The Australian Prudential Regulation Authority (APRA) has provided updated capital management guidance to authorised deposit-taking institutions (ADIs) and insurers, replacing its recommendation in July this year for banks to retain at least half of their earnings. From the start of 2021, APRA will no longer hold banks to a minimum level of earnings retention.
Since July, there has been an improvement in the economic outlook, bank capital and provisioning levels have strengthened, and the majority of loans that were previously granted repayment deferral have recommenced repayments. However, a high degree of uncertainty remains in the outlook for the operating environment.
In determining the appropriate level of dividends, APRA expects ADIs and insurers to remain vigilant, regularly assess their financial resilience through stress testing, and undertake a rigorous approach to recovery planning. The onus remains on boards to moderate dividend payout ratios to ensure they are sustainable, taking into account the outlook for profitability, capital and the broader environment.
In the case of ADIs, APRA’s updated capital guidance has been informed by the results of extensive stress testing conducted by APRA since the onset of COVID-19. 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 developed a Severe Downside scenario, which involved a 15 per cent fall 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. The scenario assumed that banks do not take any mitigating actions, such as raising capital or reducing operating costs.
The result of the Severe Downside scenario was a 5 percentage point fall in the CET1 capital ratio of the banking system, from 11.6 per cent to 6.6 per cent. However, this remains well above the 4.5 per cent minimum capital requirement, and does not factor in mitigating actions that would inevitably offset this impact. It is important to note that stress testing is not a forecast, nor is it used by APRA as a pass-fail test for individual institutions. Nevertheless, it does provide important insights into the underlying resilience of the banking system to a period of severe economic stress.
APRA Chair Wayne Byres said an improved economic outlook and the capital strength of the banking system have enabled a change in APRA’s capital management guidance.
“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,” Mr Byres said.
The letter to banks and insurers on capital management is available on APRA’s website at: Capital management.
The ADI stress testing information paper is available on APRA’s website at: Stress testing banks during COVID-19.