John Laker, Chairman - Senate Standing Committee on Economics, Canberra
Firstly, Madame Chair, can I introduce APRA's new Member, Ian Laughlin. Ian joined us on 1 July this year after a long career in the life insurance industry in Australia and abroad, and he will bring considerable experience and skills to our work.
Secondly, I would like to provide a brief update on developments.
We last appeared before this Committee in early June at a time of renewed turbulence in global financial markets. A spotlight on European sovereign debt problems and on the serious challenges facing banking systems and the public finances of a number of advanced countries led to a sharp decline in equity prices around the globe and heightened uncertainties, yet again, about the openness of global funding markets. We advised the Committee that we were closely monitoring the various impacts of this turbulence on our regulated institutions and that those impacts were being well managed.
Since then, global financial conditions have become a little more settled and Australian banks, which had held back for a time from tapping long-term offshore funding markets, have returned to those markets. The episode is a reminder, nonetheless, that there is an underlying fragility in global market sentiment that may produce further ‘twists and turns’ until the outlook for global economic recovery is more assured, pressures on banking systems and public finances abroad are contained and reforms to strengthen the resilience of the global financial system are in place.
This uncertain global setting is a counterweight to the positive outlook for the Australian economy, where a strong terms-of-trade boost is at work, and it argues for continued caution on the part of our regulated institutions and of APRA itself. The operating environment for our institutions is certainly more favourable than it has been since the global financial crisis first erupted but this is no time for boards and management to succumb to an adrenalin rush or to gloss-over the lessons from the crisis.
One action that helped to calm market sentiment in Europe, in addition to support packages to troubled European sovereigns, was an EU banking sector stress-test exercise, completed in July, which tested the capital resilience of 91 EU banks to an adverse economic and financial scenario. Just after our last appearance, APRA published the results of a macroeconomic stress-test it had conducted for the largest authorised deposit-taking institutions (ADIs) in Australia. The goal in our case was not to assuage market nerves — the strong capital position of our banking system has been well recognised — but to ensure that we understood what ‘near death’ could imply for ADIs and whether existing capital buffers would be sufficient to cope. The macroeconomic stress-test, developed in conjunction with the Reserve Banks of Australia and New Zealand, generated an economic downturn in Australia significantly worse than that experienced in the early 1990s recession and more severe than that built into other recent macroeconomic stress-tests in some other countries. The results, published in a different format to those of EU banks, confirmed that the ADI industry has the capital resources to weather much greater adversity than it has confronted to date.
During the crisis, APRA has also undertaken stress-testing in the other industries it regulates. In particular, we stress-tested the impact of declining equity and asset prices, widening credit spreads and increased market volatility on the capital positions of the life and general insurance industries. Stress-testing now forms an important part of APRA’s supervisory armory.
Since our last appearance, reforms to strengthen global capital and liquidity regulations have taken firmer shape. Over the first half of 2010, the Basel Committee on Banking Supervision, which is driving these particular reforms, carried out a quantitative impact study of its December 2009 proposals, as well as assessments of their economic impact over the transition period and of their long-run economic benefits and costs. After reviewing the various impacts, the Basel Committee announced in July 2010 that it had reached broad agreement on the overall design of its capital reforms. Broad agreement on the calibration and transition arrangements for those reforms was announced in September 2010.
In brief summary, the agreed capital reform package gives much greater weight to common equity in the capital base, raises the minimum requirements for common equity substantially and introduces stricter eligibility criteria for other forms of capital and for regulatory capital adjustments. It also introduces two new capital buffers in the form of a conservation buffer and, if needed, a countercyclical capital buffer. APRA does not expect that this tougher global capital regime will have significant implications for ADIs in Australia, which have remained well-capitalised throughout the crisis. Implementation of the reforms does not begin until 1 January 2013, giving us ample time to consult extensively with industry and other interested parties on the reforms.
The Basel Committee’s liquidity reforms seek to promote stronger liquidity buffers and more stable sources of funding to ensure that banking systems are more resilient to the sort of liquidity stresses that emerged, often very sharply, during the global financial crisis. The reforms involve two new global liquidity standards — a 30-day liquidity ratio to address an acute stress scenario and a longer-term structural liquidity ratio. Details on the measures were agreed at a Basel Committee meeting I attended yesterday in Seoul. In contrast to the capital reforms, the proposed liquidity coverage ratio does pose problems for Australia, since the volume of high-quality liquid assets (particularly government securities) needed to meet the requirement is simply not available. Acknowledging this reality, the Basel Committee is considering refining the standard to accommodate countries in this position. Alternative arrangements are under discussion and we will outline how this standard will be implemented in Australia once the Basel Committee announces full details of its liquidity reforms in December this year. The liquidity coverage ratio will come into effect on 1 January 2015 and the longer-term structural liquidity ratio by 1 January 2018.
Finally, can I note that the United Nations has designated today, 20 October, as World Statistics Day. APRA is proud of its Statistics Unit, which was formed from seven statistical groups in our predecessor bodies. APRA statistics not only inform our prudential supervision and research, but also support other agencies, particularly the Reserve Bank of Australia and the Australian Bureau of Statistics, in their missions. APRA’s statistics have also proven very useful in better informing industry and the public on the economic dynamics of the industries we supervise.
We are now happy to take the Committee’s questions.