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    APRA Publishes Capital Management Guidance and Stress Test Results

    December 15, 2020

    APRA updated the capital management guidance for authorized deposit-taking institutions and insurers. From the start of 2021, APRA will no longer hold banks to a minimum level of earnings retention. The updated guidance for authorized deposit-taking institutions has been informed by the results of extensive stress testing conducted by APRA since the onset of COVID-19. The tests indicated that the banking system in Australia could withstand a very severe economic downturn and continue to support the economy by supplying credit to households and businesses. APRA published an information paper that presents the results of this stress testing exercise.

    The updated capital management guidance replaces the July 2020 guidance, which expected all entities to maintain caution on dividend distributions and required banks to retain at least half of their earnings. Since July, the economic outlook has improved, 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 banks and insurers to remain vigilant. 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 case of a marked change in operating conditions or the expected outlook, APRA will provide further guidance as required. In its guidance, APRA emphasizes that entities should implement the following:

    • Regular stress testing to assess financial resilience in a range of scenarios, including severe but plausible downturn conditions
    • Assurance on the capacity to continue to lend and underwrite insurance, with the use of capital buffers to absorb the impact of stress, if needed
    • A rigorous approach to recovery planning, to ensure readiness to initiate contingency measures and respond to conditions, if required
    • Caution in capital distributions, with an ongoing measured approach to dividends in this heightened risk environment

    In addition to the results of the stress testing exercise, the information paper discusses the benefits and key lessons learned from this exercise, along with the next steps of APRA. APRA believes that regular and iterative stress testing is critical to provide assurance in a period of continued uncertainty and to contribute to the continued development of stress testing capabilities within the banking system. APRA’s engagement with the largest banks on stress testing has also highlighted the importance of a dynamic and iterative approach to stress testing being integrated into a bank's capital management framework to inform their decisions on capital and their understanding of key risks as uncertain economic conditions evolve. The progression to a more regular regime of APRA-led industry stress testing for the banking system will play an important role in building these capabilities. This includes continued engagement with banks on stress testing processes and outcomes.

     

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    Keywords: Asia Pacific, Australia, Banking, Insurance, COVID-19, Basel, Regulatory Capital, Stress Testing, Dividend Distribution, APRA

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