There has been plenty of press recently around the potential impact of changes to the rules around how much capital our banks are required to hold. But why is the amount of capital held important, and what are the possible impacts from changes to the rules?

Very simply, it is important in trying to reduce the potential loss to depositors that help fund the banks.

Banks are typically highly leveraged, with every $100 lent to individuals and businesses often supported by as little as $4 of capital. If a greater than expected number of borrowers do not repay their loans, the bank’s entire capital could run out. If this happens, other funding sources including deposits may need to be used to absorb the losses.

That is why the amount of capital held is important, to ensure debt and equity holders can absorb unexpectedly large losses and not customers.

So what are the potential impacts? This will ultimately depend on the actual changes required and how long banks have to implement the new requirements. However this could include changes to the composition of a bank’s lending books, a reduction in return on equity, no further increases to dividend payout ratios, credit rationing, higher borrowing costs and/or lower deposit rates.

Stay tuned…

If you would like more information please call 1300 ELSTON or email info@elston.com.au and an adviser will be in touch.