Going the distance: APRA's approach to the COVID-19 fight
Hello, and thank you for inviting me to join you today, even if it is only via technology rather than in person. I hope you and your families are all safe and well as we deal with what has been a terrible period of loss for many countries and communities.
Had things gone to plan, I would be joining Anna Bligh in welcoming you to the wonderful city of Sydney. You would have made a long journey to get here, but I assure you it would have been worth it. At some point in the future when borders reopen, I hope you will again have the opportunity to make the trip.
Sadly, things haven’t gone to plan. At the start of the year, none of us envisaged the events of the past few months. That said, this scenario should not be a complete surprise. Given SARS in 2003, H1N1 (swine flu) in 2009, and MERS in 2013, we should not be caught off guard by the emergence of a pandemic. In Australia, we have had prudential guidance on pandemic planning for financial institutions in place for many years, and it has certainly proved its worth in recent months.1
Of course, planning for a crisis before it happens is the easy bit. Unfortunately, even with the best preparation, things rarely go exactly to plan. Military strategists have long acknowledged the axiom that no battle plan survives first contact with the enemy. Or simply, former world heavyweight boxing champion Joe Louis is said to have observed: “Everyone has a plan until they’ve been hit.”
The global economy has taken some ferocious blows of late as COVID-19 has spread around the world, shutting businesses, confining residents to their homes, and leaving millions globally with reduced hours of employment or no job at all. The simultaneous contraction of supply and demand, and the speed with which it has occurred, has been unprecedented in our working lives. The economic pain is very severe, and the outlook remains highly uncertain.
A bad situation would become dramatically worse should a financial institution find itself under stress or possibly fail. Thankfully, the financial sector – unlike 2008, when the crisis was in large part self-inflicted – is thus far playing its role as a shock absorber for the economy. The post-2008 reforms have no doubt played their part here. Banking systems, with the aid of central bank and government support packages, are helping dampen rather than amplify the impacts of the economic shutdown. But as much as we have all worked to overcome a torrid past few months, we also need to keep in mind that the real battles for the financial sector remain ahead. Measures to backstop liquidity have worked well and bought us time, but solvency pressures are mounting as credit risks come to the fore.
So today I thought I would cover three issues: how we have responded thus far in Australia; how international cooperation and coordination is working; and how the virus might change regulatory and supervisory priorities into the future.
The opening bell
I pointed out in some public remarks last week that in January we released a comprehensive set of policy and supervision priorities for the year ahead.2 Eight weeks later, we had to announce a complete change of tactics. Most of what we had planned was put on hold until later in the year, if not 2021, as we narrowed our focus to surviving the rapid onslaught of a major operational disruption coupled with a very severe economic contraction.
Put simply, the past few months have seen APRA focused on three core areas when it comes to the banking sector:
- operational resilience, and ensuring that all banks are managing the operational challenges through a period of quite intense disruption;
- financial resilience of individual banks, shoring up balance sheet strength and liquidity profiles at a time of volatile and fragile financial markets; and
- financial stability more broadly, so that there is confidence the industry as a whole can continue to support households and businesses at the time when they most need it.
Of course, these areas apply beyond banking – we have had a similar focus in the insurance and superannuation sectors we also supervise.
In its earliest days, COVID-19 was viewed through a health lens. As a result, our focus was directed towards operational resilience. As the spread of the virus increasingly disrupted normal working arrangements, we targeted our supervisory attention on the extent to which firms had adequate business continuity plans in place to ensure they could maintain their critical operations and obligations to customers in the unfolding scenario. The guidance I referred to earlier provided a very useful template for firms to ensure they were prepared, and for us to identify gaps and vulnerabilities.
I cannot stress enough how important the continuity of essential financial services has been at a time of heightened anxiety within the community. Like many places around the world, we saw that anxiety first hand as groceries were stripped from supermarket shelves. A fear of shortages quickly generated actual shortages. It was essential that concern about access to groceries did not translate into concern about access to money. Thankfully, firms’ plans have stood up well and (along with a great deal of reactive work behind the scenes) the level of disruption to financial services has thus far been minimal. The financial sector and its dedicated employees, both in Australia and elsewhere, deserve considerable credit for that very positive outcome. Ongoing vigilance to make sure it stays that way will be vital.
The early rounds
While the operational resilience of the system has held up well, it quickly became clear that the very necessary public health actions to protect the community would result in major economic disruption. Our scope of attention therefore rapidly broadened to financial resilience as well.
We were fortunate that Australia went into 2020 with a banking system in generally good health. We had been working for some years to position our largest banks in the top quartile of international peers from a capital adequacy perspective, and fortuitously they had achieved that positioning before the crisis struck. On an internationally comparable basis, our largest banks are operating with CET1 ratios in the order of 15-16 per cent, and capital within the broader banking system is at a historical high – and about twice the level heading into the 2008 crisis. Funding and liquidity positions were also stronger, and asset quality was good, reflecting a lot of supervisory attention in recent years.
