## _cr06372 ## Source details **Canonical URL:** [_cr06372](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06372.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06372.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06372.pdf.json) --- ### Macroeconomic and Financial Environment - Real GDP growth averaged just under 4 percent annually during 1992 to 2005. - Unemployment rate has fallen to a 30-year low of around 5 percent. - Net foreign liabilities rose to 56 percent of GDP from 43 percent in 1990. - Financial sector size and banking concentration: - Financial system assets close to $A 3.0 trillion, equivalent to over 300 percent of GDP. - Financial sector more than doubled relative to GDP over the past twenty years. - Authorized deposit-taking institutions (ADIs) account for over half of financial sector assets. - The four major banks hold about two-thirds of Australian banking system assets. - Four majors: around $A 960 billion of domestic-book assets (100 percent of GDP); including overseas and nonbanking activities hold around $A 1.4 trillion (140 percent of GDP). - With St. George added, concentration rises to about 70 percent of total ADI assets. - All four major banks were rated AA- by Standard & Poor’s (as at March 2006). - Banking performance and soundness: - Return on equity (ROE) for major banks around 20 percent since the mid-1990s. - System balance sheet growth averaged 13 percent per annum since 1985. - Nonperforming assets represented 0.4 percent of total (on-balance sheet) assets as of end 2005. ### Superannuation, Insurance, and Capital Markets - Superannuation scale and drivers: - Assets in superannuation schemes as of June 2005 are estimated to be $A 762 billion. - Represents over a quarter of total financial system assets or 85 percent of GDP. - Compulsory employer contributions now stand at 9 percent of wages. - Real annual investment returns over the last 20 years averaging 6.5 percent. - Insurance and life: - General insurance assets exceeding $A 80 billion as of year end 2005; insurance penetration close to 3 percent (general insurance premium to GDP). - Capital more than two times the minimum requirement in general insurance. - Six major financial services groups account for 85 percent of total Australian life insurance premiums; by end-2004 nearly 90 percent of life industry assets were superannuation assets. - Capital market and FX: - ASX capitalization by end-2005 exceeded 110 percent of GDP. - ASX performance: over 20 percent average increase in each of the past two years. - Foreign institutional ownership about 42 percent of market-by-value. - Government share of debt fell from over 56 percent in mid-1990s to 19 percent in mid-2005. - Debt issuance by banks and financial institutions reached some $A 240 billion at end-2005. - Global rankings (as stated): seventh biggest foreign exchange market; U.S. dollar/Australian dollar fourth most-traded currency pair; Australian dollar sixth most-traded currency; stock market eighth largest in the world; tenth largest market for international debt securities. ### Key Vulnerabilities and Funding Structure - Identified vulnerabilities: - Macroeconomic shocks. - A highly leveraged household sector (debt-to-income ratio above 150 percent). - Dependence on wholesale funding and declining retail deposit base at large banks. - Increased competitive pressure from foreign entities and non-bank financial institutions. - Lack of diversification: sectoral concentration (residential mortgages) and geographic concentration (Australia and New Zealand). - Household and mortgage specifics: - Ratio of interest payments to income has almost doubled since the early 1990s. - Majority of household debt is at variable rates. - Approximately 45 percent of assets at the five largest banks invested in residential mortgage loans. - Low-doc lending: estimated 1 percent of new loans in 2000 → estimated 10 percent of new loans (up to 30 percent for some regional banks). - Mortgage brokers originate 30–40 percent of new loans (in some regional banks over 80 percent). - Bank funding and liquidity: - Around 50 percent of bank funding is wholesale domestic; 27 percent is wholesale offshore funding. - Reported unhedged proportion of banks’ net foreign currency debt positions about $A 18 billion; after allowing for foreign equity assets of $A 33 billion and other FX derivative positions of –$A 10 billion, banks’ overall foreign currency position was $A 5 billion. - Average maturity on Australian banks’ offshore bonds currently around four years. - APRA requires banks to establish a liquidity management strategy for “going-concern” and “name-crisis” scenarios. - Factors reducing liquidity risk: stable international funding environment, flexible exchange rate policy, mortgage securitization, RBA widening acceptable collateral, APRA prudential standard on liquidity. ### Stress Testing: Scope, Scenarios, and Results - Exercises performed: - Macroeconomic stress scenario run by five largest domestic banks over a three-year period. - Single-factor interest rate/trading-book stress tests by same banks. - APRA mortgage portfolio update using data from two regional banks with heavy mortgage exposure. - Macroeconomic stress scenario (high-level features and Table 6 timeline): - Q4 2006: Real GDP growth (%) -1; Nominal TWI (%change) -40; House Price Growth (%) -30; Equity Price Growth (%) -27; Consumption Growth (%) -2½; Unemployment Rate (5% 2005) 7; Nominal Cash Rate (5.5% 2005) 5½ - Q4 2007: Real GDP growth (%) 2; Nominal TWI (%change) 10; House Price Growth (%) 0; Equity Price Growth (%) 8; Consumption Growth (%) 0; Unemployment Rate (5% 2005) 9; Nominal Cash Rate (5.5% 2005) 5½ - Q4 2008: Real GDP growth (%) 4; Nominal TWI (%change) 7; House Price Growth (%) 2½; Equity Price Growth (%) 10; Consumption Growth (%) 2¼; Unemployment Rate (5% 2005) 8¾; Nominal Cash Rate (5.5% 2005) 5½ - Macroeconomic stress test severe-shock features (Box 4): - -30 percent drop in housing price in the first year; - unemployment increase from 5 percent to a peak of 9 percent; - exchange rate shock: a 40 percent depreciation of the Australian dollar vis a vis the trade weighted index; - increased funding costs for the banks. - Single-factor interest rate/trading-book scenarios: - (i) gradual 300 basis points steepening of the yield curve out to three years; - (ii) 200 bps upward parallel shift; - (iii) 100 bps downward parallel shift; - (iv) trading book only: 250 percent increase in volatility across the yield curve; - (v) trading book only: 75 percent decrease in volatility. - APRA mortgage portfolio update: - Limited to two regional banks with high low-doc, large-size, and investor loan exposure; both rely heavily on securitization and had grown housing loan portfolios by nearly 50 percent since 2003. - Main results: - No near-term stability issues revealed; large banks exhibited considerable resilience. - Five-major-banks stress outcomes (selected Table 7 figures): - Profit Before Tax (annualized, percent of Tier 1 capital): Q4 2005 Ave 30.6 Max 35.7 Min 22.3 → Q4 2006 Ave 18.0 Max 27.8 Min 7.4 → Q4 2007 Ave 16.9 Max 24.4 Min 7.6 → Q4 2008 Ave 23.2 Max 29.7 Min 17.8. - Bad and Doubtful debts (percent of Tier 1 capital): Q4 2005 Ave 1.1 → Q4 2006 Ave 2.6 → Q4 2007 Ave 3.2 → Q4 2008 Ave 2.3 (Q4 2007 Max 8.1 Min 0.9). - On residential mortgage (percent of Tier 1 capital): Q4 2005 0.1 0.3 0.0 → Q4 2006 0.6 1.7 0.1 → Q4 2007 0.6 1.3 -0.1 → Q4 2008 0.4 1.3 0.0. - Return On Equity (%): Q4 2005 Ave 20.7 Max 23.8 Min 16.4 → Q4 2006 Ave 16.8 Max 25.7 