 1990). In the reform package of Basel III, the Basel III committee focuses on the improvement of the capacity of the banking sector to consume shocks that arise from economic and financial stress[Cum14]. This, as a result, reduces the spill-over risk to the real economy from the sector of finance. There is a couple of discretionary bank behaviour on the provisions of loan-loss as a result of Basel III. There are characteristics that tend to influence the decision-making of a bank or provisioning. Loan-loss provisions, in principle, are a buffer for preserving the solvency of a bank by absorbing estimated and existing future business losses. To an extent where the provisions give a reflection of the loan portfolio quality, they may be susceptible to the fluctuations that are short term that result in macroeconomic conditions changes and the developments in the individual counterparty’s solvency. Counter specific circumstances may as well affect provisions. This is in regard to tax rules, regulatory and accounting circumstances and by the behaviours of the bank with respect to risk and performance management practices[Col95]. The conceptual framework that the Basel Accord proposes is that the losses expected in the future will have a provisions cover while those losses that were unexpected have a capital cover (Cummings & Durrani, 2014). These are the changes propagated for by the Basel III. However, they may seem backward-looking if a bank mainly sets provisions when responding to problem loans. During such economic expansion periods, there are fewer identified problem loans with allowing provision level. When there are downturns economically, conversely, there is an increase in provisions because the defaults tend to be more widespread across the lending business of the bank. The buffers o the banks, therefore, ought to be restored at downturns. This precisely means that the profits that are available are fewer, and they are expected to supplement the capital that exists, and this possibly forces banks to reduce lending. Credit risks, however, arise when there are loans made, not just during a downturn when there are more defaults. In such a case, therefore, a bank may be under provision during a period of economic expansion. Provision may alternatively be forward-looking in case it takes an account of the intrinsic risk that could have been estimated to exist in the loan portfolio of the bank with no regard to the business cycle’s stages. There are three key discretionary actions proposed by Basel III that bank managers out to embrace when setting provisions. Firstly, there is the need to focus on the capital management. Both general and specific provisions reduce the capital equity through their retained earnings effect. A bank that is poorly capitalised may not be very willing to make loan-loss provisions. Secondly, there is the need for income smoothing. A bank manager, in this case, seeks to reduce the variability of earnings. At the same time signalling lower business risk, funding costs reduction, improve management rewards or reduce tax expenses. The third action, on the other hand, occurs at times when a manager uses a revision of signal his or her strength financially to investors (Greenawalt & Sinkey, 1988). More banking institution capital means that there are lending interest rates that somewhat, slower the growth of the economy of a country even in good times and hence promoting less borrowing (Ahmed, Takeda, & Thomas, 1999). It however also means that that there will be a financial system that is safer and banking institution that is safer by the reduction of financial crises risk and bank failures. The regulator’s challenge is balancing the benefits relating to safer systems of the bank, with whichever, completion or efficiency costs that are associated with the requirements of higher capital. The Basel III impact can be quantified in various contexts. So as to quantify its impact, therefore, APRA made an assessment of the marginalized regulatory requirement of capital. That was hence the underlying difference between the ratios of CET1 an institution for bank is likely to target (Beatty, Chamberlain, & Magliolo, 1995). The target is inclusive of the buffer over the regulatory requirements of APRA. The targeted CET1 ratios are therefore compared to the ratio of CET1 it could have had in meeting its board or many times, rating constraints of agency in the absence of the requirements of Basel III. In the context of the banks in Australia for instance, this is an indication of the difference between whatever is contemporarily held, approximately seven per cent CET1 ratio, and whatever will be held when 2016 reaches. This will be when the Basel III rules have been put in place fully. APRA, therefore, a mathematical analysis basing it on a two per cent CET1 ratios increase by the large banks. It is therefore stated that the increase, whatsoever, cannot make a prediction of the likely outcomes, but it’s usually used as an illustration of the broad impact of the requirements of the higher capital[Col95]. Basel III also had significant regulatory changes on the interest rates of the banks. For a two per cent increase in the ratio of CET1 for instance, there will be a change in the non-housing-loan. The change will be at most 0.10 per cent in general and at most 0.04 per cent for home loans. There is, however, an offset of the figures from the banking institutions of Australia becoming safer. And enjoying funding costs that are lower with more finding accessibility and a required equity return that is lower (Laeven & Majnoni, 2003). Calculating the benefits is entirely difficult in any particular banking institution’s context. Another change that the banks will experience is increased lending rates. The increase is presumed to be just minimal. An increase in the rates of lending and maybe a lending rate that is reduced may lead to an aggregate demand that is lower hence leading to a decrease in the GDP. APRA made suggestions that very small loan prices increases can empirically just lead to mild decreases in the demands of a loan. The GDP overall reductions are hence correspondingly small[Lae03]. APRA points out that: Even increases in the bank capital that requirements that are substantial don’t produce major increases in the rates of ending. Small lending rate increases entirely lead to loan demands that have correspondingly minor changes. Minor loan demand decreases will entirely lead to mild decreases in GDP over several years. Conclusion In conclusion, Basel III came with several impacts that have led to changes in the banking sector. It allows the foreign subsidiaries of banks to make use to make of the allocation mechanism of the parent bank for the sake of establishing the capital requirement regulatory. The APRA, as a result, has provided a detailed criteria and conditions to be satisfied by a foreign bank subsidiary before the recognition of its mechanism of allocation. This is inclusive of the sufficiency requirements of allocated capital, the allocation mechanism’s appropriate risk-sensitivity, governance and data control and the risk management operational framework that align to AMA (Advanced Measurement Approaches). Any benefit of the global reforms initially agreed can accrue when the standards are thoroughly incorporated in the regulatory framework of the member countries. List of references Car13: , (Carr, 2013), Bas14: , (Basel Committe, 2014), PWC10: , (PWC, 2010), APR13: , (APRA, 2013), Lae03: , (Laeven & Majnoni, 2003), Bea95: , (Beatty, Chamberlain, & Magliolo, 1995), Cum14: , (Cummings & Durrani, 2014), Col95: , (Collins, Shackelford, & Wahlen, 1995), Read More