APRA updated its capital management guidance for banks, particularly easing restrictions around paying dividends as institutions continue to manage the disruption caused by COVID-19 pandemic. The updated guidance replaces the April recommendations of APRA. Uncertainty in the economic outlook has reduced somewhat since then and APRA has had the opportunity to review financial projections and stress testing results of banks. Taking these and other developments since April into account, APRA has now written a letter addressed to banks advising them to maintain caution in planning capital distributions, including dividend payments.
Over the past three months, APRA has assessed resilience of the banking industry to a range of stress scenarios. With significant uncertainty over the depth and duration of the economic impact from COVID-19 pandemic, the objective has been to test the ability of the industry to withstand stress of different magnitudes. From this stress testing, it is clear that the banking system, overall, is well-positioned to withstand a severe downturn, but also that it would be severely impacted if such a scenario unfolded. Thus, a need for continued vigilance and careful planning exists: there remains uncertainty in the outlook both domestically and internationally; there is always a margin for error in any forward-looking analysis; and stress test results for individual banks will inevitably vary from the average. In this context, it is important that banks manage their capital capacity prudently. APRA is, therefore, providing further guidance on capital planning for authorized deposit-taking institutions for the period ahead:
- Buffers are available to be used if needed. As announced in March 2020, APRA does not expect institutions to meet the unquestionably strong capital benchmarks in the period ahead. Authorized deposit-taking institutions are free to, and should, make use of management buffers held above minimum regulatory requirements to absorb the impact of stress and continue to lend to support households and businesses. The capital conservation buffer provides an additional layer of capital that is available to be used if conditions deteriorate markedly.
- Caution should be maintained on distribution of dividends. For 2020, APRA expects that authorized deposit-taking institutions will retain at least half of their earnings and actively use dividend reinvestment plans and/or other capital management initiatives to at least partially offset the diminution in capital from distributions.
- Stress testing should be conducted regularly to guide decision-making. Authorized deposit-taking institutions should use stress testing to inform decisions on dividends and other capital actions as well as to assess their lending capacity under a range of different scenarios. Institutions should build positive loan growth assumptions into capital projections and stress testing to test and demonstrate the capacity to continue to lend: reductions in credit supply should not be relied on to meet internal stress testing benchmarks.
- Plans for any capital rebuild should be orderly. Authorized deposit-taking institutions should plan on the basis of an orderly rebuild in capital levels, where needed. APRA is committed to ensuring any rebuild of capital buffers, if required, will be conducted in a gradual manner. APRA notes that the implementation of the Basel III capital reforms, which will embed the "unquestionably strong" level of capital in the framework, has been postponed to January 01, 2023.
The APRA approach on the use of buffers is consistent with recent statements by BCBS (June 17, 2020) and FSB (July 15, 2020). BCBS noted that using capital resources to support the real economy and absorb losses should take priority at present. APRA expects that all authorized deposit-taking institutions will embed these principles in their capital management for the period ahead. This should include regular review of capital buffers and targets, prudent decisions on dividends, and ongoing stress testing to forecast and plan capital levels.
Keywords: Asia Pacific, Australia, Banking, COVID-19, Basel, Regulatory Capital, Capital Buffers, Dividend Distribution, Stress Testing, APRA
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