APRA Chair John Lonsdale - Speech to Australian Banking Association Conference 2024

Good morning. It’s great to be here in Melbourne attending the Australian Banking Association Conference once again.

For the next 30 minutes I’m here to talk to you, but as APRA Chair I also do a lot of listening. I meet regularly with boards and CEOs across all levels of the banking industry: the majors, the mid-tiers and the mutuals. I have conversations with industry associations such as the ABA, and discussions with Treasury and international regulators.  Those discussions are an opportunity to provide updates on APRA’s assessment of the operating environment as well as our agenda and priorities. But they are also a chance to hear how those we supervise – and those to whom we are accountable – see the environment and the impact of our regulatory decisions.

Over recent months, 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. It’s also not a debate that’s confined to Australia. New Zealand regulators were recently said to be stifling competition to their “Big Four” banks¹, while bank lobby groups in the US have even gone so far as to run television advertisements opposed to the Basel III reforms during sports broadcasts.²

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.

How we got here

If we wind the clock back to March last year, the nature of the debate about bank regulation was very different to what we see today. The global financial system had been badly shaken by a bank crisis that began in the US before spreading to Europe. Urgent and significant intervention by American and Swiss governments and regulators was needed to bring it under control. As a mid-sized economy heavily dependent on access to international funding markets, Australians watched closely as events overseas unfolded, well-aware of the contagion risk that exists in an ever-more interconnected financial system.

While it would be inaccurate to say the crisis had no impact on these shores, it was minimal, fundamentally due to the strength of the most critical component of bank resilience – trust. At a time of global skittishness, APRA, the Government, banks and commentators  could confidently assure the community that our banking system was amongst the strongest in the world; that our banks had “unquestionably strong” levels of capital that put them in the top quartile globally; and that our prudential framework was super-equivalent to international standards in a number of areas, including the management of interest rate risk that sparked the collapse of Silicon Valley Bank.

These regulatory settings 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 (GFC) 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 (FSI) pushed APRA to go further in building a more resilient banking system. Most significantly, the Inquiry’s final report³ recommended APRA require banks to hold increased capital to make them “unquestionably strong” – a status that all of our banks achieved by January 2020. The FSI’s reasoning for this was not purely about minimising the risk of a bank failure or other financial crisis. It pinpointed the importance of Australia’s banks being internationally recognised as financially sound to ensure continued efficient access to international funding markets. It found that while making the banks unquestionably strong would cost more, the cost was very low relative to the risk it was mitigating. It also found that unquestionably strong capital levels reduce moral hazard in the system by lowering the likelihood that Government support would be needed to prevent a financial crisis.

History lesson

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.

Memories of bank failures and expensive taxpayer-funded bailouts are fresher overseas. In analysis undertaken in 2013, the Federal Reserve Bank of Dallas conservatively estimated that the GFC cost the US economy the equivalent of between 40 to 90 per cent of GDP.⁴ Figures from the International Monetary Fund show that between 2007 and 2013, government debt rose sharply across the world: more than 20 per cent in Italy; more than 30 per cent in Spain; more than 40 per cent in the US and United Kingdom and more than 80 per cent in Ireland.⁵ 

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 GDP⁶, 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. In a hypothetical scenario with high inflation, unemployment rising to 10 per cent and house prices falling by more than a third, no banks breached their prudential requirements on capital, all retained sufficient liquidity and banks continued to provide credit to households and businesses. It’s a good news story that should give the community ongoing confidence in the resilience of the banking system in the face of a major financial crisis.

But 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.⁷ 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.

These results highlight why APRA’s focus is broader than the strength of any one bank; it’s the strength of the entire system because that underpins the strength of the Australian economy. The results also underline why, after spending more than a decade building the resilience of the banking system, we have no intention of dialling it back and weakening these gains.

Are we there yet?

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.

This isn’t a new stance. Consider our macroprudential settings, which are constantly assessed and periodically adjusted in response to changes in the operating environment. An examination of those settings since 2014 shows that APRA has introduced and later removed limits on interest-only and investor lending, removed the serviceability floor, adjusted the serviceability buffer twice and lifted the counter-cyclical capital buffer to a new default rate of 1 per cent of risk weighted assets.

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. A good example is the recent release of the finalised guidance to accompany our new prudential standard on operational risk management, CPS 230. Although CPS 230 rationalised five prudential standards into one, we’re acutely aware of the challenges the new requirements create for some parts of the industry, especially at the smaller end. As a result, the finalised guidance gives more time for smaller entities to comply with parts of the standard, modifies or entirely removes aspects that were causing industry confusion, and provides greater transparency on our intended supervision approach to help entities plan ahead.

