The Vickers Report – implications for Australia

Capital Requirements and Loss Absorbency

The Vickers report proposes higher capital requirements for large retail ring-fenced banks, and particularly for non-ring-fenced systemically important banks. An important consideration arises here of whether this is a matter best dealt with via regulation (such as implied under the Basel III proposals for SIFIs) or via supervision. In Australia, APRA operates a graduated approach to supervisory intensity of individual institutions based upon its PAIRS and SOARS framework. In principle, assessments of the severity of micro and macro – prudential risks arising from that framework can lead to imposition of higher, and tailored, capital requirements for SIFIs, rather than a specified regulatory requirement of "x" per cent.

Compliance with international standards suggests that there is limited scope for not adopting the Basel III regulatory proposals for large banks. However, the Vickers structural separation proposal would, arguably, enable a supervisory approach towards the retail ring-fenced entity while applying Basel III regulatory requirements to the non-ring-fenced entities.

Failure Management Powers

The Vickers report proposes the implementation of "depositor preference" arrangements for the ring-fenced bank whereby depositors are senior to all other claimants in the event of bank liquidation. Australia is one of a relatively small number of countries where depositor preference already exists – although it is in the process of being slightly weakened to enable issuance of "covered bonds", and its rationale somewhat reduced since the introduction of deposit insurance via the Financial Claims Scheme.

Depositor preference arguably increases the cost of other (wholesale market) funding for banks – because of its subordinated status in bank liquidation. In this regard, the Vickers proposals of structural separation and limitation of depositor preference to the retail-ring-fenced bank would provide the opportunity for Australia to remove depositor preference from the non-ring-fenced banks.

Another of the Vickers proposals is to provide the authorities with "bail-in" powers, such that long-term unsecured debt ("bail-in" debt) of a bank requiring resolution could be subject to some degree of write down by the authorities[3]. Such powers may enable an open resolution to take place rather than having to place the bank into liquidation. The dilemma with such a power is the uncertainty it may create unless potential bail-in arrangements are clearly specified, and thus the consequences for the costs of debt.

While "bail-in" debt seems unlikely to garner much support in Australia, it is worth noting that New Zealand, having decided against continuation of explicit deposit insurance after the end of 2011, is considering such arrangements as part of the Open Bank Resolution proposals on which the Reserve Bank of New Zealand is currently consulting. A particularly noteworthy feature of those proposals is that "bailing-in" or "haircuts" would also apply to depositors. (Deposits would be written down to some level consistent with the solvency of the bank, and the remaining balances government guaranteed to prevent outflows while the open resolution (eg by takeover by another bank) was effected). Since New Zealanders can place funds in the parent Australian banks (in AUD) and get the protection of the Financial Claims Scheme, any preference for doing so, rather than maintaining deposits at risk in the New Zealand banks in any future period of uncertainty, may create additional liquidity problems for the NZ banks.