RBNZ orders independent review of Westpac NZ's capital modelling, Westpac says 'never any suggestion it did not have appropriate capital'

Westpac New Zealand is to have its capital modelling independently reviewed at the behest of the Reserve Bank.

The bank's latest general disclosure statement details a series of errors in its capital modelling dating back as far as eight years. This means Westpac has breached its conditions of bank registration.

Westpac's capital modelling errors include classifying its local government exposures as sovereign exposures instead of bank exposures, and making changes to its internal SME retail/corporate asset class definitions without first obtaining the required Reserve Bank approval. The bank says it has been operating some capital models without having first obtained Reserve Bank approval since July 2014. (See full details at the foot of this story).

"Consequently, the Reserve Bank has advised that the Bank's compliance with advanced internal rating-based aspects of [Prudential Supervision Document] BS2B is to be independently reviewed. This review is to be conducted under section 95 of the Reserve Bank Act," Westpac says.

"The Bank estimates that the changes it implemented resulted in an increase of risk weighted assets in excess of $1bn and the Bank considers its internal credit model methodologies result in the retention of an appropriate amount of capital to reflect its credit risk."

The penalty for an offence under section 95 of the Reserve Bank Act is a fine of up to $2 million.

Like ANZ, ASB and BNZ, Westpac uses the internal ratings based (IRB) capital modelling approach. This IRB capital approach means banks build their own models to calculate their regulatory capital requirements and must then get them approved by the Reserve Bank. All other New Zealand banks use what's known as the standardised approach where the Reserve Bank prescribes their capital risk weights. Effectively using the IRB approach allows banks to hold less capital and thus bolsters profitability.

A Westpac spokesman said the bank will "fully engage in the review" with the Reserve Bank.

"The changes to our models resulted in us holding more capital and there was never any suggestion that the bank did not have appropriate capital," the Westpac spokesman said.

A Reserve Bank spokesman said: "We generally don’t comment on the individual institutions that we regulate and we won’t be providing any additional comment on Westpac’s disclosure statement."

The Reserve Bank is currently undertaking a review of all aspects of New Zealand banks' capital requirements.

Below is the full detail of non-compliance with its conditions of bank registration disclosed by Westpac.

The Bank has fully complied with its capital requirements as set out in the Bank's conditions of registration except in the following respects in which it was non-compliant with the condition of registration 1B.

The Bank identified that since 2008 it had:

 classified its Local Government exposures as Sovereign exposures instead of Bank exposures. The increase in risk weighted assets as a result of the change is $11m as at 30 September 2016; 

 not applied the 1.06 scalar to its Securitisation Exposures. The increase in risk weighted assets as a result of this change is $33m as at 30 September 2016. 

The Bank has identified that it has been operating versions of the following capital models without obtaining the Reserve Bank’s prior approval as required under the revised version of the Reserve Bank’s Capital Adequacy Framework (Internal Models Based Approach) (BS2B) that came into effect on 1 July 2014. 

 Loss Given Default (‘LGD’) model affecting exposures to unsecured institutional customers

 LGD and Exposure at Default models for credit card exposures

 Probability of Default (‘PD’) masterscale for wholesale customers

 PD model for wholesale property development and investment customers

 PD model for wholesale rural customers 

The Bank has also identified that it made changes to its internal SME retail/corporate asset class definitions without obtaining the Reserve Bank’s prior approval as required under the revised version of BS2B that came into effect on 1 July 2014. 

Consequently, the Reserve Bank has advised that the Bank's compliance with advanced internal rating-based aspects of BS2B is to be independently reviewed. This review is to be conducted under section 95 of the Reserve Bank Act. 

The Bank estimates that the changes it implemented resulted in an increase of risk weighted assets in excess of $1bn and the Bank considers its internal credit model methodologies result in the retention of an appropriate amount of capital to reflect its credit risk. 

*This is an abbreviated version of an article that was published in our email for paying subscribers early on Friday morning. See here for more details and how to subscribe.