Min 9.8 → Q4 2007 Ave 13.7 Max 22.4 Min 3.9 → Q4 2008 Ave 17.7 Max 26.4 Min 9.2. - Total Tier One Capital (% of risk-weighted assets): Q4 2005 7.4 8.7 6.6 → Q4 2006 7.4 8.9 6.6 → Q4 2007 7.3 8.4 6.4 → Q4 2008 7.1 8.4 6.0. - Single-factor results (Table 8) — impact as percent of Tier 1 capital: - 300 bps steepening: Banking book Average -1.8 Minimum -7.2 Maximum 1.5; Trading Book Average 0.5 Minimum -1.1 Maximum 3.2. - 200 bps upward shift: Banking book Average -1.0 Minimum -3.6 Maximum 1.9; Trading Book Average 0.2 Minimum -0.8 Maximum 1.5. - 100 bps downward shift: Banking book Average 0.5 Minimum -1.1 Maximum 3.6; Trading Book Average -0.3 Minimum -0.6 Maximum -0.1. - 250 percent increase in volatility: Trading Book Average 0.1 Minimum 0.0 Maximum 0.1. - 75 percent decrease in volatility: Trading Book Average 0.0 Minimum -0.1 Maximum 0.0. - Sensitivity analyses: - Deeper/prolonged recession could lead to unemployment tripling to 12 percent (instead of doubling to 9 percent in base). - Under deeper shock, mortgage default rate could double vs base, with bad and doubtful mortgage loans peaking at around 0.9 percent of tier 1 capital in year 2. - Illustrative increase in banks’ funding costs of 10 basis points would reduce overall profits by around 1 percent. - APRA Panama Project (2003) results: - Covered 120 ADIs; under a 30 percent house-price fall scenario all 120 institutions would continue to have positive capital, but 11 institutions (less than 2 percent of banking assets) would fall below regulatory minimum; all LMIs would breach capital solvency requirements under the scenario. ### Crisis Management, Depositor Priority, and Resolution Framework - Historical practice: - Responses to troubled institutions have been ad hoc and relied on official support rather than remedial powers of the Banking Act or insurance legislation. - Long history of no depositor losses from bank insolvencies has created a perception of government bailouts for depositors. - Banking Act depositor priority: - Intended to reduce likelihood Australian depositors suffer loss in a bank/ADI failure even without government bailout. - Key limitations: depositor preference system untested; “deposit” not precisely defined in the Banking Act; coverage may be subject to litigation; timing of depositors’ fund availability in liquidation may be lengthy. - Compensation scheme and politics: - CFR released a proposal to establish an explicit financial claims compensation scheme; banking industry opposed the proposal. - Observation: absent a credible alternative, political pressure for official bailouts may persist. - Recommended elements for strengthened framework: - Address deposit insurance and policy-holder protection as part of comprehensive resolution and crisis management framework. - Establish legal foundation and policy approach for speedy and minimally disruptive resolution of nonviable institutions while minimizing cost to government. - Build on Trans-Tasman Council progress to improve crisis management coordination given New Zealand exposure. ### Supervisory, Regulatory and Institutional Findings - Institutional setup: - Prudential authority: APRA; market conduct authority: ASIC; RBA: payment system oversight; AUSTRAC: FIU and AML/CFT regulator; Treasury: law and policy. - Australia described as having a sound overall structure with generally high compliance with international standards. - Basel II and supervisory capacity: - Good progress by banks and APRA preparing for Basel II implementation. - Areas for strengthening: AML/CFT framework, APRA and ASIC capacity (staffing, resources, compensation flexibility), legal powers for dealing with troubled general insurers, and framework for failure resolution and crisis management. - Basel Core Principles (BCP) and IOSCO assessments: - High overall compliance with Core Principles and IOSCO principles; some shortcomings noted: - CP 15 (Prevention of Use of Banking System by Criminal Elements) identified as a major shortcoming pending AML/CTF legal changes. - Variation in supervisory quality related to high APRA staff turnover. - Exemption criteria for foreign banks and non-bank entities require revision to avoid regulatory gaps. - Recommended action plan (selected): - Remove legal obstacles to AUSTRAC sharing information with APRA (CP 1(6)). - Revise exemption criteria so entities undertaking bank-like activities are subject to APRA oversight (CP 2 and CP 25). - Establish effective supervisory verification program and enhance AUSTRAC/APRA coordination (CP 15). - Empower APRA to deal with troubled general insurers; harmonize APRA powers across banking, life and general insurance. - Consider amending ASIC Act to remove Treasurer’s power to give directions and address ASIC funding and consultation processes. - Enhance AML/CFT legislation to comply with FATF recommendations; proposed legislation expected in 2006 (government consultation ongoing). ### APRA Operational Independence, Funding, and Government Position - Shift of APRA’s financial framework to FMA Act: - Government does not consider the change will materially affect APRA’s operational independence or funding. - APRA exempted from a small number of FMA Act conditions that could affect efficiency. - Government view: APRA’s enabling legislation establishes required operational independence; Treasurer’s power to give directions has conditions (consultation, Gazette publication, parliamentary tabling) and has not been used to date. - AML/CTF reforms and information sharing: - Processes in place to amend Financial Transaction Reports Act 1988 to allow AUSTRAC to share FTR information with APRA; an MOU between AUSTRAC and APRA is planned. - Under proposed AML/CTF legislation, APRA will be a partner agency with which AUSTRAC can share FTR information. ### Payment Systems: RITS Assessment and Recommendations - RITS system and usage (2005): - Launched as RTGS in 1998; 60 participants; 24,000 transactions daily on average; average daily value AUD 150 billion. - Four major banks have 67 percent of the volume and value of total RTGS transactions. - RITS settles continuously in central bank money with irrevocable finality. - CPSS Core Principles assessment: - RITS complies with all CPSS Core Principles for Systemically Important Payment Systems. - Strengths: well-founded legal basis; risk management; liquidity provision via intraday repurchase agreements; operational redundancy and contingency planning. - Recommendations include: analyze conflict-of-law risks for non-Australian entities participating in RITS; external review of business continuity plan; security enhancements to proprietary communications network; review pricing structure; re-establish advisory user group for participants. - Authorities’ planned actions (2006 references preserved): - RITS user interface upgrade due for implementation during 2006 to improve confidentiality, integrity and authenticity of transmitted information. - Reserve Bank to finalize a review of pricing during 2006 and consider IMF recommendations regarding legal risk, business continuity, and user consultation. ### Main FSAP Recommendations (selected) - Banking: - APRA should emphasize strong risk-management practices and maintenance of strong capital reserves as ADIs shift into SMEs, wealth management, and overseas expansion. - APRA should monitor banks’ liquidity closely given declining retail deposits at large banks. - APRA and RBA should build on stress-test experience, continue dialogue with banks, and consider requesting banks to conduct and report stress tests