Take the latest stress tests of European banks by the European Central Bank, the results of which were announced over the weekend. Of 130 banks tested, 25 were still short of capital. A similar test by the European Banking Authority delivered a not dissimilar outcome.
Critically though, of those banks registered as falling short, 12 have built up sufficient capital to pass since the year end calendar 2013 cut-off. The ECB reckons the remaining 13 need to raise $12 billion over the next nine months. Most of those banks were in the “periphery”, Italy and Greece – British, German and French banks did pretty well.
Overall, the ECB found Europe's banks faced a shortfall of €24 billion in capital in 2016 under the most adverse downturn scenario considered. The downturn modelled cut the common equity ratio by 260 basis points, from 11.1 per cent to 8.5 per cent after the stress test.
The ECB doesn’t see these results as static and this is where the focus on how much capital Australian banks may have to raise – as a result of Murray or something else – misses the point.
The regulators focus on capacity to generate and replenish capital as well as minimum levels. The ECB made it clear in its process: 25 banks in 10 countries failed the first round but half were able to build up buffers in the interim.
Large European banks layered on more than €200 billion since the stress tests were announced and the regulators have argued that is what they want.
APRA already has the power to change capital charges and risk weightings today. It can do so both explicitly and via its discretionary powers to shift capital levels for individual institutions.
In the previews from the broking houses of this season’s results, the consensus is the likelihood of meaningful changes to bank capital out of the Murray Inquiry is marginal nevertheless boards are likely to err on the side of caution.
That would mean no special dividends and allowing dividend reinvestment programs to bolster capital.
Judging by APRA’s own pronouncements, there is little specific guidance but there is a sense the supervisor has its eye on the gradual build-up of capital rather than measures which would require something more drastic such as a capital raisings.
Investors in Europe appear to have responded favourably to the latest stress tests but, judging by commentary, not so much because of the numbers but because the process was deemed credible and rigorous.
Make no mistake, this process was a stress test of the regulators as much as a stress test of the institutions they regulate. Another round of insubstantial testing would have seriously undermined faith in the ECB and other bodies – to the detriment of the system.
It is an interesting point for Murray and others to consider: does confidence in the financial system reside in the numbers such as capital levels (which in the financial crisis proved absolutely no guide to the survival chances of banks) or in the integrity of the system? And particularly its regulators.
One argument around the strong performance of the Australian banks both during the crisis and in its aftermath is APRA (and the other CFR members) has a reputation for being a rigorous and intrusive supervisor.
Abrogating their right to determine regulatory settings would not necessarily help faith in the financial system. It could be argued taking regulation out of the hands of those in whom the investment community has great faith may actually shake that confidence.