investor daily logo

Big banks put through new stress test

By Charbel Kadib
4 minute read

The prudential regulator is set to release the results of a new stress test assessing the stability of the banking sector following a shock to the global banking system earlier this year.

Chair of the Australian Prudential Regulation Authority (APRA) John Lonsdale has sought to reassure stakeholders of the resilience of the Australian banking sector just under seven months after vulnerabilities were exposed in the United States and Europe.

The aggressive monetary policy tightening cycle brought to light poor liquidity management practices, which led to the collapse of three US banks – Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank – as well as Swiss giant Credit Suisse.

Liquidity pressures were exacerbated by swift deposit runs, accelerated by what Mr Lonsdale termed the “digital financial revolution”.

The Australian banking sector was largely unharmed by international system “aftershocks” but equities investors were spooked at the height of the crisis.

Australia’s prudential framework was praised for its rigour, with particular reference to interest rate risk in the banking book (IRRBB) standards.

But in his address to the Citi Australia & New Zealand Investment Conference on Thursday (12 October), Mr Lonsdale said the regulator must remain vigilant to ensure local banks withstand future shocks to the system.

As part of this campaign, APRA has put 11 of Australia’s largest banks through another stress test scenario using the new bank capital framework, which came into effect earlier this year.

In the stress test scenario, a “severe downturn” and elevated inflation lifted the unemployment rate to 10 per cent, and residential property lost a third of its value.

Mr Lonsdale said APRA was still reviewing the results, scheduled to be released to the public early next year.

However, the chair revealed none of the banks breached their capital requirements, all “retained sufficient liquidity”, and banks continued to support the flow of credit to households and businesses.

“Although a hypothetical exercise, these results provide confidence in overall financial system resilience,” he said.

“The scenarios used for APRA’s stress tests are designed to be severe yet still plausible. That’s why, in addition to hypothetical factors such as a domestic recession and high unemployment, we often insert a sudden non-financial shock – such as a natural disaster or a major cyber attack.”

This was the second reported assessment in 2023, with APRA conducting a stress test months out from the banking crisis in the United States and Europe.

The test also suggested Australia’s banks were well placed to absorb shocks to the financial system.

Under the scenario, banks were subject to a “deep and prolonged global economic downturn” underpinned by rising interest rates and “prolonged inflationary pressures exacerbated by energy supply shocks”.

GDP fell 4 per cent, unemployment surged to 11 per cent, and national home values plunged 43 per cent over three years.

This resulted in sovereign and bank debt ratings downgrades, a temporary closure of offshore funding markets, a sell-off in the Australian dollar, and a widening in credit spreads.

Additionally, each of the 10 banks were hit with a “major and costly cyber attack”, with APRA also assuming no mitigating actions to absorb the shock.

All banks experienced significant credit losses under this scenario, with profits falling sharply and slashing investor dividends.

However, the banks remained above minimum capital requirements, retained sound funding and liquidity positions, and kept deposits “safe”.

Despite these assurances of the stability of the banking system, Mr Lonsdale warned regulators would need to adapt to the rapidly evolving landscape.

“To ensure Australia’s banking system is equipped for this new reality, APRA will continue to press boards to lift their standards of risk management, and is prepared to act promptly, and forcefully, if necessary, to rectify weaknesses ahead of serious problems emerging,” he said.

“As our policy agenda evolves in response to developing risks, we will also look to respond in a way that enables competition while recognising that all banks are significant to financial system stability.

“Just as importantly – all bank customers are significant. And regardless of whether they choose an industry giant, a mid-size bank or their local credit union, all depositors need to know their money is safe and will be available when they need it.”