Australia's major banks have been steadily growing their total loss-absorbing capacity (TLAC) since 2019. This can make banks safer in the event of distress, lowering the need for taxpayer-funded bailouts. Why then does S&P Global Ratings still expect such banks to be bailed out if a financial crisis hits?

That's a good question and one we are hearing a lot from investors and others.

To answer it, this FAQ will be divided into three parts:

• The first explores why we believe the Australian government remains highly likely to support the systemically important banks in the country.

• In the second part, we discuss important analytical implications of the growing stock of Tier 2 securities. We estimate the four majors will issue A$15 billion-A$20 billion in Tier 2 securities for each of the next two years. The major banks are partially using Tier 2 capital instruments to meet their TLAC requirements.

• The final part broadens out to how we incorporate our assessments on likely government support for all banks in Australia--including those that are not systemically important.

Frequently Asked Questions

Part I: Why Bailouts Remain A Likely Resolution Option For Australian Major Banks

Why does S&P Global Ratings consider the Australian government as highly supportive toward systemically important banks?

A range of somewhat interdependent factors drive our view. We would like to emphasize the "interdependent" aspect. Some of these factors are also apparent in many countries where we consider governments as less supportive of the private sector banks. The difference is that in Australia's case, all of these factors are in play, and generally with greater intensity:

The Australian economy's significant dependence on the banking system's access to offshore borrowings.  It is extremely important for the Australian economy that offshore creditors continue to see their debt in Australian major banks as low-risk investments. Disruption in their access to offshore borrowings could meaningfully hurt the economy, because:

• Australian banks' net external borrowings as a proportion of domestic customer loans will remain at about 20%-25%, high versus most peers. Despite Australia's balanced current account in recent years, we expect the deficit to remerge in two to three years' time. Australian major banks source most of the external debt, which is used to partly fund this deficit.
• Australian banks account for more than 80% of the domestic private sector debt in the country.

Contagion risk from the four major Australian banks' interconnectedness, significant similarities, and dominant share of the Australian banking market.  Collectively, these banks have a market share of about 75% of the sector's loans and deposits. Allowing one of them to fail could lead to distress across all four, translating into substantial and long-lasting damage to the Australian financial system and consequently, the economy.

Pragmatic political stance and little social opposition for government support.  In our view, the Australian authorities hold a pragmatic view that government support for the systemically important banks remains is the best way to maintain financial system and economic stability. We believe that the two main political parties share the same philosophy on this issue. Lack of widespread social opposition to a bailout option backs the political fortitude on this issue, in our view. In contrast, bailouts were contentious in the U.S. and parts of Western Europe following the global financial crisis in 2008-2009.

The existing legislation and regulation in Australia do not pose any impediments or preconditions for a bailout.  This is unlike the resolution framework adopted in the EU. Consequently, government support is likely to be a more feasible option in an Australian financial system crisis, in our view.

Track record of prompt and decisive action to support banks.  The banks have not faced a major crisis since the early 1990s. Nevertheless, the track record points to support. In October 2008, the Australian government announced its guarantee for customer deposits (up to A$1 million) and wholesale funding of Australian banks to support their funding stability during the global financial crisis. Similarly, when the pandemic broke out in 2020, the Reserve Bank of Australia extended low-cost term-funding to the banks. Total drawdown under this facility peaked at A$188 billion, or nearly 8% of the GDP.

But doesn't S&P Global Ratings usually consider the introduction of a TLAC framework as a signal of reduced government tendency to support banks based on systemic importance?

Globally, we have often viewed the introduction of TLAC requirements and bail-in powers as a sign of a government's reduced willingness to rescue a failing bank. But in our opinion, Australia's TLAC framework does not include any concrete actions that would suggest reduced government support.

We see the TLAC framework in Australia as part of broader efforts to make banks operationally resolvable. Increased loss-absorbing capacity could also bolster creditors' confidence in the Australian banking system thus reducing the risk of a stress scenario. That, in turn, would lessen the need for the Australian government to provide financial assistance to banks.

The TLAC framework in Australia did not introduce any policy or process impediments to the government bailing out a systemically important bank. Nor does it suggest any diminution in the Australian authorities' willingness to do so, in our view.