regularly. - Insurance: - Proceed with Stage II reforms: capital management, reinsurance documentation, formalized corporate governance standards and fit-and-proper framework, enhanced disclosure requirements. - Enhance APRA’s legal authority to deal with a troubled general insurer. - Supervisory framework and AML/CFT: - Ensure APRA and ASIC maintain momentum in staffing, resourcing, and systems; provide compensation flexibility to attract experienced staff. - Prioritize AML/CFT legislative and operational arrangements and ensure AUSTRAC collaborates with APRA on on-site verification in financial institutions. - Ensure Taskforce on Reducing Regulatory Burdens does not unintentionally constrain supervisors’ prompt actions. - Review Treasurer’s role to clearly establish supervisory independence. - Failure resolution and crisis management: - Continue developing a formal process, including legal foundation and policy approach, for speedy and least-cost resolution of failing institutions. - Address deposit insurance and policy-holder protection as elements of a comprehensive resolution and crisis management framework. - Build on Trans-Tasman Council progress to improve crisis management coordination given New Zealand exposure. *Source: Executive Summary and selected sections from IMF Financial Sector Assessment Program — _cr06372_ (Executive Summary; Sections 8, 24, 46, 68, 101, 131, 156 and annexed assessments).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Macroeconomic and Financial Environment - Real GDP growth averaged just under 4 percent annually during 1992 to 2005. - Unemployment rate has fallen to a 30-year low of around 5 percent. - Net foreign liabilities rose to 56 percent of GDP from 43 percent in 1990. - Australia’s financial system: - Assets close to $A 3.0 trillion, equivalent to over 300 percent of GDP. - Financial sector has more than doubled its size relative to GDP over the past twenty years. - Banking sector: - Authorized deposit-taking institutions (ADIs) account for over half of financial sector assets. - The four major banks (“four pillars”) together hold about two-thirds of the Australian banking system assets. - The four majors have around $A 960 billion of assets in their domestic book, equivalent to 100 percent of GDP. - When overseas and nonbanking activities are included, the four majors hold around $A 1.4 trillion, equivalent to 140 percent of GDP. - When the fifth largest bank, St. George, is added, concentration increases to about 70 percent of total ADI assets. - All four major banks were rated AA- by Standard & Poor’s (as at March 2006). - Banking performance and soundness: - Return on equity (ROE) for the major banks of around 20 percent since the mid-1990s. - System experienced strong balance sheet growth averaging 13 percent per annum since 1985. - Nonperforming assets represented only 0.4 percent of total (on-balance sheet) assets as of end 2005. - Insurance and superannuation: - General insurance controls assets exceeding $A 80 billion as of year end 2005. - Insurance penetration close to 3 percent (general insurance premium to GDP). - Capital more than two times the minimum requirement in general insurance. - Life insurance: six major financial services groups account for 85 percent of total Australian premiums. - By end-2004 nearly 90 percent of life industry assets were superannuation assets. - Market structure and competition: - Foreign banks account for about 19 percent of ADI assets and have increased retail market activity. - Securitization market is exceptionally well-developed. ### Sources of Potential Risks - Stress tests did not reveal near-term stability concerns and suggest the banking system is likely to be resilient to adverse shocks. - Key vulnerabilities identified: - Macroeconomic shocks. - A highly leveraged household sector. - Dependence on wholesale funding. - Increased competitive pressure (from foreign entities and non-bank financial institutions). - Overall lack of diversification (sectoral concentration and geographic concentration in Australia and New Zealand). - Historical context: - The banking system rebuilt its balance sheet following losses in the early 1990s relating mostly to commercial real estate lending. - Since then, the industry has concentrated lending on the residential mortgage sector, enhancing asset quality and profitability. - Funding structure: - Large banks rely heavily on wholesale funding; retail deposit base declining at the large banks. - Cross-border exposure: - Geographical concentration includes significant exposure to New Zealand (New Zealand exposure discussed elsewhere in the document). ### Supervisory and Regulatory Framework - Institutional setup: - Prudential authority vested in APRA; market conduct authority vested in ASIC. - Overall structure described as sound with generally high levels of compliance with international standards. - Areas noted for further strengthening: - AML/CFT framework. - Capacity of APRA and ASIC (staffing, resources, and compensation flexibility). - Framework for financial institution failure and crisis management. - Basel II preparations: - Good progress being made by both banks and APRA in preparing for the implementation of Basel II. - Post-HIH actions: - Following the 2001 collapse of HIH insurance group, government fast-tracked reform of general insurance and strengthened prudential regulation in key areas identified by the Royal Commission. - Proposed legislation intended to provide APRA with enhanced legal powers to deal with troubled general insurers; APRA implementing Stage II Reforms and formalizing prudential practices. - Supervisory priorities highlighted: - Maintain momentum in building staffs and systems at APRA and ASIC. - Ensure AUSTRAC collaborates with APRA on AML/CFT responsibilities, including on-site verification in financial institutions. - Ensure Taskforce on Reducing Regulatory Burdens does not unintentionally constrain supervisors’ prompt actions. - Review the role of the Treasurer to clearly establish independence of supervisory agencies. ### Systemic Liquidity, Crisis Management and Safety Net - Mission support: - Mission strongly supports authorities’ initiative to develop a formal process to manage failure of individual institutions and wider crises. - Historical practice: - Responses to troubled institutions have been ad hoc and relied on official support rather than remedial powers of the Banking Act or insurance legislation. - Long history of no depositor losses from bank insolvencies has created a perception of government bailouts for depositors in failed ADIs. - Recommended elements for a strengthened framework: - Address deposit insurance and policy-holder protection as part of a comprehensive resolution and crisis management framework. - Establish legal foundation and policy approach for speedy and minimally disruptive resolution of nonviable institutions while minimizing cost to government. - Build on progress within the Trans-Tasman Council to improve coordination in crisis management given New Zealand exposure of ADIs. ### Medium-Term Challenges - Structural challenges and strategic options for banks: - Four largest banks are domestically owned and have significant sectoral concentration (two thirds of ADI assets) in low-risk residential mortgages and geographical concentration in Australia and New Zealand. - Domestic opportunities for growth and further diversification are relatively limited. - Growth through domestic mergers among large banks may raise concentration and competition issues. - Historical