Westpac will be required to hold an extra A$500 million (265 million pounds) in capital after the Australian Prudential Regulatory Authority (APRA) announced an investigation into the bank's alleged money laundering breaches.
Westpac shares were down 1.2% in early afternoon trade on Tuesday, while the broader ASX200 was 0.1% higher.
Bell Potter analyst TS Lim said that while the APRA capital charges could be absorbed by the bank, the investigation would be a further distraction for its executive team.
"The bigger issue is that Westpac will be reviewing the risk practice at the same time that the bank is going to be transitioning to a new chief executive," he said.
In a research note to clients, Macquarie analyst Victor German said Westpac's increased "compliance and regulatory expenses will continue to weigh on earnings in the short to medium term" as the bank worked through the AUSTRAC claims.
APRA said in a statement the lender would now need the extra capital to "reflect the heightened operational risk profile of the bank".
It is the first time APRA has carried out a formal investigation using the Banking Executive Accountability Regime (BEAR) legislation which came into effect in July last year.
Under the laws, APRA has the powers to directly disqualify directors and executives itself rather than pursue people through the Australian court system.
APRA will investigate whether Westpac's directors or staff gave false or misleading information to auditors, a charge that carries up to five years jail.
Westpac Chairman Lindsay Maxsted, who will retire early as a result of the allegations, said the bank "accepted the gravity" of the AUSTRAC claims and would co-operate with the APRA investigation.
"As previously stated, these shortcomings are unacceptable and we are determined to urgently fix these issues and lift our standards," Maxsted said in a statement to the ASX.
Westpac in June was ordered by APRA to hold an extra A$500 million following a self-assessment programme which found it needed to toughen its oversight of "non-financial risk".
Australia's second-largest bank by market capitalisation was accused by AUSTRAC, the financial crimes agency, last month of breaching anti-money laundering laws up to 23 million times between 2013 and 2019..
The investigation could take up to two years, a source with direct knowledge of the matter said.
"AUSTRAC's statement of claim in relation to Westpac contains serious allegations that question the prudential standing of Australia's second-largest bank," APRA Deputy Chairman John Lonsdale said in the statement.
"While Westpac is financially sound, there are potentially substantial gaps in risk governance that need to be closed."
(Reporting by Scott Murdoch; Editing by Lisa Shumaker and Stephen Coates)
By Scott Murdoch