CBA faces huge capital call as risk-weighted reserves decline

The Australian 12:00am September 12, 2017

Michael Roddan

Commonwealth Bank could be forced to hold billions more in regulatory capital after levels of risk-weighted capital fell in recent years, in contrast to rival lenders.

The threat of a huge new regulatory bill comes as analysts forecast the “significant” and “vicious” plunge in the bank’s share price will continue, with the regulatory hangover facing the sector to persist for years. Since the anti-money laundering agency Austrac filed allegations in August that the nation’s largest bank had breached the law more than 53,000 times, CBA shares have sunk about 13 per cent.

While the threat of large fines from both Australian and international authorities looms for CBA, the bank is also likely to face large increases in regulatory costs.

According to Credit Suisse, the amount of capital put aside by CBA for its risk-weighted assets is relatively low compared to rivals NAB and ANZ.

Risk-weighted assets are used to determine the minimum amount of capital that must be held by banks and other institutions to reduce the risk of insolvency.

Since 2008, “operational risk” has been included in a bank’s capital requirements, which keeps a capital buffer for events outside credit and market risk.

While ANZ and NAB have been increasing risk-weighted capital in recent years, CBA and Westpac have seen falling balances. “CBA is currently almost equal lowest with Westpac in terms of its operational risk RWA mix,” Credit Suisse said.

The analysts said CBA could face a “permanent capital impact” by being forced to put more money aside — about $15 billion.

Morgan Stanley analyst Richard Wiles said the sharp sell-off in CBA shares had left the stock with a price-to-earnings premium of 5 per cent to the other major banks — down from its long-run average of about 11 per cent.

“At a 5 per cent premium, CBA is still slightly overvalued,” Mr Wiles said.

His colleague Chris Nicol said CBA had been subject to a “significant and vicious” de-rating and the prospect that the bank would lose its trading premium was “not out of the question”.

“The focus on conduct has been growing over the past 12 to 18 months,” Mr Wiles said. “We think it weighs on the outlook for bank sector growth and also for bank sector returns. It’s one of the reasons we’ve got a negative stance on the sector.”

Mr Wiles said there were seven potential implications for the bank stemming from the Austrac allegations, which are before the Federal Court.

These included penalties or fines, brand damage, and a likely increase in costs for upgrading compliance processes and systems.

Management changes have already begun, with chief executive Ian Narev’s exit flagged for early next year, and the retirement of several non-executive directors.

Mr Wiles said there would probably be a change to the bank’s strategy regarding sales and growth. The banking regulator APRA will also increase its oversight of the sector — it has already launched a six-month inquiry into the culture and governance of CBA. Lastly, the sector faces a heightened risk of a royal commission and other inquiries, he said.