Response to AFR 'Bank prudence was partly a mirage' 19 November 2014

19 November 2014

Letter to the Editor, AFR

Dear Editor,

Re: Stress Tests

Christopher Joye’s claim (‘Bank prudence was partly a mirage’, 19 November) that APRA’s recent stress tests found that major bank capital would be “wiped out” in a severe economic downturn, with its implication that parts of the banking system failed the stress test, is untrue.

In a recent speech, the APRA Chairman clearly stated that under APRA’s stress scenarios, including a substantial fall in the housing market, the capital levels for all banks remained above the minimum requirements. In an aside, APRA noted that, looking at residential mortgages in isolation, the cumulative mortgage losses under the stress scenario would exceed the core equity capital put aside for mortgages. This is not the same as saying this capital would all be lost in a real life situation.

In reality, the total loss from mortgages would not be experienced immediately. Losses would actually be experienced over a number of years. Over that period, the income from mortgages would offset those losses. Banks’ risks are managed across diversified portfolios with appropriate capital buffers. The analysis also assumes that banks take no action for a number of years to mitigate the impact, even though the financial crisis showed that banks respond to a deteriorating market by strengthening their capital. Nor is capital the first line of defence for banks. Margins would need to be eroded before capital was touched.

In making the aside, the APRA Chairman noted that the comparison he drew needed a degree of caution. Unfortunately, caution has not been displayed when reporting the footnote out of the context of the full speech.

A key lesson from the financial crisis is that countries need strong banking systems and Australia continues to benefit from the strength of our banks. This does not mean that bank capital levels should not be tested, assessed or even adjusted. But claims that bank mortgage capital would be “wiped out” do not reflect reality.

Steven Münchenberg
Chief Executive Officer
Australian Bankers’ Association

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