Australia's banking regulator says it can't make banks invincible and is actively preparing for the worst

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Australia’s major banks have been forced to raise more capital because the banking regulator, APRA, is trying to ensure they meet the requirements of holding enough capital to be “unquestionably strong” when compared with their global banking peers.

But even as they edge into the top tier of global banks and gain this “unquestionably strong” accreditation, APRA chief Wayne Byers said in a speech to the Actuaries Institute Banking Conference ‘Banking on Capital’ in Sydney yesterday that such high levels of capital don’t make Australia’s banks “invincible”.

That’s because banking is about more than just capital, Byers said.

It’s always important to remember, though, that a stable and resilient banking system is not just delivered by more capital. Capital adequacy is a relative concept – is capital adequate relative to risk? When we judge a bank’s capital to be high or low, or something in the middle, we are making a judgement that takes into account a range of issues that impact on bank risk profiles: funding and liquidity, asset quality, governance, risk management and risk culture, to name a few, all come into the equation in some way or another.

And that means “there are no guarantees”, Byers said. “No level of capital (short of 100 per cent equity funding) can provide creditors with an absolute guarantee against the possibility of bank failure”.

That’s worth remembering because Byers also said that to give “the community … an iron-clad guarantee that nothing can go awry would require severe limitation on the risk-taking ability of the banking system”.

This in turn would limit the banking system’s ability to do its job properly for the economy. So, “a zero failure regime is not desirable”, Byers said.

APRA needs contemplate bank failures and what they look like in the modern financial context. It also needs to consider how it, as the regulator, would deal with such an event.

“The failure of a bank is not like the failure of a bakery. The potential for contagion to other financial firms, not to mention the widespread adversity it can impose on the broader community, means the failure or near-failure of a bank is no run of the mill matter,” Byers said.

Orderly and disorderly failures

Byers said that if you “start with the proposition that failures are inevitable”, this meant “the regulatory system needs to be assessed against two benchmarks”.

These are the rarity of the failures and how they are handled.

APRA contemplates two types of failures: orderly and disorderly, with the aspiration being, clearly, for orderly failures. It is the attempt to ensure this type of outcome that drives “APRA’s active supervision regime and a willingness to intervene”, though this may seem like the heavy hand of the regulator to many bankers over the past couple of years.

Starting with a plan that a failure is inevitable in the system means that APRA also requires banks to submit themselves to stress tests and undertake resolution planning – living wills – in order to make that failure, if it occurs, as orderly as possible.

Whatever the plan, things can still go awry so, Byers said, it’s important that APRA works with banks to ensure their critical functions can be maintained and that there are ways to rebuild capital, like bail-in bonds, during times of stress should they be needed.

And of course if the worst happened, the safety net of the financial claims scheme would be available to provide “certain depositors with prompt access to their funds – up to $250,000 per account holder – in the event [that a bank] fails,” Byers said.

That means banks must face the difficult task of planning for their own demise. “So APRA will be reinforcing its expectations in relation to ADI’s FCS testing programs in the near future, with a view to ensuring there is genuine readiness to activate the FCS if it is ever needed” Byers said.

“Successful failures might seem a contradiction in terms” Byers said, “but they are far better than the alternative”.

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