difficulty with successful expansion overseas. - Profitability pressures and risk-shifting: - Growing competition from foreign entities and non-bank institutions has put pressure on profit margins. - As lending to the household sector slows, banks are seeking alternative income sources: - Increasing lending to the corporate sector, particularly SMEs. - Increasing emphasis on wealth-management activities. - Expanding overseas. - These strategic shifts may raise banks’ risk profiles and hence capital requirements. ### Main FSAP Recommendations (selected) - Banking: - APRA should emphasize strong risk-management practices and maintenance of strong capital reserves as ADIs shift focus into SMEs, wealth management, and overseas expansion. - APRA should continue to closely monitor adequacy of banks’ liquidity in light of declining retail deposit base at large banks. - APRA and RBA should build on FSAP stress test experience, continue dialogue with banks, and consider requesting banks to conduct and report stress test results regularly. - Insurance: - Push ahead with Stage II reforms (capital management, reinsurance documentation, formalized corporate governance standards and fit-and-proper framework, and enhanced disclosure requirements). - Enhance APRA’s legal authority to deal with a troubled general insurer. - Supervisory framework: - Ensure APRA and ASIC maintain momentum in staffing, resourcing, and systems; provide compensation flexibility to attract experienced staff. - Give high priority to legislative and operational arrangements in the AML/CFT area and ensure AUSTRAC collaborates with APRA on-site verification in financial institutions. - Ensure implementation of Taskforce on Reducing Regulatory Burdens does not constrain supervisors’ ability to act promptly. - Review Treasurer’s role to clearly establish supervisory independence. - Ensure APRA and ASIC have adequate financial and staff resources and deployment flexibility. - Failure resolution and crisis management: - Continue developing a formal process, including legal foundation and policy approach, for speedy and least-cost resolution of failing institutions. - Build on Trans-Tasman Council progress to improve crisis management coordination given New Zealand exposure. - Address deposit insurance and policy-holder protection as an element of a comprehensive resolution and crisis management framework. _Executive Summary — IMF Financial System Stability Assessment (Australia) — External Publication (Executive Summary section)._ ### 8. Superannuation has been the fastest growing sector of the financial services ### _cr06372 - 8. Superannuation has been the fastest growing sector of the financial services ### Superannuation: scale and drivers - Assets in superannuation schemes as of June 2005 are estimated to be $A 762 billion. - This represents over a quarter of the total assets of the financial system or 85 percent of GDP. - Key drivers: - Demographic pressures, with ageing population. - Compulsory employer contributions, which now stand at 9 percent of wages. - Significant tax concessions on contributions and invested income. - Real annual investment returns over the last 20 years averaging 6.5 percent. - Supervisory framework: - Australian Prudential Regulatory Authority (APRA): prudential regulation of superannuation entities. - Australian Securities and Investment Commission (ASIC): market conduct, disclosure and complaints. - Australian Taxation Office (ATO): regulates the Self-Managed Superannuation Fund (SMSFs). ### Capital market structure and recent developments - ASX capitalization by end-2005 exceeded 110 percent of GDP. - ASX performance: over 20 percent average increase in each of the past two years (driven largely by the resource sector). - Foreign institutional ownership: about 42 percent of the market-by-value is owned by foreign institutions. - Debt market composition: - Government share fell from over 56 percent in the mid-1990s to 19 percent in mid-2005. - Debt issuance by banks and other financial institutions increased sharply to reach some $A 240 billion at end-2005. - Global rankings (as stated): - Seventh biggest foreign exchange market. - U.S. dollar/Australian dollar is the fourth most-traded currency pair. - Australian dollar is the sixth most-traded currency. - Stock market is rated eighth largest in the world. - Australia has the tenth largest market for international debt securities. ### Overall assessment and external exposures - Overall the financial system is strong and stable, following major losses in the early 1990s and post-Wallis reforms. - External shock exposures identified: - Commodity price fluctuations in the mining sector. - Climatic shocks to agriculture. - Shocks to international tourism. - Increased exposure to variations in China’s economic growth. ### Historical episodes of financial distress (summary) - Early 1990s commercial real estate crisis: - By 1992, problem assets for the Australian banking system had increased to 6 percent of total on balance sheet assets. - Aggregate losses for the banking system from 1990-1992 were more than $A 9 billion and represented a loss equivalent to about 36 percent of shareholder funds in the system as of 1989. - Capital ratios of major banks remained above the 8 percent Basel minimum throughout the early 1990s. - HIH Insurance Group collapse (March 2001): - Causes: overly-optimistic valuation of assets, underestimation of liabilities, mismanagement of core business, poor governance, aggressive accounting. - Government response: General Insurance Reform Act 2001; strengthened prudential standards in valuation of insurance liabilities, capital adequacy, corporate governance, risk management, and reinsurance. - APRA still lacks some key legal powers to deal decisively and cost-effectively with a troubled general insurer; APRA is building on reforms with a second stage. ### Household leverage and vulnerability - Debt-to-income ratio is now above 150 percent. - Ratio of interest payments to income has almost doubled since the early 1990s despite the fall in interest rates. - Majority of household debt is at variable rates. - Household debt appears concentrated in high income groups who have relatively low debt service burdens and significant financial assets. ### Banks’ exposure to housing and lending standards - Approximate exposure: Australian banks are heavily exposed to the housing sector, with approximately 45 percent of assets invested in residential mortgage loans at the five largest banks. - Real estate prices increased sharply in 2001–03, leading to a potential overvaluation, though they have leveled out more recently. - Table 1 (changes in residential lending standards) highlights: - Debt-servicing burdens: Traditional 30 percent rule of thumb → Up to 50 percent. - Low-doc lending: Estimated one percent of new loans in 2000 → Estimated 10 percent of new loans. Up to 30 percent for some regional banks. - Pricing of low-doc: Priced at premium to standard variable rate → Reduced premium, often to standard variable rate. - Mortgage brokers: Banks originated loans mainly through branch networks → 30–40 percent of new loans originated through brokers. - Maximum loan-to-value ratios: 80 percent, unless mortgage insured; No down-payment loans rare → Low and no down-payment loans actively promoted by some banks. - Genuine savings requirements: Requirement to prove part of down-payment is “genuine.” → Reduced (value and time period), and sometimes waived completely. - Supervisory responses: - Increased capital requirements