In July this year, the Australian Prudential Regulation Authority (APRA) updated its capital management guidance for banks and insurers, which recommended that banks should retain at least half their earnings and reduce dividends to investors, among several other changes, to ensure their resilience in an uncertain economy.
APRA has now updated its capital management guidance and replaced this recommendation, with banks no longer required to retain a minimum level of earnings from the start of 2021.
The loosening of the requirements has come amid a brighter economic outlook, with APRA stating that since July, there has been an improvement in the outlook, while bank capital and provisioning levels have strengthened, and the majority of loans that were previously granted repayment deferrals have recommenced payments.
APRA said that ADIs and insurers should remain vigilant when determining the appropriate levels of dividends, and regularly assess their financial resilience through stress testing, and adopt a “rigorous” approach to recovery planning.
In a letter to ADIs and insurers, APRA chair Wayne Byres said: “APRA expects banks and insurers to continue to moderate dividend payout ratios, and consider the use of dividend reinvestment plans (DRPs) and/or other capital management initiatives to offset the impact on capital from distributions.
“While APRA will no longer hold banks to a minimum level of earnings retention, the onus will be on boards to carefully consider the sustainable rate for dividends, taking into account the outlook for profitability, capital and the economic environment.”
ADIs withstand APRA stress testing
According to APRA, in the case of ADIs, the updated capital guidance has been informed by the results of extensive stress testing conducted by APRA since the onset of the coronavirus pandemic.
It developed a severe downside scenario, which involved a 15 per cent drop in gross domestic product (GDP), a rise in unemployment to over 13 per cent, and a fall in national house prices of over 30 per cent.
According to APRA, the scenario assumed that banks do not take any mitigating actions, such as raising capital or reducing operating costs.
The result was a 5 percentage point fall in CET1 capital ratio of the banking system, from 11.6 per cent to 6.6 per cent, but this remains well above the 4.5 per cent minimum capital requirement, and does not take into account any mitigating actions that would offset this impact.
“The tests indicated that Australia’s banking system could withstand a very severe economic downturn and continue to support the economy by supplying credit to households and businesses,” APRA said.
Capital management plan needed
Nevertheless, in his letter to ADIs and insurers, Mr Byres warned that banks and insurers must continue to support household and businesses as a high level of uncertain remains in the outlook for the operating environment.
He said all entities should remain vigilant and carefully plan capital management, which he said should include:
- Regular stress testing to assess financial resilience in various scenarios, including severe but plausible downturn conditions;
- Assurance on the capacity to continue to lend and underwrite insurance, with the use of capital buffers to absorb the impacts of stress if needed;
- A “rigorous” approach to recovery planning to ensure financial institutions are prepared to activate contingency measures and respond to conditions if needed; and
- Caution on capital distribution, with an ongoing measured approach to dividends in a heightened risk environment.
Commenting on the change in APRA’s capital management guidance, Mr Byres said: “A decade-long process of increasing capital levels and bolstering resilience in the banking system has put Australian banks in their current position of strength, allowing the sector to support customers and the broader economy at a time of crisis.”
“The results of APRA’s extensive ADI stress testing provide reassurance that the banking system remains well positioned to absorb the impact of a severe economic shock and retain the capacity to continue supplying credit into the economy.
“While the reduction in the number of loan repayment deferrals and improved economic outlook have allowed APRA to relax its July guidance for ADIs to retain at least half their earnings, the boards of ADIs and insurers are expected to maintain a prudent approach to capital management and dividend payouts.”
Malavika Santhebennur is the features editor on the mortgages titles at Momentum Media.
Before joining the team in 2019, Malavika held roles with Money Management and Benchmark Media. She has been writing about financial services for the past six years.