February 21, 2019

IMF published its staff report and selected issues report under the 2018 Article IV consultation with Australia. Directors supported the Financial Sector Assessment Program (FSAP) recommendations and welcomed the macro-prudential interventions of authorities to reduce credit risk and reinforce sound lending standards. They encouraged the authorities to strengthen the integration of systemic risk analysis and stress testing with supervisory processes, complete the resolution framework, and expedite the development of bank-specific resolution plans.

The staff report highlights that Australian banks are well-capitalized and profitable. Following the requirement for capital to be “unquestionably strong,” banks’ capital levels are high in relation to international comparators. The regulatory emphasis on banks applying strong lending standards remains, but caps limiting investor and interest-only lending were removed by the end of 2018. Prudential interventions introduced by APRA sought to lower systemic risks from rapid household credit growth and already high debt levels at the outset of the recent housing boom. The capital adequacy framework for banks was further refined in 2018. Since the global financial crisis, APRA has raised capital adequacy requirements in several steps and introduced tighter liquidity requirements, including a net stable funding ratio (NSFR) in line with the Basel III requirements. Furthermore, in 2018, APRA established a framework and timeline for introducing a minimum leverage ratio for Australian banks and proposed changes to the capital adequacy framework to increase banks’ loss absorbing capacity.

FSAP stress test results found solvency and liquidity of banks to be relatively resilient to stress. While the tests revealed some pressure on capital, the banks examined would still be meeting regulatory minima. Liquidity stress tests revealed some vulnerabilities to severe stress, given the continued reliance on wholesale funding. Financial vulnerabilities from household debt and house price overvaluation are also expected to stay elevated. Against such vulnerabilities, macro-prudential policy should hold the course on implementation of stricter lending standards. The prudential caps restricting investor loans and interest-only mortgages have contributed to slowing household credit growth and cooling the housing market. The readiness of an extended macro-prudential toolkit should be explored.

The prudential measures used by APRA in the recent housing and credit boom have dampened growth in high-risk lending and reinforced sound lending practices. A further tightening is not warranted at this point in the cycle. Nevertheless, given the prospect of interest rates remaining low and household debt ratios remaining high for some time and expectations of continued strong growth in housing demand, the authorities should prepare for a possibility of another house price boom or increased macro-financial vulnerabilities for other reasons. Having a broad macro-prudential toolkit ready for deployment would provide for a flexible and targeted response to systemic risks that could emerge. 

The Australian authorities have developed a robust regulatory framework, but further reinforcement in two broad domains would be beneficial. First, the systemic risk oversight of the financial sector could be strengthened. The parallel 2018 FSAP recommends buttressing the financial stability framework by strengthening the transparency of the work of the Council of Financial Regulators (CFR) on the identification of systemic risks and actions taken to mitigate them. Improving the granularity and consistency of data collection and provision would support the analysis of systemic risks and policy formulation. Second, financial supervision and financial crisis management arrangements should be further bolstered. The recommendations of FSAP include:

  • Increasing the independence and budgetary autonomy of the regulatory agencies
  • Strengthening the supervisory approach, particularly in the areas of governance, risk management, and conduct
  • Enhancing the stress testing framework for solvency, liquidity, and contagion risks
  • Strengthening the integration of systemic risk analysis and stress testing into supervisory processes
  • Completing the resolution policy framework
  • Expediting the development of bank-specific resolution plans

 

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Keywords: Asia Pacific, Australia, Banking, Credit Risk, Systemic Risk, Financial Stability, FSAP, Article IV, Macro-Prudential Policy, Basel III, Stress Testing, APRA, IMF

 

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