for riskier loan products and for the mortgage insurance industry. - Need to enhance risk management and develop robust mechanisms for evaluating banks’ portfolios under different potential stress scenarios. ### Bank funding structure and liquidity considerations - High reliance on wholesale funding (domestic and offshore) due to strong credit growth and erosion of retail deposit base (shift of household financial assets to superannuation funds). - Funding risks: foreign exchange, interest rate, and liquidity risk; hedging has reduced foreign exchange and interest rate risks but introduces operational and counterparty risks. - Reported unhedged proportion of banks’ net foreign currency debt positions is only about $A 18 billion; after allowing for foreign equity assets of $A 33 billion, and other foreign exchange derivative positions of –$A 10 billion, banks’ overall foreign currency position was only $A 5 billion. - Factors reducing liquidity risk: - A stable international funding environment. - An appropriately flexible exchange rate policy to absorb stress. - Banks’ efforts to develop alternative sources of funding (including mortgage securitization and interbank deposit agreements) and to diversify funding sources and instruments while lengthening the tenor of their debt. - RBA’s decision to widen its definition of acceptable collateral. - APRA’s prudential standard on liquidity management and its review/agreement of banks’ liquidity management strategies. - APRA requires banks to establish a liquidity management strategy to ensure sufficient liquidity under both a “going-concern” scenario and a “name-crisis” scenario. ### International exposure, geographic concentration, and contagion risk - The banking sector is domestically oriented with limited exposure abroad, mostly to New Zealand and to a lesser extent the United Kingdom. - New Zealand exposure: largest overseas exposure of the four major banks (15 percent of their total assets and 85 percent of the New Zealand banking market by assets). - Contagion risks from New Zealand could be material, particularly via funding channels and reputational costs impacting external funding of parent banks. - Trans-Tasman cooperation: - Trans-Tasman Council on Banking Supervision (TTC) formed in February 2005 to enhance information sharing, coordinated crisis response, and policy advice. - TTC recommended legislative changes to enhance cooperation between APRA and the RBNZ; recommendations gained support of both governments in February 2006 and are expected to pass through the usual legislative process. ### Stress testing exercises and scenarios - Three types of stress tests performed: 1. Five largest domestic banks ran a macroeconomic stress scenario over a three-year time period. 2. Same banks ran a series of single factor stress tests on interest rates. 3. APRA updated its mortgage portfolio stress tests using data from two regional banks with heavy exposure to the mortgage market. - Single factor interest rate/trading book stress scenarios simulated: - (i) a gradual 300 basis points (bps) steepening of the yield curve out to three years; - (ii) a 200 bps upward parallel shift in the yield curve; - (iii) a 100 bps downward parallel shift in the yield curve; - (iv) for the trading book only, a 250 percent increase in volatility across the yield curve; - (v) for the trading book only, a 75 percent decrease in volatility. *Source: _cr06372 - 8. Superannuation has been the fastest growing sector of the financial services* ### 24. The update of APRA’s mortgage portfolio stress test was limited to two regional ### 24. The update of APRA’s mortgage portfolio stress test was limited to two regional ### Scope of the stress-test update - Limited to two regional banks with heavy exposure to the more risky mortgage products. - These two banks hold more low documentation (low-doc), large-size, and investor loans than the average Australian bank. - Selected as most suitable candidates for a limited update of the original 2003 mortgage portfolio stress tests. ### Main findings from the stress tests - Confirmed the resiliency of the banking system; tests had a mild impact due to favorable initial conditions. - Favorable initial conditions cited: - The exceptionally clean balance sheet of banks after a decade and a half of uninterrupted economic expansion. - Dominance of residential mortgage loans in banks’ loan portfolios. - Recourse by banks to mortgage insurance, which helps absorb part of the risks and hence the “hit” on banks under the scenario. - Modeling of the macroeconomic scenario translated into a relatively short-lived recession followed by a recovery, producing a less stressful environment for credit risk. - Sensitivity analysis with a deeper and more prolonged recession still showed the banking system to be resilient (see Box 4). ### Box 4 — Scenarios and results - Three types of stress tests undertaken under the FSAP: - A macroeconomic stress scenario envisaging: - -30 percent drop in housing price in the first year; - increase in the rate of unemployment from 5 percent to a peak of 9 percent; - exchange rate shocks: a 40 percent depreciation of the Australian dollar vis a vis the trade weighted index; - increased funding costs for the banks. - A series of single factor stress tests to determine sensitivity of banking and trading books to interest rate shocks. - A partial update of APRA mortgage portfolio stress tests. - Results: - No near-term stability issues were revealed. - Under the macroeconomic stress test, the large Australian banks exhibited considerable resilience; financial performance deteriorated but banks withstood the adverse scenario relatively well. - Single factor tests suggested limited exposure to interest rate shocks, concentrated in the banking book. - APRA’s partial update indicated the tested regional banks would remain above their regulatory minimum capital requirements in the envisaged stress scenario. ### Explanatory factors for stress-test outcomes - Favorable macroeconomic starting point: - After almost 15 years of economic expansion, bank portfolios are very healthy (NPAs in 2005 amounted to 0.4 percent of assets). - Business sector balance sheets exhibit considerable strength. - A flexible exchange rate regime acts as an important cushion. - Portfolio composition: - Heavy residential mortgage exposure to the household sector, generally resilient to a short-lived recession. - Mortgage insurers absorb some credit losses from mortgage defaults, limiting banks’ losses. - Major impact of the scenario likely indirect through lower consumer spending affecting parts of the corporate portfolio and SMEs; credit risks in personal loans and credit cards will increase. - Modeling restrictions: - Tension between assuming unchanged monetary policy (cash rate) and the length of the recession; assumption of unchanged monetary policy implied a short-lived recession. - Lack of recent recession experience (no recession in last 15 years) makes statistical inferences on defaults and losses difficult; default outcomes from past recessions may not be a good guide given changes in household balance sheets and mortgage product risk characteristics. - Availability of liquidity: - Around 50 percent of bank funding is wholesale domestic; 27 percent consists of wholesale offshore funding. - Short-term stresses on offshore liquidity can be compensated by domestic liquidity (at a higher price); currency risk is typically fully hedged. - In the medium-term, refinancing risk seems limited; average maturity on Australian