The Australian Prudential Regulation Authority or APRA is to introduce liquidity coverage ratio (LCR) next year. To say LCR is the kernel of global Basel III banking rules is to undervalue it. It’s a step that could save banks from global economic meltdown in the future.
Once LCR is phased in, all major Australian banks will have to pay a yearly sum of $400 million to comply with the new liquidity rules. The rule demands banks to have sufficient amount of “high-quality liquid assets”. Government bonds and residential mortgage securities that are high-performing qualify as such assets.
The reason banks are required to show liquid assets is to convince APRA that they could endure 30 days of acute stress. Problem for banks is that the government bond market in Australia is fairly small. APRA knows that and allowed banks to apply for “committed liquidity facilities” (CLF). CLF was provided by RBA on the basis of 15 basis points so banks could qualify for the LCR. Otherwise, banks would place low-quality assets to LCR.
Banks applied for a CLF of $288 billion. The regulatory authority however, granted only $275 billion. The base fee from four major Australian banks to RBA is $40 million. Murray Inquiry was earlier approached by Westpac to increase the amount of capital requirement. In that context, a senior VP at a credit rating agency called Patrick Winsbury said “It just fits into the global discussion about safety versus returns in banking. Presumably we’ve got more of that to come with the Murray inquiry.”
There’s a counter argument to CLF. It is the same argument that is cited to show the dependence of US banks on the discount lending policy of the US Fed. If there was no such dependence, risk of bankruptcy would have been more likely and a bank’s ability to survive on its own would have been clear.
Critics are voicing against the CLF that support from RBA would make the banks incompetent. The advocates of CLF might argue back that since banks would show high-quality assets, there’s no question RBA propping them up.
But do such high quality assets exist in Australia? This question should be kept open. The APRA has faith in the banks as extra $40 billion was added to $235 billion that came after 100 percent liquidity coverage. But banks relied heavily on offshore funding market and that proved highly incredible during financial slowdown.
Thus, we have no other way than to wait for the future because only time can tell whether or not APRA is right betting on the banks.