The changes that are going ahead are a requirement for MLH banks to adjust the value of their liquid assets regularly to account for movements in market prices, and that all banks must be “operationally ready to provide certain key information regarding their financial position when requesting exceptional liquidity assistance from the Reserve Bank of Australia”.

The third proposed change, which is now on hold, is that bank debt securities be phased out from MLH liquidity books completely. This would have meant a massive overhaul of liquid asset holdings: APRA reports that an average of 60 per cent of MLH banks’ liquids books comprises bank debt securities.

The rationale behind the proposal is clear. Erica Santosaputri, APRA’s head of liquidity risk, told seminar delegates: “Past experience has shown that bank securities are less liquifiable in a banking stress scenario, and that their yield can rise and value be lost quite dramatically. We are thinking about whether these are really liquid assets that are available in such situations.”

On the other hand, the consequences for the mutual bank sector are broad and deep. Replacing bank securities with regulated high-quality liquid assets (HQLAs) – which in Australia largely means local sovereign and semi-government securities – could slash the yield generated by liquids books, creating a material cost of carry.

There are also operational considerations. Shane Marchant, group treasurer at Great Southern Bank, explained: “Holding government and semi-government paper comes with its own risks, which we need to understand, measure, monitor and manage. Meanwhile, if we’re going to be participating in fixed-rate bonds we will need to asset-swap them to manage duration risk. This will require setting up ISDA [International Swaps and Derivatives Association] agreements, CSAs [credit support annexes] and other considerations such as the ability to repo.”

The ripples extend to the funding side of the ledger, too. While they typically have strong retail deposit bases, many mutuals source a large proportion of their wholesale funding from their peers via the negotiable certificate of deposit (NCD) market. This source of demand would need to be replaced if it is removed, potentially forcing mutuals to access alternative asset classes and investor groups with higher cost of funds.

Police Bank’s treasurer, Brendan Albury, revealed that modelling based on APRA’s initial proposal suggested the annual impact on Police Bank of more reliance on HQLAs would be “not immaterial for an entity like ours”, though the precise impact would depend on how full implementation is. “It can be offset by not holding as big a volume of liquid assets, but this effectively means taking a negative approach and shrinking the balance sheet,” Albury added.

The significance of the impact was behind APRA’s decision to take its foot off the gas on the liquid assets proposal. But the clear message is that this is a pause rather than a change in fundamental direction.

Santosaputri explained: “We took on board some of the feedback from the industry and decided, after a long deliberation, to defer the proposal. However, I think it’s quite clear in our response paper that we continue to be concerned about the level of bank securities held in the system. We would still like ADIs [authorised deposit-taking institutions] to think proactively about their liquid asset portfolios.”

APRA has noted both that it believes the 60 per cent industry average holding is too high, and that there is “significant variation across the cohort of MLH ADIs” with some holding “materially above the average level”. On the other hand, Santosaputri also acknowledged that a uniform approach may not be the best fit for every bank.

For instance, she revealed that APRA “gave a lot of thought” to whether it should settle on a holding limit number, and if so what it should be. But it concluded that the outcome could be “very different depending on the ADI’s circumstances, balance sheet, capabilities and its decisions on diversification”. For the time being, the regulator “quite consciously decided not to come up with a fixed number or target”.

More lead time could in and of itself help mutual ADIs manage forthcoming changes. Marchant said: “With time, we can work through all these things in a methodical way. It may mean more change for some institutions but I believe it is achievable.”

Others argued that even a fairly significant update to liquidity rules should be manageable. On liquid assets themselves, Neil Stevenson, treasurer at Qudos Bank, argued that the yield drag of holding more HQLAs can be offset by extending tenor beyond the short term of the NCD market.

He explained: “It’s true that the yield on semi-government CP [commercial paper], at 5-10 basis points below BBSW, would offer significant cost of carry. But it doesn’t have to be a like-for-like replacement: we can also buy term semi-government FRNs [floating-rate notes] at 35-40 basis points over BBSW. There is capacity to change the book without taking credit risk or mark-to-market risk, or giving up too much income.”

Marchant added: “There is an opportunity for semi-government issuers to work with mutual banks as new incremental investors – perhaps with an eye to supplying us with FRNs at tenor of five years and less. More lead time allows this work to happen, to see if there is a place we can meet and participate in the primary market.”

A positive input in this aspect is that the Australian semi-government cohort as a whole has a significantly larger ongoing funding need to fulfil and there are signs that it is therefore more than happy to work with a new group of potential investors – even if doing so means tailoring issuance to meet its preferences.

Treasury Corporation of Victoria (TCV)’s head of markets, Paul Kelly, told seminar delegates: “We will be really interested to hear the feedback of the mutual bank sector, directly or indirectly, as it goes through its transition over the next 12 months or so.”

While emphasising that TCV is primarily a long-dated, fixed-rate issuer, Kelly also highlighted TCV’s A$17 billion stock of FRNs on issue. “We don’t often tap our FRN lines and we won’t be able to supply all the demand in floating-rate format, but if the sector is seeking 3-5 year semi-government FRNs it is something we will be able to help with in some way,” he revealed.

