Thank you to FINSIA for setting up today’s webinar. I am a long-time member, and a great supporter of FINSIA’s efforts to improve professional practice and standards of conduct across the industry, so I’m very happy to be part of today’s event.
Before I say a few words about APRA’s response to COVID-19, I want to reiterate the Governor’s comments about the successful and very important coordinating role that the Council of Financial Regulators (CFR) plays in ensuring our actions are pursued to promote the best financial system impact and outcomes for the benefit of the Australian community. It is a very important part of Australia’s economic response to COVID-19.
A fundamentally strong financial system acts as a shock absorber
From APRA’s perspective, critical to our COVID-19 response has been the underlying strength of the financial system. Australia was fortunate to enter 2020 with a financial sector in good financial health overall. It has also been very resilient from an operational perspective. Both those things have proven very valuable in navigating the past few months.
That strength is the product of a concerted and persistent effort by the industry, reinforced by regulators, to build-up resilience during the good times. The age-old adage of saving for a rainy day is never more apt than now. We’re glad we did it, even though it wasn’t always easy or popular at the time.
So, for example, compared to the 2008/09 financial crisis (or even the 1991/92 recession), the major banks entered this period with much stronger balance sheets: capital is higher, liquidity and funding profiles are stronger, and asset quality better. More broadly, the Australian banking system is well-capitalised by both historical and international standards. The CET1 capital ratio of the banking system – the key metric of financial soundness – was above 11 per cent during 20191Going into the GFC, the equivalent ratio would have been roughly half that.
That strength has been a virtue over the past few months, and allowed Australian banks to play a role as a shock absorber for the economy. And it is not just banks that have had the strength to contribute to the immediate COVID-19 response: insurers have been able to support customers by modifying terms and conditions to help those affected by the virus, and the superannuation sector has been playing a role in promptly dealing with payments under the Government’s early release scheme.
All of these things are helping soften the blow of the very severe economic contraction over the past couple of months.
We regulators have had a role to play too. Showing just how fast-moving this crisis has been, in January APRA published a comprehensive policy and supervisory agenda for 2020. Eight weeks later, we announced most of it would be deferred until at least the end of September. Realistically, many items will not restart until 2021.
It is important to note why we did this. It was not because the original set of plans was ill directed, or we have had a change of heart. Rather, it was to allow regulated entities to dedicate time and resources to maintaining their operations and supporting customers in a time of need, while also enabling APRA to intensify our focus on monitoring and responding to the impact on entities’ financial and operational capacity. For the industry and APRA, COVID 19 has been a case of ‘all hands on deck’. We will come back to our broader agenda once we have a better sense of the landscape ahead of us.
Beyond deferring many activities, one of the first actions we took was to issue a statement regarding the ‘unquestionably strong’ capital benchmarks. We set those benchmarks – very fortuitously to be achieved by the start of 2020 – to ensure banks were well capitalised in the event of stress. We therefore moved quickly, and simultaneously with the announcement of the Term Funding Facility by the RBA, to relax those expectations.
As I noted earlier, bank capital ratios have been at historical highs. That capital has been built up precisely so that banks are able, in times of stress, to absorb losses and sustain the flow of credit to the broader economy. Now is the time to allow that to happen. It means capital ratios will come down over the year ahead: that should surprise no one. For example, major bank CET1 ratios below 10 per cent again are to be expected. As that occurs, we need to keep it in perspective: less than three years ago, the aggregate major bank CET1 ratio had never been above 10 per cent, yet they were still regarded by investors and rating agencies as very strong banks.
Our message to make use of capital buffers to support economic activity has not, though, been without strings attached. Capital can essentially be used for three purposes: to sustain and grow the business, to absorb losses, or to reward shareholders. We prefer capital buffers utilised for the first two. As a result, we wrote to banks and insurers in early April asking that they seriously consider deferring, or at least materially reducing, discretionary capital distributions in the months ahead. A number chose to defer dividends, while those that paid have generally offset them with other capital raisings.
I want to stress we did not intervene on dividends lightly. We recognise the important role they play in the investment returns of many Australians. However, our mandate is first and foremost to protect the safety of bank deposits and ensure insurers have the means to pay claims.
While decisions such as this are invariably difficult, we believe we have chosen a balanced approach. We hope the impact on dividends from the current COVID-19 crisis will be temporary, but obviously the outlook remains highly uncertain. For that reason, we firmly believe prudence is the appropriate strategy for the time being. Our approach is designed to underpin financial system stability over the longer term, which ultimately benefits all Australians.
The other action I want to quickly touch on is in relation to bank loan repayment deferrals. I should stress that we do not determine whether, and in what form, banks choose to offer support to their customers. But we do have a role in deciding the capital and reporting treatment of those loans. It is a subtle but important distinction.
Again, the reason we were comfortable granting capital concessions to banks offering loan deferrals was because, even though we know unfortunately not all customers will recover, banks have a strong starting position to absorb eventual losses. It was another ‘on balance’ judgement, weighing up the risks and benefits. Banks’ ability to provide support is not limitless, but it was the right decision for the time. It is not without risk, however, and in the interests of transparency we have also required banks to disclose the extent of deferrals granted, so that investors and markets can understand the impact.
Through all of our actions, we are trying to facilitate an orderly adjustment to the post-COVID world. I would stress that does not mean hiding from reality, but we can help facilitate an adjustment that is not excessively disruptive. These actions, and the others we have taken, are designed with that goal in mind.
1 At end-2019, the aggregate CET1 ratio for the four major banks was 11.3 per cent. In internationally comparable terms, this is in the order of 16 per cent – well within the top quartile when measured against internationally active banks.