APRA “is actively seeking ways to make our regulatory framework simpler, more proportionate and easier to comply with” John Lonsdale, the APRA chair, told an industry conference yesterday.
APRA, along with all other members of the Council of Financial Regulators, has recently been tasked to review banking regulation, a topic Lonsdale largely avoided in his speech yesterday, preferring to allude to relevant themes.
“We will not take risks that might compromise stability or the ability of our banks to keep credit flowing to support the economy” Lonsdale said.
“With last month’s Federal Budget forecasting a weaker global and domestic economic outlook and with risks in the environment increasing, now is not the time to wind back the clock on financial safety.”
Over recent months, he said, “APRA has heard a consistent message from the banking sector that the industry has become too risk averse and that some in the community may be unfairly missing out on vital services, including access to credit.
“In summary: there is a view that the regulatory pendulum has swung too far towards safety at the expense of dynamism and considered risk taking. The narrative suggests that regulators, including APRA, should consider loosening constraints to boost the flow of credit, especially for new business ventures.
“The question of whether or not the current regulatory settings remain appropriate as economic conditions evolve is a legitimate matter for debate. No one wants unnecessary red tape nor to look to more regulation to solve every problem.
“Within APRA, we constantly ask ourselves these types of questions and not everyone in the room always has the same view.
“The case put forward here in Australia by those who say it’s time to rethink the regulatory settings for banking contains some good points that are worthy of reflection, but it also strikes me that the argument to date has been quite one-sided; heavily focused on the costs of financial regulation but paying little attention to the benefits or why it exists.
“There’s a strong emphasis on profit margins, return on equity and credit growth, but few – if any – mentions of the safety of deposits, protecting vulnerable people from unmanageable debts or the potential cost to taxpayers if a banking crisis unfolds.
“My purpose in addressing you today is not to argue that APRA’s prudential framework for banks is flawless. It’s not, which is why we are constantly reviewing and fine-tuning our settings, such as the current consultation on liquidity and capital requirements. Rather, I want to defend the importance of a strong, stable and resilient banking system – not only to protect the community and taxpayers, but also to support a thriving economy.
Present regulatory settings, he said, are not an accident. They are the product of deliberate decisions by governments and regulators in response to events, crises and inquiries over many years. These include the financial services Royal Commission that concluded in 2019 and the Financial System Inquiry final report of 2014, but chiefly stem from the Global Financial Crisis of 2007 and 2008.
“A decade and a half on, the true cost of the GFC remains hard to pin down, especially as it can’t only be measured in dollars, euros or yen, but also in jobs lost, homes repossessed and lives destroyed. Suffice to say, there seems little contention in acknowledging it as the most significant financial downturn the world has endured since the Great Depression.
“The internationally agreed Basel III reforms that emerged from the GFC laid the foundation for APRA’s modern prudential framework for banking with higher capital and liquidity requirements, as well as greater emphasis on risk management, governance and accountability.
“The Financial System Inquiry pushed APRA to go further in building a more resilient banking system.
“Most significantly, the Inquiry’s final report recommended APRA require banks to hold increased capital to make them ‘unquestionably strong’ – a status that all of our banks achieved by January 2020.”
Lonsdale went on to reflect on the circusmstances of an industry “in a country that hasn’t experienced a significant bank failure in almost 35 years.
“It’s easy to forget or become complacent about their impact on the economy and the community. When the Pyramid Building Society fell into liquidation in 1990, the Victorian Government had to repay $900 million dollars to affected depositors, which it funded with a five-year levy on petrol. In other words, taxpayers footed the bill.
“With the Basel Committee on Banking Supervision estimating that the median cost of a financial crisis is more than 60 per cent of a country’s annual GDP, APRA is understandably keen to shield Australia from such an outcome. Should one occur, however, our banking system is well-prepared.”
The results of APRA’s 2023 bank stress test found Australia’s banking system “was well-placed to remain resilient in a financial crisis.”
But, Lonsdale asked, “ what if the strength of our banks was ‘questionable’?”
“To put this to the test, we re-ran the stress test – using the same hypothetical scenario – but this time assumed the participating banks started from the capital positions that were required before ‘unquestionably strong’ – 1.5 percentage points lower for the major banks and 0.5 percentage points lower for all other banks.
“What we found was that several large banks in this alternative scenario would fully deplete their capital buffers and either breach their prudential requirements or be close to doing so. If this were to occur in real life, the best case is that the banks would need to rebuild their capital positions over time.
“This would likely involve a restriction of the supply of credit to households and businesses, potentially exacerbating any economic shock. The worst case is we would see one or more bank failures, which would either cause a severe credit crisis and recession or would require taxpayer-backed support of the banking system.
“That doesn’t mean we intend to keep ratcheting up the settings or that the current settings are frozen in time. Nor should it be assumed that safety and stability are our only concerns.
APRA supports less complexity and more proportionality where it’s safe to do so and we are open to fine-tuning our regulatory settings when appropriate.
“Our focus is increasingly about maintaining the strength of the banking system. While this is challenging in a moving operating environment where new risks emerge and existing ones evolve, we are transitioning to a more targeted approach focused on fine-tuning existing settings.”
Some of that fine-tuning will come in the form of “changes designed to make our prudential framework simpler, less burdensome to comply with and more proportionate.
“Whether recalibrating parts of the existing framework or introducing new policy, our considerations go well beyond financial safety and simply minimising risk. A safe financial system means the likelihood of less disruption from failures, which is more conducive to investment choices.
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We look forward to working with our colleagues on the Council of Financial Regulators on the recently announced competition inquiry to see if those challenges can be addressed in a way that doesn’t undermine those banks’ resilience.”
John Lonsdale was speaking at the annual conference of the Australian Banking Association.