Just to be clear, that didn’t mean we were in any way relaxed and comfortable – we were and remain on high alert – but it did allow us a degree of flexibility and room to manoeuvre as we thought about our response.
Broadly, we have done three things.
The first has been to look for opportunities to grant what you might call ‘operational relief’: easing the operational burden on firms by postponing some activities and granting additional time to satisfy some supervisory requirements. As I noted earlier, much of our 2020 agenda has been deferred until we have a clearer idea of the landscape before us.
The second has been to provide selective temporary concessions to assist in facilitating the broader package of economic and financial support being offered by the government, the central bank and the industry itself. The most important of those has been the capital treatment of the repayment holidays being offered by banks to household and small business borrowers. Here, I would like to acknowledge the important and proactive role played by the Australian Banking Association (ABA) in working very constructively with government and regulators to help put together an industry-wide package that provides help for customers in a genuine time of need.
And the third has been to make clear that the industry’s financial resilience has been built up to be utilised in times such as this. In particular, the government and central bank are both providing support to allow banks to keep credit flowing. It is in everyone’s interests – including the banking industry’s – that this happens.
To put it simply, our strategy in Australia thus far has been to exercise a degree of flexibility where it is clear that a rigid adherence to regulatory requirements would amplify the shock. It’s certainly reasonable to look through impacts and effects that we genuinely think will be reversed in the short term, and provide a smoothed (but still relatively prompt) transition for medium-term impacts. But we don’t have any real appetite for proposals that seek to hide from the facts: denial is not going to be a successful strategy for anyone. Moreover, just ‘kicking the can down the road’ risks making the adjustment process even more onerous than it already is by undermining confidence in the health of the system.
That is an outcome we need to avoid at all costs.
Sharing ideas and enlisting support
COVID-19 is clearly an international crisis. The financial impacts are being felt around the globe, and we know from experience that the interconnectedness of the financial system means that every jurisdiction needs not just to keep an eye on its own patch, but also be alert to vulnerabilities and spill-overs from weaknesses and actions elsewhere. Even if, as in Australia, we look to be successfully suppressing the infection rate and able to reopen significant parts of the economy, from a financial system perspective we cannot begin to breathe easier until that is occurring elsewhere as well.
The good news in the meantime is that, amongst the international community of central banks and supervisory agencies, there is a strong commitment to working together where possible to ensure a coordinated response. Although we cannot meet physically at present, the frequency of international engagement has definitely increased. In addition to many bilateral discussions, there are many conference calls of all the international bodies: the FSB, BCBS, IAIS, IOPS and IOSCO3 are all very active. For an Australian, that means many late nights on the phone given our time zone, but that is a small price to pay for the benefits that international engagement brings.
Four key principles are guiding much of the international work at present.
First, timely and active information sharing. This is critical to coordination in a fast-moving crisis. The international bodies have played an important role as a hub for collecting and disseminating information about developments in each member jurisdiction. This has provided valuable real time intelligence on developments and responses elsewhere.
Second, minimising the extent of regulatory change. A prominent example is the Basel Committee’s announcement of a one-year deferral on the implementation of the remaining Basel III reforms. Less visible but no less important are activities that were in the pipeline but have now been put on ice. International work on issues like operational resilience and cyber security are critically important, so the decision to defer them is not without risk. But it is better the industry is focused on responding to real life operational and cyber risks, rather than hypothetical examples in discussion papers, just at the moment.
Third, using flexibility in the regulatory framework to the maximum extent possible. This has been evident in the Basel Committee’s recent pronouncements on, for example, utilising buffers, transitioning to expected credit loss (ECL) provisioning, and the capital treatment of loan repayment holidays.
And fourth, not undermining the important benefits of the internationally agreed framework. While there is tolerance for temporary measures to smooth the transition to a post-COVID world, these should be done in a way that does not undermine the post-2008 reforms.
Of course, when it comes to international coordination, even with the best will in the world not everything ends up coordinated. Common approaches are most important where there are significant spill over effects; where there is not, the case is less clear cut. There is therefore always a delicate balance to be had between finding a common approach across many jurisdictions, and allowing individual responses to local circumstances. That is why international standards have always been set as minimum, not uniform, standards and why complete uniformity can never be a goal.
The virus has impacted different parts of the world differently, and so the economic and financial impacts will inevitably be different too. That means regulatory responses will differ to a degree. The divergent approach to dividend payments has been an interesting case study in that regard. But, on the whole, my observation on international coordination in the current environment is that it is very active, and there is a genuine commitment to making sure we coordinate wherever it makes sense to do so – and that is to everyone’s benefit.