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. As the Government’s latest Statement of Expectations spells out, “APRA cannot and should not seek to guarantee a zero-failure rate”. Rather, we are charged with balancing safety with a range of other factors, including competition and efficiency, contestability and competitive neutrality. With regards to banking, we are also tasked with facilitating the flow of finance to support strong, sustainable economic growth.

Running like clockwork

This last point is where much of the recent debate has been focused. Specifically, we’ve heard concerns about regulatory requirements impeding the ability of households and businesses to access loans; and that banking services, especially home loans, are increasingly the preserve of the wealthy.

Looking at the data we collect across the banking sector, the story it tells is more positive and nuanced.
In the 12 months to April this year, housing credit grew 4.5 per cent, while business credit grew by a touch under 7 per cent. While both figures are lower than they were during the peak days of the pandemic when interest rates remained at record lows, they are historically robust figures that remain above pre-Covid levels.

Is it getting harder for homebuyers to get sufficient credit to buy homes? Yes, it is. The primary reason for that is a rise in house prices since the start of the pandemic of over 35 per cent during a period where wage growth has been 13 per cent, combined with a rising cost-of-living and an official cash rate that’s risen 4.25 per cent since May 2022.

APRA’s serviceability buffer also plays a role in reducing borrowing capacity, and that has led to calls for us to lower it. If we believe economic conditions warrant changing it, we will do so. However, it’s important to understand that the purpose of the buffer is not only to reduce credit risk, which protects the stability of the bank and the safety of deposits. It also protects people.

Time for self-reflection

So if some borrowers can’t get access to the amount of credit they want, while others have been given loans they now can’t afford, what is the answer?

APRA’s solution has been to grant banks the discretion to offer loans using exceptions to our guidance on mortgage serviceability in cases where they are confident the borrower has the capacity to repay the loan. And this leads me to the final point I want to make before wrapping up.

APRA’s prudential framework is prescriptive in some key areas: capital, liquidity, governance frameworks, and information security hygiene requirements. However, most of the framework is principles-based, which creates significant room for banks, as well as insurers and super trustees, to run their businesses the way they want. In banking, that means the ability to set their own business strategy, pricing and risk appetite.

At a time when banks are well-provisioned and seeing lower-than-expected losses, there is ample scope for banks to rethink their business strategies, lift their risk appetites in some areas and adjust their pricing. Ultimately, a bank’s commercial success is far more a function of the decisions its board and management make than it is a reflection of the broader financial regulatory framework. In saying that, we recognise that regulation can create a financial impost, especially among smaller entities, and 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.

The challenge will be to ensure we preserve the safety of our system while also promoting the opportunity for maximum innovation and dynamism.

Stronger but simpler

The concept of a regulatory pendulum is not a new one, and nor is debate about the volume or toughness of regulation. Back in 2005, the Australian Government created a Regulation Taskforce to review red tape across the entire economy. The Taskforce’s report, released a year later, concluded there was “too much regulation and, in many cases, it [imposed] excessive and unnecessary costs on business”. The report then recommended 100 reforms to relieve the regulatory burden on Australian businesses, including banks, insurers and superannuation trustees.⁸

A common theme among submissions from the financial services industry, the report noted, was a belief that APRA and the Australian Securities and Investments Commission (ASIC) were overly risk-averse. Yet within two years, the GFC was upon us and it became clear that financial regulators globally hadn’t been risk-averse enough. The weight of that realisation caused the pendulum to swing towards the stronger regulatory settings we have today. It doesn’t follow that regulation is always the answer or that more rules create better outcomes. But episodes such as the GFC and the financial services Royal Commission are reminders of why it’s necessary in the first place for appropriate prudential regulation.

APRA is actively seeking ways to make our regulatory framework simpler, more proportionate and easier to comply with. But we will not take risks that might compromise stability or the ability of our banks to keep credit flowing to support the economy. 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.

Footnotes

¹Reserve Bank gets a mauling at ComCom banking conference | The Post (waikatotimes.co.nz)

²Basel III Bank Rule Fight Hits NFL Sunday Night Football as Lobbying Heats Up - Bloomberg

³treasury.gov.au/sites/default/files/2019-03/p2014-FSI-01Final-Report.pdf

⁴staff1301.ashx (dallasfed.org)

⁵International Monetary Fund World Economic Outlook Database 2014

⁶Basel Committee on Banking Supervision 2010, An assessment of the long-term economic impact of stronger capital and liquidity requirements, Bank of International Settlements, p10

⁷It should be noted that given the subsequent calibration to APRA’s risk weighed assets framework by the updated capital framework at the start of 2023, these reductions understate the impact.

⁸Rethinking Regulation (pc.gov.au)