Read the extract from a speech by Wayne Byres (APRA) on 18th November 2020 provided above:

a) Using a numerical example you have created, illustrate the comments by Byres that following the changes suggested by APRA simultaneously RWA would decrease, and the actual capital ratio would increase but the required regulatory capital would not change. {for simplicity focus on CET1 regulatory capital and show before and after the reform}

(5 marks)

b) One of the proposal of APRA reform is a non-zero default countercyclical buffer instead of the current zero default countercyclical buffer. Explain to which mechanisms Wayne Byres refers when he says " helping preserve the flow of credit at a time when it is most needed".

(3 marks)

APRA Chair Wayne Byres - About bank capital requirements 18 November 2020 Bank capital I'll turn now to another piece of unfinished business that I have spoken about at many of these events - bank capital. This has been a long-running exercise, 4 influenced not just by our own views, but the direction set by the Financial System Inquiry and the international Basel reforms. We want to bring this to the finish line. There are a number of key outcomes that these changes are designed to achieve. The first point I would make, however, is that we believe the banking system is adequately capitalised. The result of this reform will not be that the industry needs to raise additional capital. What we are seeking to do is complex and multi-faceted. We want to make the capital regime: . more risk-based - by adjusting risk weights in a range of areas, some up (e.g. for higher risk housing) and some down (e.g. for small business); more flexible - by changing the mix between minimum requirement and buffers, utilising more of the latter; . (...) (...) We are just putting the finishing touches to the consultation package, which we will release in the next few weeks. Without delving into all the details, probably the most fundamental change flowing from the proposals is that bank capital adequacy ratios will change. Specifically, they will tend to be higher. That is because the changes we are proposing will, in aggregate, reduce risk-weighted assets for the banking system. Given the amount of capital banks have will be unchanged, lower risk-weighted assets will produce higher capital ratios. However, that does not mean banks will be able to hold less capital overall. I noted earlier that a key objective is to not increase capital requirements beyond the amount needed to meet the 'unquestionably strong' benchmarks. Nor is it our intention to reduce that amount. The balance will be maintained by requiring banks to hold larger buffers over their minimum requirements. (...) In our case, bank capital ratios will go up, but the dollar amount of capital the banking system has to hold should be largely unchanged.5 You might then ask why we are proposing an extensive set of changes, if we don't want to change the amount of capital held? One reason is to improve risk sensitivity. We will be adjusting risk weights in a range of areas to help make sure capital is better allocated according to risk. Housing loans, which dominate the industry's balance sheet, will be a particular area of focus. Within the standardised approach, for example, you can expect to see that lower risk loans - such as amortising loans with low loan-to-valuation ratios (LVRs) - will get lower risk weights, but higher risk loans - for example, loans with extended interest- only terms will get relatively higher risk weights. A second reason is to make the framework more flexible, especially in times of stress. Holding a larger proportion of capital requirements in the form of buffers means there is more buffer available to be utilised in times of crisis, helping preserve the flow of credit at a time when it is most needed. Some of this will involve an expansion of the Capital Conservation Buffer, and some will be achieved by establishing a non-zero Countercyclical Capital Buffer as the default setting. Both of these steps are mirroring steps being considered elsewhere in the world. APRA Chair Wayne Byres - About bank capital requirements 18 November 2020 Bank capital I'll turn now to another piece of unfinished business that I have spoken about at many of these events - bank capital. This has been a long-running exercise, 4 influenced not just by our own views, but the direction set by the Financial System Inquiry and the international Basel reforms. We want to bring this to the finish line. There are a number of key outcomes that these changes are designed to achieve. The first point I would make, however, is that we believe the banking system is adequately capitalised. The result of this reform will not be that the industry needs to raise additional capital. What we are seeking to do is complex and multi-faceted. We want to make the capital regime: . more risk-based - by adjusting risk weights in a range of areas, some up (e.g. for higher risk housing) and some down (e.g. for small business); more flexible - by changing the mix between minimum requirement and buffers, utilising more of the latter; . (...) (...) We are just putting the finishing touches to the consultation package, which we will release in the next few weeks. Without delving into all the details, probably the most fundamental change flowing from the proposals is that bank capital adequacy ratios will change. Specifically, they will tend to be higher. That is because the changes we are proposing will, in aggregate, reduce risk-weighted assets for the banking system. Given the amount of capital banks have will be unchanged, lower risk-weighted assets will produce higher capital ratios. However, that does not mean banks will be able to hold less capital overall. I noted earlier that a key objective is to not increase capital requirements beyond the amount needed to meet the 'unquestionably strong' benchmarks. Nor is it our intention to reduce that amount. The balance will be maintained by requiring banks to hold larger buffers over their minimum requirements. (...) In our case, bank capital ratios will go up, but the dollar amount of capital the banking system has to hold should be largely unchanged.5 You might then ask why we are proposing an extensive set of changes, if we don't want to change the amount of capital held? One reason is to improve risk sensitivity. We will be adjusting risk weights in a range of areas to help make sure capital is better allocated according to risk. Housing loans, which dominate the industry's balance sheet, will be a particular area of focus. Within the standardised approach, for example, you can expect to see that lower risk loans - such as amortising loans with low loan-to-valuation ratios (LVRs) - will get lower risk weights, but higher risk loans - for example, loans with extended interest- only terms will get relatively higher risk weights. A second reason is to make the framework more flexible, especially in times of stress. Holding a larger proportion of capital requirements in the form of buffers means there is more buffer available to be utilised in times of crisis, helping preserve the flow of credit at a time when it is most needed. Some of this will involve an expansion of the Capital Conservation Buffer, and some will be achieved by establishing a non-zero Countercyclical Capital Buffer as the default setting. Both of these steps are mirroring steps being considered elsewhere in the world