Australia's major banks have successfully navigated the latest stress test conducted by the Australian Prudential Regulatory Authority (APRA).
Based on the parameters set by APRA, this test was exceptionally stringent, bordering on the unbelievable. Nevertheless, APRA has confirmed that all tested banks have emerged unscathed from the hypothetical economic and financial downturn.
APRA's stress test assessed the resilience of the banking system under the assumption of a 'hard landing' for the economy. This scenario included a surge in unemployment to 10%, high inflation, and a one-third decline in house prices, reminiscent of Australia's 5.3% house price decrease in 2022 due to rate hikes by the RBA.
Remarkably, these challenging conditions did not lead to any breaches in the banks' capital or liquidity buffers. In a speech delivered in Sydney, Australian Prudential Regulation Authority Chairman John Lonsdale referred to these economic assumptions as "severe yet still plausible" and hailed the stress test results as highly favorable.
Eleven major banks, including the big four, participated in this year's test, the first to employ the new bank capital framework introduced in the current year. Lonsdale mentioned, "We are still in the process of reviewing the results, which will be published externally early next year."
Following his speech, bank shares experienced a significant uptick on Thursday. The big five banks—CBA, Westpac, NAB, ANZ, and Macquarie—saw gains ranging from 0.4% to just under 1%. This occurred on a day when the broader market struggled, managing only a modest 2.6-point increase by the end of trading.
Lonsdale assured, "What I can tell you now is that no banks breached their prudential requirements on capital, all retained sufficient liquidity, and banks continued to provide credit to households and businesses. Although a hypothetical exercise, these results provide confidence in the overall financial system resilience."
He explained that APRA's stress test scenarios aim to be severe yet still plausible, often including non-financial shocks, such as natural disasters or major cyber-attacks, in addition to economic factors like domestic recessions and high unemployment.
Lonsdale drew attention to lessons learned from the US experience, where bank runs and failures, while not directly impacting Australian banks, emphasised the importance of a strong regulatory architecture and the risks associated with the digital finance revolution. He emphasised that even banks considered not "systemically important" can undermine confidence and financial stability if they fail, thanks to the rapid spread of bank runs.
In recent months, APRA has worked to further strengthen the Australian banking system to withstand future shocks. They are enhancing areas such as liquidity and interest rate risk requirements and evaluating the effectiveness of Additional Tier 1 (AT1) instruments designed to stabilise banks in distress or support resolution in the event of failure.
To ensure Australia's banking system is prepared for this new reality, APRA will continue to push boards to elevate their risk management standards and is ready to take swift and decisive action to address weaknesses before they become serious problems.