banks’ offshore bonds is currently around four years; Australian capital markets are deep. ### Value of the exercise and operational lessons - Provided a valuable learning experience and a vehicle for dialogue on financial stability and systemic risks among banks, the RBA, and APRA. - Participating banks valued the exercise in the context of preparations for the Basel II risk-management framework. - Helped inform authorities on banks’ modeling capacity and areas for improvement. - Demonstrated importance of: - Refining stress test scenarios; - Enhancing stress testing capacity; - Running stress tests routinely. ### Footnote/contextual scenario assumptions referenced in text - The tested scenario assumed constant monetary policy (i.e., no easing in response to the recession), a general economic recovery in the third year, and that private residential mortgage insurers would honor most of their commitments. - Two main non-captive mortgage insurers have obtained an Insurer Financial Strength rating of “AA” from Fitch after being subjected to scenarios described by Fitch as “severe stresses”; they also hold capital in excess of minimum regulatory capital. *Source: _cr06372 - 24. The update of APRA’s mortgage portfolio stress test was limited to two regional* ### 46. The Banking Act provisions for depositor priority are intended to reduce the ### _cr06372 - 46. The Banking Act provisions for depositor priority are intended to reduce the ### Depositor priority and practical concerns - The Banking Act provisions for depositor priority are intended to reduce the likelihood that Australian depositors suffer a loss in the failure of a bank or other ADI even in the absence of a government bailout. - Key limitations and risks noted: - The depositor preference system has not been tested. - The concept of “deposit” is not defined precisely in the Banking Act to clarify which creditor might in fact be at risk in the event of a failure. - Exactly which liabilities would be covered by the preference may be subject to litigation. - Timing of availability of depositors’ funds in a liquidation is a concern; it may take an extended period of time for depositors to be paid under the deposit preference system, creating pressure on government to take immediate steps to pay depositors. ### Depositor and policy-holder compensation proposal and political economy - The CFR has released a proposal to establish an explicit financial claims compensation scheme to strengthen the government’s ability to address failures. - Observations: - Such a scheme could be a useful element of an enhanced framework for failure resolution and crisis management. - The banking industry has opposed the proposal. - In the absence of a credible alternative, it will be difficult for government to withstand pressure for continuation of official bailouts in future failures. ### Medium-term challenges for the banking sector (summary) - Concentration and diversification: - The four largest banks’ high concentration by sector and geography heightens the importance of risk management and capital adequacy. - Domestic opportunities for growth and further diversification are quite limited. - A merger among large domestic banks would not necessarily enhance diversification due to similarity in operations and revenue streams. - Merger with a large international bank offers potential diversification, scale and scope benefits, but is available only on application to the Treasurer and is subject to a national interest test under the Financial Sector (Shareholdings) Act and consideration by the Foreign Investment Review Board. - The four largest Australian banks are relatively small compared with internationally active banks; overseas ventures have had mixed results and may bring additional risks and demands on management. - Given limited scope to diversify portfolio risks, the prudent response is likely to focus on increasing sophistication of risk management and maintaining capital levels commensurate with concentration risks. - Strategic and operational risks: - Banks are increasing focus on business lending and moving into wealth management activities, which have different and potentially greater risks than residential mortgage lending. - Business lending may be less diversified than household lending and historically more vulnerable to rapid and large deteriorations in credit quality. - Lending and credit skills required in a less benign credit environment differ from those required in the recent past. - Similar future strategies across major banks are likely to lead to intense competition, potentially putting pressure on earnings and heightening risks. - Risk of “reaching for yield” to offset declining volume in other portfolio parts, especially given strong competition from other banks and nonbank sources of funding. - Transition management recommendations: better risk management, adjustments to banks’ capital levels to reflect any increased risk, and careful monitoring. ### Annex: Basel Core Principles (BCP) assessment — main findings - General context: - The BCP assessment was completed as part of the FSAP during December 2005. - Assessment sources included self-assessments and a pre-conditions paper from APRA, ASIC, RBA, and Treasury; reviews of legislation and documentation; discussions with supervisory authorities and Treasury; and meetings with market participants. - Overall compliance: - Australia has a high overall level of compliance with the Core Principles. - The Probability Assessment and Impact Rating System (PAIRS) and Supervisory Oversight and Response Systems (SOARS) provide a foundation for risk-focused supervision; approach is relatively new and subject to ongoing refinement. - Overall quality of supervision is good, with some variation among divisions and teams. - Institutional responsibilities: - APRA: prudential supervision of banks, insurers and superannuation funds; funded through levies on regulated entities; enjoys legislated operational independence. - ASIC: market conduct regulator and administers company law. - RBA: payment system oversight and overall financial stability. - AUSTRAC: financial intelligence unit (FIU) and regulator for AML/CFT compliance. - Treasury: preparation of laws and regulation and policy advice; Treasurer empowered to issue directions to APRA and ASIC under certain conditions. - Preconditions and legal framework: - Australian banks benefited from sound macroeconomic policies and 14 years of uninterrupted growth. - Australia adopted International Financial Reporting Standards (IFRS) from January 2005. - The Banking Act and broader corporate and bankruptcy law provide a sound regime for resolution of problem institutions. - Strengths and shortcomings by principle groups: - Licensing and structure (CPs 2–5): well developed licensing regime; concern that scope for some financial companies to operate as unregulated and unsupervised institutions is excessive; blurred boundaries due to ability of non-regulated companies to issue deposit-like instruments using short prospectuses. - Prudential regulations (CPs 6–15): most prudential regulations and implementation are of very high standard; capital and capital adequacy ratios align with international best practices; major shortcoming is CP 15, Prevention of the Use of the Banking System by Criminal Elements. - New anti-money laundering legislation released for public consultation on 16 December 2005. - Planned increase in AUSTRAC resources to allow a full program of on-site verification. - Australia’s allocation to a financial