Largest banks survive APRA stress test

John Lonsdale, the new chair of the Australian Prudential Regulation Authority (APRA), has revealed findings from a recent stress test of 10 “systemically important” Australian banks amid concerns over the stability of the global financial system.  

Under the scenario, banks were subject to a “deep and prolonged global economic downturn” underpinned by rising interest rates and “prolonged inflationary pressures exacerbated by energy supply shocks”. 

In the APRA test, GDP fell 4 per cent, unemployment surged to 11 per cent, and national home values plunged 43 per cent over three years. This resulted in sovereign and bank debt ratings downgrades, a temporary closure of offshore funding markets, a sell-off in the Australian dollar, and a widening in credit spreads. 

Additionally, each of the 10 banks was hit with a “major and costly cyber attack”, with APRA also assuming no mitigating actions to absorb the shock. 

Mr Lonsdale revealed all banks experienced significant credit losses under this scenario, with profits falling sharply and slashing investor dividends. 

However, the banks remained above minimum capital requirements, retained sound funding and liquidity positions, and kept deposits “safe”. 

“In reality, banks would take a range of actions to mitigate the financial impacts of the scenario in question,” Mr Lonsdale said.

“When we allowed banks to take these into account, we saw capital restored to above buffers and back towards their ‘unquestionably strong’ targets.”

The APRA stress test aimed to build confidence in the local banking sector in the aftermath of three banking collapses in the US (Silicon Valley Bank [SVB], Silvergate Bank, and Signature Bank) and the demise of Credit Suisse. 

Mr Lonsdale acknowledged the regulator’s limitations in safeguarding public trust in the system but said APRA would “create the conditions for it to flourish”. 

“The trust Australians feel in their banks’ ability to withstand a crisis is the product of many years of regulatory reform designed to reinforce the system’s financial and operational resilience,” he told the AFR Banking Summit on Tuesday (28 March). 

“This has enabled us to build a regulatory system for banking that has different and often tougher standards and requirements than many peer jurisdictions. 

“We might be connected, but their issues and problems are not necessarily ours.”

The APRA chair lauded the regulatory standards imposed on Australian banks, including capital requirements modelled on the Basel III framework.

“APRA talks about three levels of alignment to Basel: sub-equivalent, equivalent, and super-equivalent. And in a number of important areas, APRA’s prudential framework is super-equivalent, meaning it goes above and beyond the minimum Basel requirements,” Mr Lonsdale said. 

This includes incorporating recommendations from the 2014 Financial System Inquiry for “unquestionably strong” capital requirements, with the APRA chair claiming these reforms have put Australian banks in the “top quartile of the international pack”.

Mr Lonsdale also pointed to stricter risk-weighting requirements for the local sector, given it has a “particular concentration risk in residential mortgage lending”; and “narrower range of definitions” of high-quality liquid assets (HQLA) when determining the liquidity coverage ratio (LCR).

Notably, Mr Lonsdale said Australia is the only jurisdiction to require banks to hold capital to offset risks associated with higher interest rates — interest rate risk in the banking book (IRRBB) standards. 

According to the chair of the prudential regulator, these unique safeguards would have better protected US banks, particularly Silicon Valley Bank (SVB), reducing their sensitivity to aggressive monetary policy tightening. 

“The significance of this measure in light of current events is hard to overstate,” he said.

“SVB’s exposure to rising interest rates was one of the main factors behind its collapse. In contrast, as markets moved in response to RBA changes in the official cash rate, Australian banks have had to hold additional capital.

“Some banks had expressed displeasure about the application of capital for IRRBB but two weeks ago, the IRRBB requirement proved its worth.”

He revealed APRA is looking to expand its IRRBB standard, drawing from lessons from recent banking volatility. 

Mr Lonsdale’s assurances were echoed by Assistant Treasurer Stephen Jones in a separate address on Tuesday (28 March). 

“One thing is clear: Australia’s banking system is resilient,” he said. 

“While we are not immune from the volatility in global financial markets, Australia’s banks are well regulated, well capitalised, and have strong liquidity coverage.

“Australia’s financial system is well equipped to deal with the disruptions and challenges in the global economy.”

Markets have somewhat stabilised following the initial shock wave induced by the bank collapses in the US and Credit Suisse’s downfall and subsequent takeover by local competitor UBS. 

However, contagion fears persist, with Germany’s Deutsche Bank the latest to feel the brunt of investor uncertainty. 

Deutsche Bank recorded an 8 per cent decline in its share price on Friday (24 March), closing the trading day at €8.4 ($13.8) per share. 

The dip coincided with Deutsche Bank’s decision to prematurely redeem US$1.5 billion ($2.2 billion) in tier 2 subordinate notes. The bonds, listed on the New York Stock Exchange, were not due to expire until 2028. 

But the global investment bank’s share price has since recovered, closing trading on Monday (27 March) 6 per cent higher at €9 ($14.5).