Banks in Australia would continue to meet minimum capital ratios in the face of a severe economic downturn, modelling by APRA and banks has found.John Laker, chair of the Australian Prudential Regulation Authority, yesterday sketched out the findings of a stress testing exercise conducted by APRA and the 20 largest deposit taking entities.The difference in this exercise (worked on by APRA and the banks late last year and early this year) was that the scenario was plausibly severe, a theme lacking in earlier stress tests. On the other hand even the most recent exercise was not severe enough to send any bank broke.The scenario adopted was one in which global shocks generated "an economic downturn in Australia significantly worse than that experienced in the early 1990s" and including an assumption that the economic growth rate in China fell as heavily as in other countries.Other parameters were a three per cent contraction in real GDP in the first year followed by a V-shaped recovery, a rise in the unemployment rate to 11 per cent, a peak-to-trough fall in housing prices of 25 per cent, and a peak-to-trough fall in commercial property prices of 45 per cent.The 20 incorporated ADIs included in the test account for 98 per cent of ADI assets.The main results of the stress test for the 20 ADIs, taken as a group, Laker said, were that none of the ADIs would have failed under the downturn macroeconomic scenario, none of the ADIs would have breached the four per cent minimum tier one capital requirement of the Basel II framework, and the weighted average reduction in tier one capital ratios from the beginning to the end of the three-year stress period was 3.1 percentage points.This fall in the tier one capital ratio was higher than detected in corresponding tests in other markets.However, the test did not allow for likely market responses by banks, such as changing their approach to the pricing and quality of lending, cutting dividends or raising new capital - all likely in reality - and also the responses of banks once the original credit crunch of 2007 proved to be long lasting.Laker noted that international reviews of stress testing practices by banks found the practice was not well integrated with other risk management practices or ongoing corporate governance, but was perceived as a task required to manage regulator relationships.In Australia, he said, "Boards and management may find it hard to engage with scenarios perceived to be too remote or unrealistically severe. No institution, however, is immune from 'disaster myopia'."