Incoming capital regulation of financial institutions aimed at strengthening their capital base is expected to slow economic growth and put upward pressure on interest rates, according to the Australian Prudential Regulation Authority (APRA).
Global liquidity reforms are being implemented by APRA as part of meeting Australia's G20 commitments. In particular, Basel III liquidity reforms will impose a set of tougher capital rules on banks, intended to strengthen the liquidity framework for authorised deposit-taking institutions (ADI). The Basel III liquidity framework involves two new minimum global standards. First, a 30-day liquidity coverage ratio (LCR) to address an acute financial stress scenario. Australian banks will have until 2015 to meet the LCR standard.
To meet the LCR requirement, banks must hold level one assets, which are limited to cash and government debt. The balance of the liquidity can be obtained through a committed liquidity facility with the Reserve Bank of Australia (RBA).
The second minimum global standard is a net stable funding ratio (NSFR) to encourage longer-term resilience by creating additional incentives for banks to fund their activities with more stable funding on an ongoing basis. Banks have until 2018 to meet the NCFR standard.
The reforms were expected to slow economic growth and put upward pressure on lending rates, APRA said.
"In general, more capital in banking institutions in any jurisdiction means slightly higher lending interest rates, less borrowing and slower economic growth in good times," the prudential regulator said in its Insight publication released last month.
"But on the other hand, more capital means safer banking institutions and a safer financial system, reducing the risk of bank failures and financial crises."
Experts say the supply of government bonds may be insufficient to meet demand from banks.
"In Australia, [government bonds] are currently in very short supply. To date, the only assets accepted by APRA as meeting the requirements of a liquid asset are Commonwealth and state government securities," Mallesons capital markets expert and partner Ian Paterson said in a recent note on the changes.
"The aggregate of these securities on issue is nowhere near enough to meet the likely liquidity requirements and, at least at present, something like over 60 per cent of outstanding Commonwealth government bonds are held by foreign investors."
The federal government's expected budget surplus will exacerbate the expected shortage of bonds. The government has forecast an underlying cash surplus of $1.5 billion in 2012/13, increasing to $2 billion in 2013/14, $5.3 billion in 2014/15 and $7.5 billion in 2015/16.
According to the experts, many banks would find it difficult to implement the reforms given expected reduced profitability.
"It will be costly for banks to adjust their balance sheets by holding more relatively low-yield, high-quality liquid assets," KPMG said in a recent publication, "Liquidity: A bigger challenge than capital".
"These challenges will be compounded because many banks will be seeking to make similar adjustments at the same time - so the market will be moving against them."
