Seguridad vial

The Inquiry seeks stakeholder feedback on further increasing capital requirements on

financial institutions considered to be systemically important domestically, presumably above that already assessed and required by APRA. Importantly, APRA’s capital assessment already includes the additional D-SIB capital charge announced in December 2013, which specifically considered global capital comparisons.

Capital can have different functions. In the context of TBTF, the role of capital is to absorb loss and thereby shield other stakeholders, particularly taxpayers, from direct exposure to the risk of loss. It is therefore in this context that the Inquiry should consider whether Australian D-SIBs should be required to hold additional capital.

Westpac has earlier in this Chapter made the case that it is very well capitalised, that Australian major bank capital levels are high by global standards, bank balance sheets are strong, and that prudential supervision is conservative. These are all indicators that there is no clear basis upon which to require additional common equity, particularly when weighed against the potentially adverse effect on the capacity of the system to support economic growth.

Westpac certainly supports the principle that losses be borne by the capital and liability holders prior to taxpayer intervention. Should government choose to provide support to a failing institution, government should be in a superior position to all other unsecured creditors.

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However, this does not necessarily require institutions to hold yet more common equity capital. While the ability to absorb loss is a defining feature of capital, the exact manner in which loss can be absorbed is equally important. In practice, there is already a ‘hierarchy of loss’ that starts with ordinary equity as the first point of loss absorption, and cascades through to Tier 1 and Tier 2 hybrids, senior unsecured funding, deposits and guaranteed deposits.

The extent to which any particular class of capital or liability is exposed to, or shielded from, loss depends on its place in the loss hierarchy. In the event of a winding up of an Australian bank, each of these points of loss absorption would be exhausted prior to depositors being exposed to direct loss. There is therefore currently a deep pool of capital and liabilities that stand between a failing bank and depositors within Australia’s system – both in terms of the

level of capital and the classes of creditors that are exposed to loss before depositors.

This ‘hierarchy of loss’ is shown in Figure 20, which for illustrative purposes summarises the hierarchy within the context of Westpac’s liability structure. This hierarchy shows the many layers of protection that preferred deposits (generally, savings accounts and term deposits) benefit from due to the statutory preference they are given in a bank’s insolvency by virtue of section 13A of the Banking Act 1959.

This statutory preference, along with the immediate access to cash of up to $250,000 provided by the Financial Claims Scheme (FCS), largely alleviates the likelihood of any government bail-out being needed to protect household depositors from losing their

savings. Such depositor preference provisions distinguish Australia in this regard from many overseas jurisdictions, and lessen the impact of a bank failure on household savings, which is one of the reasons a government would consider a bank ‘bail-out.’

80 Figure 20. Hierarchy of loss post insolvency (in Westpac liability structure)

It should be acknowledged that the ‘hierarchy of loss’ scenario applies to a winding up situation where a bank is liquidated. Global regulators have also been considering layers of capital in the context of allowing a rapid response to stabilise a bank which is seen to be failing and thus allow for an orderly resolution – specifically, ‘bail-in.’ This is discussed further below.

81_{This table is provided for illustrative purposes only. Liability numbers are based on Westpac’s 2014 Interim Financial Results} and Pillar 3 Report.

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Covered bonds represent a senior unsecured claim against the bank with a secured guarantee given by a separate entity which is insolvency remote from the bank.

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The Financial Claim Scheme does not increase the ranking of these protected accounts, but provides a government guarantee for them. The government then ranks here in respect of reimbursement of the amounts it has paid under the Financial Claims Scheme.

Lower ranking Category of liability Illustrative examples81

Size of liability (A$ billions as at 31 March 2014)

Common equity Tier 1 Ordinary Shares and Retained Earnings 45.1

Tier 1 Capital hybrid securities

Westpac Capital Notes 2, and notes or preference shares in respect of TPS 2004, Westpac TPS, Westpac SPS II, Westpac CPS and Westpac Capital Notes

4.8

Subordinated

unsecured debt issued after 1 January 2013 and subordinated perpetual debt

Westpac Subordinated Notes 2013, other subordinated bonds, notes and debentures and other subordinated unsecured debt obligations with a fixed maturity date and subordinated perpetual floating rate notes issued in 1986

1.9

Subordinated

unsecured debt issued prior to 1 January 2013

Westpac Subordinated Notes 2012, other subordinated bonds, notes and debentures and other subordinated unsecured debt obligations with a fixed maturity date

4.0

Senior debt Trade and general creditors, bonds, notes and debentures (excluding covered bonds82) and other unsubordinated unsecured debt obligations (eg deposits that are not protected accounts)

160.0

Other preferred debt Other liabilities preferred by law including employee entitlements 1.1 Preferred deposits without Financial Claims Scheme protection

Protected accounts (generally, savings accounts and term deposits) in excess of A$250,000.

224.3

Preferred deposits with Financial Claims Scheme protection83

Protected accounts up to A$250,000 164.6

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The consideration of loss absorption begs the question of ‘how much capital is enough?’ What is the ‘right’ level of capital? This is partly a question of what amount of loss is believed to be plausible, but also requires that the role of capital be considered in underwriting the process of credit creation by the banking system. Put another way – more capital comes at a cost.