Indeed, some public statements by Australian authorities have indicated that the country is not just strengthening loss-absorption capacity to protect taxpayers from potential bank bailouts. The objective is to protect the community from the potentially devastating broader impact of financial crises by: (1) reducing the probability of failure; and (2) by establishing sufficient recapitalization capacity such that, should a failure or near-failure occur, the overall cost to the economy is minimized.

What about APRA's finalization last year of CPS 900 resolution standard? Does this signal potential weakening of government supportive forbanks?

No. In our view, regulatory progress on this matter should mean that APRA-regulated entities are better prepared to go through the resolution process, if needed. The standard also reinforces our opinion that APRA is one of the world's most conservative and proactive regulators.

So Australia's bank-resolution is different than those in Europe and North America?

Yes, significantly so in the following ways:

• Unlike most countries in those jurisdictions, in Australia statutory bail-ins of senior unsecured obligations of a bank does not appear to be a feasible option.
• In many other countries, the legislation requires that state aid may only be made available after substantial absorption of losses by junior creditors. No such legislative restriction is currently part of the framework in Australia.
• As we interpret it, the Australian authorities hold a pragmatic view that government support for the systemically important banks remains a preferred option to maintain financial system and economic stability.
• Australian authorities have not introduced a new class of securities to boost banks' total loss absorbing capacity, or identified any senior-debt obligations which may be bailed-in for bank resolution. Rather, APRA expects the systemically important banks to predominantly use Tier 2 capital to boost their TLAC.
• The headline TLAC requirement for D-SIBs in Australia is 18.25% of regulatory risk-weighted assets. This is significantly lower than that for their counterparts in Europe and the U.S. Banks in the U.S. have TLAC requirements well over 20%. Major European banks have loss-absorption ("MREL") requirements of about 22%-28%. Hence, the Australian D-SIBs' capacity for full recapitalization following a resolution could be considered weaker in comparison. This notwithstanding our view that APRA's capital rules are more generally conservative than those in most other countries.

Part II: How We View Australian Banks' Tier 2 Securities

How close are Australian major banks to meeting the regulatory requirement for strengthening their total loss-absorbing capacity?

Under Australia's TLAC framework, the four major banks, are required to raise their TLAC to 18.25% of risk-weighted assets by January 2026. Based on the indicative capital stack for a major bank, we expect Tier 2 capital to form at least 6.5% of the regulatory RWAs. In our consideration, these banks are well on track to meet the regulatory requirement (see table 1).

Table 1

We estimate the annual issuance collectively by the four major banks in each of the next two years to be about A$15 billion-A$20 billion. Our estimates include the Australian banks' existing stock of Tier 2 capital, the upcoming calls on the existing issues, and the gap to meet the regulatory requirement by January 2026. The Australian major banks should not face any significant hurdles in funding this volume, in our view.

How does S&P Global Ratings define additional loss-absorbing capacity (ALAC)?

ALAC is our measure of the gone-concern loss-absorption and recapitalization capacity. In some jurisdictions, ALAC can absorb losses of a financial institution (FI) at or near nonviability--for example, in the event of a resolution. This could address unrecognized losses and recapitalizing an FI as necessary in a way that reduces the risk of it defaulting, according to our definitions, on its senior unsecured obligations.

An FI's ALAC is the sum of:

• Its hybrid capital instruments not included in total absorption capacity that have the capacity to generate common equity, through conversion into common equity or a principal write-down, at the initiative of the authorities when the FI is failing; and
• In some jurisdictions (for example, the U.S., Switzerland, and the U.K.), senior and subordinated obligations of its nonoperating holding company.

We may lift our issuer credit rating on a bank above its stand-alone credit profile (SACP) to reflect extraordinary support due to the bank's ALAC.

In that case, why do the Australian major banks' significant Tier 2 buffers not lead to an uplift in the ratings above their SACPs? Do these securities support the ratings on Australian banks in any other way?

Tier 2 instruments do not boost Australian banks' going-concern capital.  We do not include Australian banks' Tier 2 capital in our primary measure of their going-concern capital strength--our risk-adjusted capital ratio. That's because we don't think these securities would absorb losses while the bank is a going concern. These longer-maturity instruments strengthen the stability of Australian banks' funding bases, although only marginally.