Preparing for a long fight
One thing we all need to bear in mind as we deal with the immediate crisis is that, once we overcome the virus, the world will not simply pick up where it left off in January. While I cannot predict its precise form, this crisis will almost certainly precipitate enduring change in the way society operates. The idea that we’ll employ some temporary measures and then everything will ‘go back to normal’ is therefore a dangerously naïve one on which to base our decisions. Flexibility and agility will be important – we have a long battle ahead.
How will the regulatory and supervisory landscape evolve? The easy answer would be to say it’s too early to tell. I think that is also the correct answer. But in the interests of prompting some discussion, let me offer some views.
First, financial and operational resilience – the core of prudential supervision – will be the primary area of focus in the foreseeable future.
That is not to say supervisory focus on other areas of interest – such as governance, culture, and remuneration – will go by the wayside. They are still important, and we will still pursue them. But supervisory resources inevitably need to be directed to the areas of greatest risk. For the next little while, ensuring financial and operational resilience will be the priority, because the threats are substantial.
In particular, capital management will come under intense scrutiny as banks’ organic capital generation comes under even more pressure. Until there are clear signs of an economic recovery and banks are able to generate capital from retained earnings, it is reasonable to expect supervisory scrutiny of capital management and stress testing results to remain very high.
Second, the post-2008 reforms will be properly tested, and inevitably we will find areas where they can be improved.
Before anyone misinterprets that comment, I am not advocating a watering down of the post-2008 reforms. It may in fact turn out they’re insufficient, and we need to do more. Maybe they just need to be reshaped a bit. I do not know. But inevitably there will be things we learn, and we should not allow a determination not to backtrack on reforms to deter us from improving them.
One area where I think we are learning a lot at present is the ability to use buffers. It is not as easy as hoped, despite them having been explicitly created for use during a crisis. One blockage does seem to be that markets, investors and rating agencies have all adjusted to contemporary capital adequacy ratios as (as the name implies) ‘adequate capital’. But in many jurisdictions, like Australia, ratios are at historical highs. We often hear concern about our major banks’ CET1 ratios falling below 10 per cent. This is even though, until a few years ago, their CET1 ratios had never been above 10 per cent and yet they were regarded as strong banks with AA ratings. So expectations seem to have shifted and created a new de facto minimum. We need to think about how to reset that expectation.
A second possible blockage is possibly that regulatory statements permitting banks to use their buffers are only providing half the story. Quite reasonably, what banks (and their investors) need to understand before they contemplate using buffers is the expectation as to their restoration. But we bank supervisors do not have a crystal ball – we cannot confidently predict the economic pathway, so we cannot provide a firm timetable. The best I can offer is that it should be as soon as circumstances reasonably allow, but no sooner. In Australia, I would point to the example of the way we allowed Australian banks to build up capital to meet their ‘unquestionably strong’ benchmarks in an orderly way over a number of years. We should not be complacent about the rebuild, but there are also risks from rushing it.
Third, transparency will become even more important.
Markets depend on information. In times of uncertainty, timely, reliable and accurate information is especially highly valued. Moreover, we have learned from previous crises that if markets lose faith in any of those characteristics, they will tend to run first and ask questions later.
We cannot afford that to happen. It is very important that we continue to promote transparency, and not be tempted to panic and switch the lights off in the mistaken view that it’d be better for everyone to operate in the dark. We do not want analysts, investors or rating agencies to over-estimate the size of the problem by assuming the worst in the absence of information. Even without regulatory prompting, banks should err on the side of revealing more rather than less.
Keeping our guard up
Whether through herd immunity, a vaccine or a determined campaign of social-distancing, this crisis will eventually end. Businesses will reopen, economic activity will regenerate, and unemployment will subside.
In the meantime, we need to keep the financial system operational and in good financial health so it can support the eventual economic recovery. That is no small task. Strength going into battle is obviously important, and we are fortunate that the Australian banking system had that. But as any experienced boxer knows, resilience in the ring requires more than just being unquestionably strong. A good fighter needs balance and flexibility, physically and tactically, to avoid or absorb punches and adjust their strategy as circumstances change.
We all have to be quick on our feet. Risks continue to evolve and we have to continually respond and adapt accordingly. For our part, we have sought to move quickly, provide flexibility and maintain a balance; this has required having an eye to the immediate threats while also bearing in mind the need to conserve strength for the longer-term. We have to make sure we can all go the distance.
Critical to this will be continuing to work together – government, regulators and industry – for the greater good. This is not always easy, but so far it has been happening and we are all the better for it. I commend you all for the roles you are playing in that, and very much hope it will continue.
1 See CPG 233 Pandemic Planning.
2 These priorities were set out to explain how APRA would deliver on the four key strategic objectives of our Corporate Plan: maintaining financial system resilience; improving outcomes for superannuation members; improving cyber-resilience across the financial system; and transforming governance, culture, remuneration and accountability across all regulated financial institutions.
3 Financial Stability Board, Basel Committee on Banking Supervision, International Association of Insurance Supervisors, International Organisation of Pension Supervisors, and International Organization of Securities Commissions.