APRA to Transition to Annual Stress Testing of Large Banks in 2020
APRA published key findings of the stress testing assessment conducted on authorized deposit-taking institutions. APRA conducted a qualitative assessment of the internal stress testing capabilities of 28 authorized deposit-taking institutions in 2018-19, with focus on governance, scenario development, and use of stress testing. The assessment identified a number of areas requiring ongoing improvements among authorized deposit-taking institutions. APRA has outlined the identified improvements in a letter to the industry. APRA plans to consult on a prudential practice guide on stress testing in the second half of 2020 and to transition to annual stress testing of large institutions in 2020.
The assessment covered the most recent enterprise-wide stress tests, or EWSTs, and the most recent internal capital adequacy assessment process (ICAAP) reports of authorized deposit-taking institutions. Participants were split into two peer groups to facilitate more meaningful comparisons. Group 1 constituted larger diversified institutions and Group 2 constituted other participants with total assets ranging from $3 billion to $25 billion. The appendix to the APRA letter to industry lists the participating banks in Group 1 and Group 2. The assessment was informed by the Prudential Standard on Capital Adequacy (APS 110), the Prudential Practice Guide on ICAAP and Supervisory Review (CPG 110), the 2018 BCBS Stress testing principles, regulatory stress tests, and expert judgment. The key findings for the focus areas of this assessment include:
- Governance. Most Group 1 institutions had enterprise-wide stress tests frameworks with formalized governance structures, clear roles and accountabilities, and documentation to support most aspects of their stress testing process. Group 2 participants generally did not have specific frameworks for stress testing and instead relied in part on various risk-specific management frameworks and ICAAP documentation. When compared to Group 2, Group 1 entities typically had broader engagement across the organization in their stress testing activities.
- Scenario Development. Most Group 1 institutions have structured and integrated scenario development processes that engage stakeholders across the organization. Stress parameters and impacts were generally well-considered, with scenarios typically covering all or most material risks identified by the entity. The process at most Group 2 institutions tended to be less structured and integrated, with the scenarios and stress parameters typically having been designed with less sophisticated considerations. Many participants used previous APRA industry stress test scenarios, either as a substitute for their own internal ICAAP scenarios or as a reference to inform the macroeconomic settings of their own internal scenarios.
- Use of Stress Testing. Group 1 institutions generally made better use of stress test results and used stress testing in a wider range of decision-making than those in Group 2. Their ICAAP reports included details of the stress tests undertaken and the implications the results had on their main capital management decisions. Group 1 institutions typically used a set of capital adequacy criteria to express their risk appetite and assess their stress test results. The role of stress testing appeared much less prominent in Group 2 institutions, where ICAAP stress testing results were generally only used for the validation of their main internal capital targets. They typically did not have well-defined risk appetites around their capital adequacy.
The results of this self-assessment and actions to improve capabilities should be incorporated in subsequent ICAAP reports. The findings of this assessment will inform the further development of the guidance on stress testing. APRA intends to consult with industry in the second half of 2020 on a prudential practice guide on stress testing to promote industry better practice and consistency. To complement the ongoing improvement in stress testing capabilities and application, APRA is moving toward greater frequency and depth of stress testing for these institutions. This includes transitioning in 2020 to annual stress testing of large institutions. APRA also plans to test resilience to broader scenarios, including the impact from operational and climate change financial risks.
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Keywords: Asia Pacific, Australia, Banking, Stress Testing, ICAAP, APS 110, CPG 110, Enterprise Wide Risk Stress Tests, Operational Risk, Climate Change Risk, BCBS, APRA
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