Current Issues in Australia n Bank Regulation

1. Current Issues in Australian Bank Regulation Kevin Davis, University of Melbourne & Monash University

2. Disclaimer • While this talk will address bank regulation issues related to the Australian Financial System Inquiry Interim Report, comments made should not be interpreted as reflecting views of the Inquiry, of which I am a member.

3. The Financial System Inquiry • Established by Treasurer end 2013 • Interim Report July, Final Report Nov 2014 • Broad terms of reference – not just banking • Relevant banking regulation issues include • Too Big To Fail / Financial Stability • Minimum capital requirements • Financial Claims Scheme (deposit insurance) • Regulatory risk weights and competition • Liquidity requirements • Bank structure and regulatory internationalcooperation

4. Too Big to Fail: Options • Levy / Tax – entrenches TBTF perceptions • Higher Capital Requirements – costs? • Regulatory dis-incentives to large size • D-SIB requirements, Swiss example • Structural separation / ring-fencing • Costs? • Due to resolution complexity or risk spillovers? • Bail-in, GLAC requirements • International agenda, domestic examples

5. Bail In: Some Issues • Trigger "ambiguity" • Ranking of claims • Bail-in conditions – conversion terms, write-downs, • Bail-in effects on creditor confidence • Exclusions from bail-in ambit • Repos, covered bonds • Agenda item for November G20 meeting

6. Minimum capital requirements • What is the impact on cost of bank funding? • MM, implicit guarantees, dividend imputation • What is the trade-off between GLAC and capital requirements? • Prudential policy considerations • Bank funding costs

7. Deposit Insurance / FCS • Australian financial claims scheme • $250,000 cap; no fee – ex post funded; APRA has first priority in liquidation for amounts paid to insured depositors • Ex ante levy (5-10 bp) proposal currently on hold • APRA priority implies actuarially fair levy is virtually zero • Arguments for a levy: rapid access in failure; funding of going concern resolutions • CUBs concern: more impact on their funding costs than for large banks (but one of many regulatory features with differential consequences for different size institutions)

8. Risk weights and competition • Recognition of benefits of risk sensitivity • Less confidence in merits of IRB • Particularly regarding housing mortgages • Leverage ratio, if set high enough, can mean a de facto increase in risk weight of low risk assets • Example: $100 of assets with risk weight of 0.2 and capital/RWA requirement of 0.08 implies $1.6 of capital. Leverage ratio of 3 implies $3. • Difference in IRB and standardised risk weights creates non-level playing field.

9. Liquidity Requirements • Liquidity Coverage Ratio (LCR) introduced • Only government securities eligible • Few available • Committed Liquidity Facility (CLF) alternative • What is appropriate fee? 15 bp charged • Rationale for exclusion of other securities?? • Crisis – RBA will need to accept private securities as collateral to provide system liquidity • Bank specific liquidity shortage – will be able to sell private securities in market

10. Regulatory Coordination and Bank Structure • What is appropriate organisational structure? • NOHC or bank as parent? • Where is bail-in debt issued within the structure? Complications include • Bailing in parent debt if subsidiary has problems and "downstreaming" • Bailing in subsidiary debt if parent has problems and "upstreaming" • Confidence spillover issues

11. Conclusion • Ongoing international strengthening of bank regulatory requirements • Australia (and NZ) cannot adopt lower standards given dependence on international capital • Relatively successful exit from GFC may have led to banking sector complacency regarding case for stronger regulatory requirements.