Prepare for ‘big, disruptive events’, says APRA

Speaking to the 2020 Forum of the Risk Management Association, Wayne Byres, chair of the prudential regulator, noted that the year 2020 had caused widespread disruption, but that the industry needed to ensure it was prepared for future “big, disruptive events” moving forward.

“If ever there was a year when risk managers proved their worth, this was it,” he told delegates, noting that 2020 had seen a series of unexpected but high-impact events unfold, from the bushfire catastrophe to the COVID health and economic crises. 

He added that as black swan events seem to be increasing, financial institutions need to be ready for the unexpected and building resilience. 

“We want a system that is able to absorb shocks, even from so-called black swan events, and [has] the means to restore itself to full health,” Mr Byres said. 

Liquidity has been a key area of focus for the regulator, he said, given the extreme volatility and also the sudden government decision to implement an early superannuation release scheme. 

“The superannuation sector, used to a stream of steady and predictable cash flows, had to grapple with a large, sudden and unexpected outflow,” Mr Byres said. 

“Banks benefited from that outflow from superannuation into household deposits, but on the other hand had to deal, for example, with a strong demand to redeem negotiable certificates of deposit (NCDs) well before their contractual maturity.”

At the heart of the challenges, he said, were behavioural assumptions that did not hold. But behavioural assumptions are what form the foundations for risk management and prudential regulation, he continued.

“The liquidity coverage ratio, for example, is built on assumptions of likely stressed outflows over a one-month time horizon,” the APRA chair explained.

“But what about when those assumed stress flows prove inadequate? And what about liquidity needs sitting just beyond the one-month window? 

“Both are issues on which we need to reflect on and consider whether – without seeking to raise requirements – we can adjust the framework to make the system more resilient to liquidity stress.”

The regulator is also contending with the troubles arising from climate change, with plans to release a prudential practice guide on related financial risks.

Mr Byres referred to this year’s State of the Climate report from CSIRO and the Bureau of Meteorology, which has painted a “stark picture”. Warming temperatures, a rise in extreme fire weather, a drier continent in areas of greatest population density, more intense rainfall events, rising sea levels and increasing acidification of the oceans around Australia have all been forecast. 

“It is impossible for these events, and the changing government policies, investor preferences and community expectations that accompany them, not to have financial consequences,” Mr Byres commented.

“At APRA, we have not sought to prescribe how climate-related risks should be managed, but we most definitely see a thorough understanding of climate-related risks as essential for a resilient financial system.” 

He went on to urge the industry to not only be financially strong, but also to become more resilient. 

He said the capital framework could also “possibly be improved in a couple of areas to make the system more resilient”.

The first suggested change is a re-evaluation of the buffer framework, to make it easier to use capital buffers without unintended consequences. 

The second is the role of additional tier 1 instruments in providing loss-absorbing capacity, which is being discussed internationally. APRA has signalled it will be watching how the debate plays out. 

Another risk to an organisation is its people. Mr Byres cautioned that risk managers will need to have social and cultural issues in their sights. 

“The people-related risks from the extended period of disruption are very real.

“They will impact on organisational performance, operational controls and risk culture – all critical to good risk management and organisational resilience,” he concluded.

[Related: Mutuals may need to prepare for mergers: APRA]