The Australian Prudential Regulation Authority (APRA) has updated its capital management guidance for banks and insurers, calling on banks to tighten up their capital management in a bid to shore up their stability.
While the regulator updated its guidance in April, near the beginning of the COVID-19 pandemic, the regulator noted that it has since been reviewing the banking and insurance sectors’ financial projections and stress testing results, which has led it to issue new guidance.
Taking these and other developments since April into account, APRA has now written to banks and insurers advising they should maintain caution in planning capital distributions, including dividend payments.
What banks will need to change
Notably, the regulator has told authorised deposit-taking institutions (ADIs) that it expects them to “retain at least half of their earnings and actively use dividend reinvestment plans (DRPs) and/or other capital management initiatives to at least partially offset the diminution in capital from distributions”.
This builds on APRA’s previous guidance from April, which urged bank boards to “seriously consider deferring decisions on dividends” and offset any distributions through other capital actions.
As well as telling banks to retain half of their dividends, APRA is also reminding banks that they are “free to, and should”, make use of management buffers held above minimum regulatory requirements to absorb the impacts of stress if needed and continue to lend to support households and businesses.
“The capital conservation buffer provides an additional layer of capital that is available to be used if conditions deteriorate markedly,” APRA’s letter to ADIs reads.
Given the uncertain economic environment, APRA also told banks they should be regularly stress testing to guide their decision making.
“ADIs should build positive loan growth assumptions into capital projections and stress testing to test and demonstrate the capacity to continue to lend: reductions in credit supply should not be relied upon to meet internal stress testing benchmark,” it added.
Finally, the regulator outlined that ADIs “should plan on the basis of an orderly rebuild in capital levels, where needed”, noting that the implementation of the “unquestionably strong” capital reforms has been postponed to 1 January 2023.
The letter reads: “Over the past three months, APRA has assessed the banking industry’s resilience to a range of stress scenarios. With significant uncertainty over the depth and duration of the economic impact from COVID-19, APRA’s objective has been to test the industry’s ability to withstand stress of different magnitudes.
“From this stress testing, it is clear that the banking system overall is well positioned to withstand a severe downturn, but also that it would be severely impacted if such a scenario unfolded. There is, therefore, a need for continued vigilance and careful planning: there remains uncertainty in the outlook both domestically and internationally; there is always a margin for error in any forward-looking analysis; and stress test results for individual banks will inevitably vary from the average.”
It continued: “In this context, it is important that banks manage their capital capacity prudently, moderating dividend payments to sustainable levels and prioritising lending to support households and businesses during the economic recovery. In addition, banks will need to navigate the challenges ahead in managing a material volume of loans on repayment deferrals, supporting borrowers in an orderly transition.”
APRA concluded: “The aim of this guidance is to assist longer-term capital planning and to ensure ADIs remain able to fulfil their role in supporting Australia’s economic recovery.”
‘Banks face additional challenges to their capital resilience’
APRA chair Wayne Byres said the updated guidance balanced the need for banks and insurers to keep supporting households and businesses while also maintaining a prudent approach in the face of a very sharp and severe economic contraction.
“Today’s announcement strikes a balance in recognising the strength of the financial system while at the same time acknowledging the difficult path ahead,” Mr Byres said
“Although the environment remains one of heightened risk, we now have a stronger sense of how Australia’s economy and financial institutions are being impacted by COVID-19. On that basis, APRA believes that banks and insurers do not need to continue to defer capital distributions, provided they moderate payments to sustainable levels based on robust stress testing and continue to prioritise supporting their customers and the economy.
“In the current environment, banks face additional challenges to their capital resilience, including the material volume of loan repayment deferrals (which are subject at present to regulatory concessions), greater financial impact from COVID-19, and restrictions on dividends from their New Zealand operations.
“APRA has therefore set an expectation that dividend payout ratios for ADIs will be maintained below 50 per cent for this year.”
He concluded: “The years spent building up the capital strength of Australia’s banking sector to historical highs have been precisely for a time such as this.
“Further, APRA is committed to ensuring any rebuild of capital buffers, if required, will be conducted in an orderly manner,” Mr Byres said.
[Related: NZ freezes bank dividends]
Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.