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BFCSA: S&P concerned banks may lose support in a crisis

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S&P concerned banks may lose support in a crisis

Australian Financial Review Apr 9, 2019 3.03pm

James Eyers


S&P Global Ratings says there's a one-in-three chance it will cut its assessment of government support of the major banks in a financial crisis, a move that would trigger a downgrade to their credit ratings and push up the cost of funding.

But for now, the international ratings agency says it believes both major political parties will "continue to hold a pragmatic view" that a taxpayer-funded bailout of any major banks would be more likely to maintain financial system and economic stability than forcing losses onto bond holders.

After the Australian Prudential Regulation Authority said in November the major banks would need to lift capital buffers by up to 5 percentage points, forcing them to raise $75 billion of additional capital, S&P said on Tuesday its "base case" remains that the Australian government "will remain highly supportive" of any major bank despite this new "loss absorbing" regime being put into place.

However, ahead of a federal election campaign that is likely to feature more bank-bashing by the major political parties, the global ratings agency said, “At the same time, we see some ambiguity in future policy direction on this matter".

It is factoring in a one-in-three chance, over the next two years, that "the Australian government supportiveness will diminish to 'supportive' from 'highly supportive'," S&P said. Such as reduction would reflect S&P's opinion that the government would be less likely to provide financial support to a bank in trouble.

The classification is important because such as reduction in perceived supportiveness would trigger a cut to the credit ratings on all four of the major banks by one notch, to "A+" from "AA-". That would be likely to make it more expensive for banks to borrow from offshore investors who would build in a higher risk premium into bank bonds. That could increase interest rates across the economy, if banks passed those higher funding costs onto customers.

Negative outlook remains

S&P said the ratings on the major Australian banks "are likely to remain on negative outlook until we gain sufficient clarity on the future of the bank resolution framework, including the TLAC [total loss absorbing capacity] framework".

APRA sources say the regulator is aware its moves to build extra "loss-absorbing capacity" could trigger ratings downgrades and higher funding costs and is keen to avoid that outcome. APRA has been moving slowly on the issue, but remains aware the financial system inquiry and the G20 commitment to the Financial Stability Board are pushing towards the creation of bank resolution frameworks to limit future taxpayer bail-outs by "bailing in" private investors.

APRA is preparing to release an updated position on the loss-absorbing proposals by the middle of the year.

S&P, in its research paper published on Tuesday, said APRA's proposal for additional issuance of Tier II securities is "a pragmatic recognition by authorities that perception of very strong government support is critical for maintaining the perception that the Australian major banks would remain strong through good times and bad”.

One of the main reasons S&P has concerns about the loss of the current high-level of government supportiveness of banks in a crisis is the way the federal government worded its response to the 2014 financial system inquiry recommendation for additional loss-absorbing capacity to be built into the system.

"The government agrees that steps should be taken to reduce any implicit government guarantee and the perception that some banks are too big to fail. Should an ADI [bank] fail, greater loss-absorbing capital will facilitate orderly resolution," the 2015 government response said.

However, S&P is maintaining its base case for strong support of banks in a crisis despite this statement, based on its belief that the authorities "do not intend to reduce the 'implicit government guarantee' or the perception that some banks are 'too big to fail'."

Also, APRA's framework "does not propose – nor have the authorities more broadly taken – any concrete actions that would suggest reduced government support".

S&P's current position is based on what it describes as a "complex, subjective assessment", which it says incorporated a “lack of widespread social opposition to a bailout option”. This contrasts with the United States and Europe, where using taxpayer funds to bail out banks became a political flashpoint in the wake of the financial crisis.

Systemic risks in the Australian economy should also point towards ongoing strong government support. Pointing to the major bank funding, the Australian economy's current account deficit, and the similar business models of the majors, S&P said "allowing one of the four major Australian banks to fail could lead to distress across all four, translating into substantial and long-lasting damage to the Australian financial system and consequently, the economy".

"It is extremely important for the Australian economy that the systemically important Australian banks retain access to offshore funding and that offshore creditors continue to see their debt in these banks as low-risk investments," it added.

S&P pointed to historical examples suggesting strong government support that existed in the past, including the October 2008 guarantee for customer deposits and wholesale funding of Australian banks.

S&P says there is nothing in APRA's November paper suggesting looming changes to regulation in Australia such as adding preconditions for the government to bail out a stressed bank, or that adding loss absorption via certain instruments is some sort of prerequisite for bailout. The lack of a framework for loss absorption and recapitalisation capacity by any class of creditors, other than hybrid holders, also supports S&P's base case that the government will remain highly supportive.

Countries with highest support

For now, Australia remains in a group of countries that also includes China, India, Japan, Qatar, Saudi Arabia, Singapore, and the United Arab Emirates where S&P factors in the level of support at the highest level.

At the other end of the scale, S&P reckons the likelihood of support from the governments of the United States and all the European Union is uncertain. There is then a middle group, comprising Brazil, Canada, Hong Kong, Israel, Mexico, and Russia, where S&P considers governments are "supportive".

S&P said it will continue to review Australian government support holistically and will focus on APRA and the government communications relating to any changes to regulations or policies around the process of rescues of failing banks and the specific design of trigger points in the new loss absorption instruments.

APRA said, when it released its paper in November, is has been working with the Council of Financial Regulators on an approach which will be "simple, flexible and designed with the distinctive features of the Australian financial system in mind".

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