Nor do Australian major banks qualify for an ALAC uplift despite a sizeable stack of Tier 2 capital.  Yes, we typically include Tier 2 capital in ALAC. However, we do not see the resolution framework in Australia as sufficiently effective to reduce default risk on senior unsecured obligations, and consequently an ALAC uplift. This is largely because we do not believe that the Australian authorities have the intent to recapitalize a failing bank using Tier 2 capital or any other gone-concern loss-absorbing resources. At least not in a manner that avoids a default, as per our definition, on the bank's senior unsecured debt.

Rather, as noted above, our ratings on the major Australian banks incorporate our view that the government is highly likely to inject pre-emptive solvency support if any of them faces severe solvency stress.

What are the credit risks associated with the Tier 2 capital instruments of Australia's four D-SIBs?

We typically rate the four major banks' Basel-III style Tier 2 securities three notches below their senior debt. This reflects our view the that the Tier 2 securities carry significantly higher overall credit risk reflecting the following factors:

• One notch for subordination in liquidation;
• One notch for our view that extraordinary support from the Australian government is unlikely to apply to the Tier 2 securities; and
• One notch for the risk of loss-absorption via conversion or write-down when the bank is at or near nonviability.

Would there be an upside to your ratings on Australian major banks if you assessed the bank resolution framework as effective?

No. We uplift our issuer credit rating on each of the four Australian D-SIBs one-notch above the SACP. This reflects our view that there is a high likelihood of them receiving extraordinary government support, if needed.

In comparison, the maximum ALAC uplift for a financial institution with an SACP of 'a' or 'a+' is one notch. Consequently, our ratings on Australia major banks should remain unchanged even if we assessed the resolution framework as effective--and other things remained unchanged. (We also note under our criteria, we may continue to classify a government as highly supportive even if it has implemented an effective bank-resolution regime; it's just that this would be atypical compared with our existing assessments).

Finally, where a financial institution qualifies for rating uplift due to more than one form of extraordinary external support such as ALAC or government, the potential issuer credit rating is the highest outcome based on the alternative forms of uplift. That is, the uplift is not additive.

Are Hong Kong and Canada in the same boat as Australia in terms of an unusual combination of efforts at loss-absorption, yet also likely government supportiveness?

Not exactly. Hong Kong and Canada are the only two banking systems globally where we consider the respective governments to be supportive and yet we also see their resolution frameworks as sufficiently effective for applying an ALAC uplift in our ratings on the banks. In essense, we see the authorities as having legal, practical, and political optionality to either bailout or bail-in.

In contrast, we assess the Australian government to be "highly supportive" and the resolution framework as not sufficiently effective for the reasons explained earlier in this article.

A key feature in our assessment for Hong Kong is the ability of the Hong Kong authorities to make senior unsecured debt legally bail-inable (though this may not happen in practice). We also consider the creation of the jurisdiction's Financial Institutions Resolution Ordinance as intended to provide a credible alternative to bailouts. And this not least aided by the bail-in of a substantial buffer of subordinated liabilities and equity that could be sufficient to absorb losses and deliver the necessary recapitalization.

Similarly, for Canada, we assess the federal authorities as having the ability and intent to permit a D-SIB that is nearing non-viability to continue going-concern activity, after loss-absorption by bail-in-eligible senior debtholders and/or junior creditors, in a manner that avoids default (by our definition) on bail-in-ineligible senior debt.

Based on the existence of this framework and public statements by the authorities in Hong Kong and Canada, we think they could use a bail-in resolution, indicating a lower probability (than in Australia) that the government would bailout first.

Still, with the supportive assessment for Hong Kong and Canada, we assume that the government might yet intervene, for example in a systemic crisis and possibly in an idiosyncratic one. Certainly, there are no legal constraints to this, and bailouts do not carry the same politically toxic connotations as in the U.S. and Europe. If intervention comes, it could be before a bank becomes non-viable, or after the bail-in of subordinated instruments.

PART III: Uplift For Government Support In Ratings On Australian Banks

How does S&P Global Ratings incorporate government support in its ratings on Australian banks in general?

To arrive at the issuer credit rating of a bank, we may apply an uplift above the bank's SACP reflecting the likelihood of extraordinary government support based on systemic importance. Key factors driving our assessment of likelihood of extraordinary government for this uplift include:

• Our assessment of a government's tendency to support banks based on systemic importance, which could be: highly supportive, supportive, or uncertain; and
• Our assessment of the degree of a bank's systemic importance, which could be: high , moderate , or low systemic importance.

