How much capital does a bank hold?
Banks are required to hold capital in excess of the minimum amounts required by APRA to absorb losses and any deterioration in the bank’s risk profile, if the bank suffers financial difficulty.
Stronger banks hold more capital which results in higher capital and leverage ratios. This will reduce the likelihood of:
- non-payment of a distribution on a Hybrid; and
- the Hybrid being converted or written-off where the bank is non-viable or its common equity capital ratio breaches 5.125%.
What is the bank’s profitability and earnings?
Stronger banks have high and consistent earnings which may lead to a higher profitability. For example, this may be reflected through higher returns on equity and assets, pre-provision earnings and net profit after tax and earnings per share.
This will mean a bank is more likely to pay distributions on the Hybrid and generate capital which will reduce the risk that its Hybrids will need to absorb loss.
Dividends on a bank’s ordinary shares are discretionary and typically dependent on the amount of its profits.
What is the bank’s asset quality?
The business mix and asset quality of a bank will impact its strength and profitability.
Stronger banks have lower bad debts and loan losses on its assets. For example, this may be reflected through lower credit impairment charges and individual and collective provisions.
If a bank’s assets are higher risk (whether related to the market, sector, person or entity that it has lent to) then it may suffer higher losses. This may reduce its profitability and capital position.
How much liquidity does the bank hold?
Stronger banks have a stronger funding position and hold more liquid assets, which are readily available to meet the bank’s obligations including the repayment of liabilities (such as deposits).
A stronger liquidity position will reduce the likelihood that the Hybrid will be converted or written-off because it is non-viable. This may be reflected through a higher liquidity coverage ratio
Bank’s require diversified and stable funding sources. Reduced access to funding or an increase in funding costs may have an adverse impact on the financial position of the bank.
What is the impact of the broader economy?
It is helpful to consider the economic backdrop in each market the bank operates in, including the level of economic activity, interest rates, inflation and employment.
In general, a stronger economic backdrop is positive for banks and support their ability to remain viable and meet their obligations.