APRA lauds ‘virtue’ of bank regulation

In an address to the Financial Services Institute of Australasia (FINSIA), chair of the Australian Prudential Regulation Authority (APRA) Wayne Byres lauded the resilience of the financial system in the face of the COVID-19 crisis.

Mr Byres claimed that safeguards employed by financial institutions in compliance with APRA’s regulatory framework have enabled the sector to assume more responsibility for supporting the broader economy.  

“From APRA’s perspective, critical to our COVID-19 response has been the underlying strength of the financial system,” he said.

“Australia was fortunate to enter 2020 with a financial sector in good financial health overall. It has also been very resilient from an operational perspective. Both those things have proven very valuable in navigating the past few months.

“That strength is the product of a concerted and persistent effort by the industry, reinforced by regulators, to build-up resilience during the good times. The age-old adage of saving for a rainy day is never more apt than now. We’re glad we did it, even though it wasn’t always easy or popular at the time.”

The APRA chair pointed to regulations, which required banks to build adequate capital buffers, strengthen liquidity and funding profiles, and improve asset quality.

According to Mr Byres, such requirements ensured that the sector was better placed to withstand a shock to the economy than during previous recessions.   

“That strength has been a virtue over the past few months and allowed Australian banks to play a role as a shock absorber for the economy,” he said.

“And it is not just banks that have had the strength to contribute to the immediate COVID-19 response, insurers have been able to support customers by modifying terms and conditions to help those affected by the virus, and the superannuation sector has been playing a role in promptly dealing with payments under the government’s early release scheme. 

“All of these things are helping soften the blow of the very severe economic contraction over the past couple of months.”

On easing of guidance

Mr Byres also defended the prudential regulator’s decisions to temporarily ease its capital benchmark to allow financial institutions to focus on managing COVID-19 risks.

“[Bank] capital ratios have been at historical highs. That capital has been built up precisely so that banks are able, in times of stress, to absorb losses and sustain the flow of credit to the broader economy,” he said.

“Now is the time to allow that to happen. It means capital ratios will come down over the year ahead: that should surprise no one.”

“For example, major bank CET1 ratios below 10 per cent again are to be expected. As that occurs, we need to keep it in perspective: less than three years ago, the aggregate major bank CET1 ratio had never been above 10 per cent, yet they were still regarded by investors and rating agencies as very strong banks.”

However, Mr Byres acknowledged the impact of APRA’s temporary concessions on shareholders, with the regulator encouraging institutions to hold back the payment of dividends.

“I want to stress we did not intervene on dividends lightly. We recognise the important role they play in the investment returns of many Australians. However, our mandate is first and foremost to protect the safety of bank deposits and ensure insurers have the means to pay claims,” he said.

“While decisions such as this are invariably difficult, we believe we have chosen a balanced approach.”

The APRA chair also made reference to the granting of capital concessions to banks offering loan deferrals.

Mr Byres claimed that while not all borrowers would recover from the impacts of COVID-19, banks have “a strong starting position to absorb eventual losses”.

“It was another ‘on balance’ judgement, weighing up the risks and benefits,” he added.

“Banks’ ability to provide support is not limitless, but it was the right decision for the time. It is not without risk, however. And in the interests of transparency, we have also required banks to disclose the extent of deferrals granted, so that investors and markets can understand the impact.”

According to the latest data from the Australian Banking Association (ABA), approximately $153.5 billion in home loans have been deferred for up to six months over the past few months in response to the economic fallout from the COVID-19 outbreak.

This equates to approximately 429,000 (one in 14) home loan customers.

Banks are bracing for a spike in defaults upon the expiry of the six-month deferral period.

The big four banks have set aside over $7.2 billion in credit provisions in anticipation of a sharp deterioration in credit quality.

Last month, S&P Global Ratings reported that it is forecasting an 85 bps increase in credit losses across the Australian banking sector’s loan portfolio in the 2020 financial year (FY20).

The 85 bps increase, which is expected to moderate to 50 bps in 2021, amounts to approximately $29 billion in gross loans, nearly six times higher than the record low in FY19.

[Related: Mortgage deferral total surpasses $150bn]