Incorporating the mutual bank update in a wider review of liquidity regulation also opens the door to an expanded list of HQLAs. APRA has never populated an Australian level-two liquid assets list but in other jurisdictions banks can hold securities such as covered bonds, and international supranational, sovereign and agency issuance in their liquids books.

Santosaputri noted that APRA is yet to finalise the scope of its liquidity review. But there may be support for a wider range of HQLAs to be considered. “A bigger list of HQLA options would always be helpful,” Marchant suggested. “European-regulated banks are able to take advantage of level-one and level-two HQLAs, and both tend to feature prominently in their books. It’s definitely worth keeping an eye on these things to see if they make sense.”

There is also some confidence that the demise of the NCD market has been overstated. Stevenson pointed out that mutual banks inevitably carry some degree of surplus liquidity over the regulated minimum, in the form of operational liquidity. This turns over frequently and therefore is most appropriately allocated to relatively short-tenor instruments.

“We can still have some flexibility in our operational risk holdings even if what we ‘park’ for prudential purposes is higher-grade securities – and I believe this will allow mutual banks to continue supporting each other,” Stevenson told seminar delegates.

David Flanagan, head of money markets at Curve Securities, added: “I don’t think there’s going to be a huge, material shift in the NCD market though, at the margin, the peer bid will probably taper by a small amount. Mutuals will need to have a reasonable amount of operational liquidity for their day-to-day functions – things like cash-flow management – and I believe NCDs will have a big role in this.”

There are also potential homes for NCDs beyond peer banks. Flanagan noted that a number of non-ADI participants are actively in the process of engaging more deeply in the mutual space. These investors tend to start with exposures to larger and more liquid transactions but, Flanagan continued, as they get more comfortable they typically take further steps into the sector.

Securing access to multiple forms of wholesale funding will still be important, though. Albury commented: “I think the MLH peer bid will still be there, at least until we know for sure what APRA is going to decide. But it is important that we explore diversifying our investors away from the banking sector. Getting other investors to do the credit work and start allocating is going to be key to weathering what we’re going to run into in the next little while.”

This progression hints at the central issue, and one that is reshaping the mutual bank sector from a number of angles: the need for scale. This is particularly apparent in wholesale term funding markets, where issuers need to hit a minimum benchmark size to complete cost-effective transactions – a hurdle that is getting higher.

“Deal size matters, no matter what,” explained Helen Mason, fund manager and senior credit analyst at Schroder Investment Management. “We need liquidity in public markets, and we also have to be able to get sizeable exposures to justify allocating resources to a deal. For us, deal sizes of less than about A$250 million (US$165.5 million) are a bit problematic – which obviously presents problems for some mutuals.”

This does not mean Schroders is not willing to support the sector – far from it. Mason revealed that deals from mutual banks are of interest thanks to the diversification benefits they offer even though there may be better value elsewhere. For instance, senior mutual bank debt issued earlier in 2024 offered similar margins to major-bank tier-two deals, even though mutuals are typically in the triple-B credit rating bracket while major-bank tier-two is single-A.

Market access challenges are likely to be most acute for smaller ADIs. “It’s entirely likely that we end up with a segmented sector when it comes to funding markets, and I think deal size is the key consideration,” Albury argued. “It seems that A$200 million is the new benchmark size at which bigger investors will consider buying – it used to be A$100 million. For an issuer with needs in the A$50 million area, it will be harder to break into the debt capital market.”

This reality is only adding to the drivers pushing mutual banks toward consolidation. Speakers at the KangaNews seminar suggested the end state for the sector could be dramatically different from today’s landscape despite the amount of mergers that have already taken place.

Jen Dalitz, chair at Qudos Bank – which is itself exploring a merger with Bank Australia – said: “In 2004, there were about 185 operators in the mutual sector. We are down to the mid- 50s and there will be 51 of us left if the currently announced mergers in train all eventuate. Some analysis predicts the ‘magic number’ for Australian mutual lenders could be less than 10, and my guess is it’s going to be significantly less than 10 at the finish post.”

Dalitz explained that the proposed Qudos Bank-Bank Australia merger would take the combined entity to number four in the mutual sector. “This is quite a large bank, which we think will enable us to do better for the mutual sector, for our customers and for our people, offering more career opportunities, making us a stronger bank, and enabling us to deal with the very challenging compliance and technology environment we find ourselves in.”

Lisa Barrett, director, financial services ratings at S&P Global Ratings, added: “Structural change is underway in the Australian banking sector, particularly in the mutual space. Our view is very much that consolidation will continue. There is not necessarily any definitive number of mutual banks but, at the end of the day, banks need enough scale to manage all the regulatory changes that have been coming in over recent years and will continue to come along, to continue to meet their customer demands and to deal with other ongoing structural changes – including digitalisation.”