intelligence unit full responsibility for verification of banks’ prudential AML/CFT management is an approach rarely seen internationally. - Conditional on AUSTRAC being able to share necessary information so APRA is fully apprised, Australia can move towards full compliance with CP 15. - Methods of ongoing supervision (CPs16–21): supervisory function embodies many best practices; principles-based prudential framework; consolidated supervision approach noteworthy; concern about variation in quality likely due to high APRA staff turnover. - Formal powers of supervisors (CP 22): legislation and prudential standards provide a broad range of remedial powers and enforcement processes. - Home-Host supervision (CPs 23–25): sound regime with memoranda of understanding with many foreign supervisors; MoUs concluded with several host supervisors; concern that foreign banks may under certain conditions be exempt from regulation and supervision in Australia and that exemption rules should be updated. ### Table 2: Recommended Action Plan (excerpted) - CP 1(6): Information sharing - Remove the legal obstacles to AUSTRAC sharing information with APRA and implement effective coordination with respect to the information gathered by AUSTRAC that is relevant to APRA’s prudential oversight of the adequacy and implementation of banks’ internal policies. - CP 2: Permissible activities - Revise the criteria for exempting institutions from regulation so that the demarcation line between regulated and non-regulated entities becomes clearer. - CP 15: Use of banks by criminal elements - Establish an effective supervisory verification program, ensuring that APRA is able to obtain all necessary information regarding prudential issues, including those that extend beyond AUSTRAC’s narrow mandate. - CP 25: Supervision Over Foreign Banks’ Establishments - Revise the criteria for exempting institutions from regulation so that all foreign bank subsidiaries undertaking bank-like business in Australia are subject to APRA oversight. ### Implementation status and authorities’ response - Steps underway: - Plans to address the need for an on-site verification regime to ensure banks have appropriate policies and procedures to prevent use of the banking system by criminal elements. - Governance and accountability issues: - Greater certainty regarding APRA’s operational independence would be provided by removing the legal power of the Treasurer to give directions. - It is important that APRA’s transition to the Financial Management and Accountability Act does not lead to measures (such as further budgetary restrictions or subjecting staff to civil service salary scales) that might impair effective supervision. - The Government considers that the power of the Treasurer to issue directions to APRA on policies and priorities (but not particular cases) strikes an appropriate balance, and the conditions attached (consultation with APRA Chair, publication in the Gazette, tabling in Parliament) provide transparency and accountability; to date the Treasurer has not given APRA any directions under this power. - As part of a government-wide review of statutory authorities, the Treasurer has agreed to move APRA’s financial framework to the Financial Management and Accountability Act 1997 (FMA Act) from the Commonwealth Authorities and Companies Act 1997 (CAC Act). *Source: _cr06372 - 46. The Banking Act provisions for depositor priority are intended to reduce the (PDF).* ### 68. The Government does not consider that this change will materially affect APRA’s ### _cr06372 - 68. The Government does not consider that this change will materially affect APRA’s ### APRA operational independence and funding - The Government does not consider that this change will materially affect APRA’s operational independence or funding. - APRA’s enabling legislation (the Australian Prudential Regulation Authority Act 1998) establishes the required level of operational independence necessary to exercise statutory powers objectively. - The Government has exempted APRA from a small number of conditions under the FMA Act that may affect its ability to fulfill its duties efficiently and effectively. - As a result, the change to the FMA Act will not: - affect how APRA is funded; or - reduce APRA’s autonomy in deciding how it spends its funding and organizes itself (including its ability to set the employment terms and conditions of its staff) to meets its statutory obligations. ### Fiscal framework and broader government approach - The Australian Government considers that its overall budget approach, in which all government agencies are subject to appropriate accountability, has: - facilitated a sustained period of responsible fiscal outcomes; and - allowed adequate resourcing of core government activities. ### AML/CTF reforms and information sharing - The Government is committed to updating Australia’s anti-money laundering and counter-terrorist financing (AML/CTF) regime to reflect developments in financial crime and revised international standards from the Financial Action Task Force on Money Laundering (FATF). - The Government is closely consulting with industry on a range of reforms; legislation is expected to be introduced during 2006. - Expected outcomes of reforms: - bring Australia into compliance with the FATF recommendations; and - ensure Australia’s financial sector remains robust and internationally competitive. - Processes are in place to amend the Financial Transaction Reports Act 1988 (FTR) to allow AUSTRAC to share FTR information with APRA, including establishment of a Memorandum of Understanding (MOU) between AUSTRAC and APRA. - Under proposed AML/CTF legislation, APRA will be included as a partner agency with which AUSTRAC can share FTR information to support APRA’s assessment of reputational and liquidity risks within APRA-regulated institutions. - APRA and AUSTRAC will continue to improve broader cooperation and coordination arrangements. ### Summary assessment of observance of the Insurance Core Principles (ICP) - The assessment of observance with the Insurance Core Principles was conducted as part of a Financial Sector Assessment Program from November 30 to December 14, 2005, examining Australia’s observance with the ICP issued by the IAIS in October 2003. ### Institutional framework and arrangements - Australia uses a functional "Twin-Peaks" approach: - APRA: prudential supervision. - ASIC: investment market integrity and transparency. - Reserve Bank of Australia: oversight of financial system stability. - AUSTRAC: federal FIU and AML/CFT regulator. - The Treasurer: overall responsibility for policy matters and legal/regulatory framework for the financial sector. - The Minister for Justice and Customs: overall responsibility for policy matters and legal/regulatory framework for AML/CFT. - Federal, state and territory legislation regulate the Australian insurance industry; State and Territory governments regulate certain mandated lines of insurance (workers compensation, compulsory third party (CTP) motor vehicle insurance, home builders warranty), sometimes via government monopolies. - Professional bodies and self-regulatory industry associations provide market discipline. ### Main findings - The insurance regulatory and supervisory regime demonstrates a high level of observance with the IAIS standards. - Substantial reforms have been undertaken to facilitate market innovation and reflect international best practices. - APRA and ASIC continuously review and update supervisory regimes. ### Conditions for effective insurance