We determine this uplift in our ratings on a bank, if we assess it to be of moderate or high systemic importance, after considering the relevant mapping tables in our Financial Institutions Methodology, the local currency rating on the government, and the bank's stand-alone credit profile.

We consider the Australian government as highly supportive toward banks based on systemic importance. We assess each of the four major Australian banks to be of high systemic importance.

In addition, we view Macquarie Bank Ltd. and Cuscal Ltd. to be of moderate systemic importance. We apply an uplift for extraordinary government support in our issuer credit ratings on each of these six institutions--and ratings on senior debt issued by them (see table).

Nevertheless, we do not apply any uplift in our ratings on their additional Tier 1 or Tier 2 instruments because we consider that the Australian government is unlikely to extend extraordinary support to these instruments, which may absorb losses via coupon nonpayment, principal write down, or conversion.

Table 2

Why do you not apply a similar uplift in your ratings of other Australian banks if you consider the government is likely to support Australian banks?

We apply such uplift only if we assess that bank to be of moderate or high systemic importance. Currently, we assess all financial institutions, other than those listed in table 2 to be of low systemic importance to the Australian financial system. Consequently, we do not apply an uplift in our ratings on any other Australian banks to reflect the likelihood of extraordinary government support based on systemic importance.

Our treatment does not rule out the possibility that the Australian government could bail out a bank we assess of low systemic importance. Rather, it reflects our opinion that such an outcome is unlikely.

The ongoing "business-as-usual" support from the well-functioning and predictable institutions in Australia bolsters our ratings on all banks in Australia. In contrast, the uplift for systemic government support is applied only to systemically important banks.

We consider that the government is more likely to directly support the systemically important financial institutions, for example, in a situation of economic or financial system crisis when there will be elevated competition on government resources.

How do you assess systemic importance of financial institutions?

We define systemic importance as the degree to which a financial institution's failure affects all or parts of a country's financial system and economy. We classify an FI as having high, moderate, or low systemic importance based on our view of how adverse we expect the impact of the entity failure would be.

For example, an FI has high systemic importance if a default of its senior unsecured obligations is likely to:

• weaken the country's financial system,
• limit the availability of credit for the private sector,
• and trigger a significant financial stress at several other financial institutions.

Size is not the only determining factor. We also assess the level of interconnectedness, or the linkages of a financial institution with other parts of the financial system.

For example, the entity may be a significant counterparty within the country and international financial system or play a critical role in the national payments system, such that its failure would lead to a loss of confidence in the financial system and significant losses among other counterparties in the market. Another example may be if no other institution can step into an FI's key role in the economy if it fails.

Related Research and Criteria

Related Criteria

• Sector And Industry Variables: Criteria: Financial Institutions: Banks: Banking Industry Country Risk Assessment Update: March 2024, March 27, 2024
• General Criteria: Hybrid Capital: Methodology And Assumptions, March 2, 2022 S&P Global Ratings
• Financial Institutions Rating Methodology, Dec. 9, 2021
• Banking Industry Country Risk Assessment Methodology And Assumptions, Dec. 9, 2021

Related Research

• Most Non-Major Australian Banks Upgraded On Strengthened Institutional Framework; Outlooks Stable, April 3, 2024
• Major Australian Bank Outlooks Revised To Stable, Macquarie Bank To Positive, After Policy Clarity On Government Support, July 9, 2019
• Asia-Pacific Banking: Despite Different Strokes, Government Lifeline Is Still Likely, April 4, 2019
• Ending Too Big To Fail: Different Journeys, Different Destinations, April 4, 2019
• Credit FAQ: Australian Government Support For Banks: Will There Be More Twists In The Tale?, April 9, 2019
• Hong Kong Likely To Stay Supportive Toward Banks With Effective Resolution Regime In Place; No Immediate Rating Impact, March 4, 2019
• APRA Proposal To Enhance Loss Absorbing Capacity Could Lead To Stable Outlook For Australian Major Banks, Macquarie Bank, Nov. 8, 2018
• Review Of Canadian Bank Resolution Regime Completed; Ratings And Outlooks On Systemically Important Banks Unchanged, Aug. 17, 2018