supervision - Australia has sophisticated macroeconomic and legal frameworks, adopts international accounting and auditing standards, and benefits from deep, liquid and well functioning financial markets that facilitate effective asset-liability management by insurers. ### The supervisory system - Functional approach provides clarity in supervisory objectives but has overlaps and tension between prudential supervision and conduct-of-business supervision. - Coordination is facilitated through MOUs, councils, committees, working groups, and the Council of Financial Regulators (CFR). - APRA is responsible for general administration of insurance legislation; Treasury handles financial sector policy formulation and reforms, with APRA having substantial input and often initiating reforms. - APRA has wide powers to establish prudential standards; ASIC issues guidelines and preferred practices but has no rule making powers. - The Treasurer has a power of direction over APRA policies and priorities but must not give direction regarding individual cases under the APRA Act. - Recommendation: insurance legislation should be amended to remove the Treasurer’s power to give direction on institution-specific issues and to clearly spell out circumstances under which the Treasurer may give directions to APRA to better reflect international best practice. - APRA has adequate powers and financial resources; staff have legal protection for actions taken in good faith. - Current financing arrangements do not undermine APRA’s autonomy or independence; strong safeguards protect confidential information. - Governance: APRA Members are appointed for a minimum term but there is no requirement to publicly disclose reasons for removal. - APRA uses a risk-based supervisory approach supported by documentation, procedures, and an Enforcement Unit reporting to an Enforcement Committee; supervisory activities are transparent and subject to judicial and administrative review. - APRA has MOUs with domestic and overseas supervisors and cooperates fully with overseas counterparts. ### The supervised entities - APRA has limited powers to deal with unauthorized persons carrying on general insurance; prosecution timing is determined by the Director of Public Prosecutions. - Direct Offshore Foreign Insurers (DOFIs) and Discretionary Mutual Funds (DMFs): - DOFIs and DMFs are neither licensed nor subject to prudential supervision by APRA. - DOFIs must hold an AFSL from ASIC and must disclose they are not APRA-authorized when dealing with retail customers. - DMFs are not subject to insurance regulation because providers have discretion whether to meet insured event costs. - Potts Review (commissioned September 2003) reported DOFIs and DMFs accounted for approximately 2.5 percent and 0.5 percent of the Australian insurance market; the domestic insurance industry asserts that market share of DOFIs has since increased. - Government agreed to implement a Potts Review recommendation that, absent an APRA finding of no contingent risk, DMFs may only offer cover as a contract of insurance and will be regulated under the Insurance Act (IA). - APRA formalized the fitness and probity framework for all APRA-regulated entities in March 2006 with new harmonized "fit and proper" standards. - Recommendation: APRA should be given legal power to conduct cross-border supervision of insurance activities carried out by subsidiaries of insurers domiciled in Australia. - APRA issued harmonized prudential standards on governance in May 2006 (except superannuation trustees); draft prudential standards on risk management have been released for consultation. ### Ongoing supervision - APRA prioritizes ongoing supervision using PAIRS and SOARS to ensure consistent risk assessment and proportionate prudential interventions. - Consolidated supervision framework is in progress; all financial groups are under APRA supervision as integrated prudential supervisor. - Minor issues handled by moral suasion; serious cases escalated to the Enforcement Committee. - Powers under the Life Insurance Act are wide; powers under the IA have high thresholds and narrow triggers, limiting APRA’s ability to deal with troubled general insurers timely and cost-effectively. - APRA cannot appoint an administrator to manage a general insurer’s affairs; a general insurer may voluntarily appoint an administrator, potentially frustrating regulatory intervention. - Domestication of a general insurer’s assets in Australia aids policyholder protection but does not give policyholders priority of claim above other unsecured creditors in winding up. - No restriction on encumbrance of insurers’ assets; pledged assets result in higher capital requirements and do not qualify as "assets in Australia." ### Prudential requirements - APRA adopts the same on-site prudential review processes for life and general insurers, including insurance and investment activities. - Explicit risk management standards exist for general insurance; life insurers are implicitly required to adopt effective risk management through solvency and capital adequacy compliance. - Prudential principles for valuation of insurance liabilities for life and general insurance are based on actuarial valuations incorporating risk margin requirements and issued by the Life Insurance Actuarial Standards Board or APRA. - Capital adequacy regime for general insurance is prudent and comprehensive and will be extended to group level. - Capital adequacy regimes for life insurance have worked well; APRA plans to harmonize life company capital regime with that of banks and general insurers as far as practicable. ### Markets and consumers - ASIC’s supervision of professional conduct of insurers and intermediaries is robust and complemented by industry codes of practice, independent complaint resolution schemes, and Insurance Ombudsman Service. - ASIC has embarked on a Consumer Education Strategy. - Considerations: explicit regulatory measures to encourage industry to adopt effective practices to combat insurance fraud. ### AML/CFT supervision of insurers - AUSTRAC supervises insurers and intermediaries only in relation to their AML/CFT obligations. - A draft exposure Bill was being prepared to bring Australia’s AML/CFT regime in line with the FATF recommendations. ### Table 3 — Recommended Action Plan (selected highlights) - The Supervisory System (ICP2, 3, 4 and 5) - Ensure ASIC policy inputs are addressed appropriately and timely in the absence of policymaking powers. - Clearly spell out circumstances under which the Treasurer may give directions to APRA. - Consider public disclosure of reasons for removal of APRA Members; consider APRA consulting or notifying ASIC when taking action on an insurer’s license, where appropriate. - The Supervised Entities (ICP6, 7, 8, 9 and 10) - Implement Potts Review recommendations on DOFIs and DMFs as appropriate. - Review requirement that APRA can only refuse registration of a life insurer with Treasurer approval. - Give APRA explicit powers for cross-border supervision of insurance activities by subsidiaries of insurers domiciled in Australia. - Ongoing Supervision (ICP11–17) - Empower APRA to deal with troubled institutions in a timely and cost-effective manner; expedite review on harmonizing APRA powers across banking, life insurance and general insurance. - Markets and Consumers (ICP24–27) - Consider making claims fraud a punishable offence; require insurers to report fraud promptly; promote mechanisms for exchange of information between insurers on fraud (e.g., industry databases). - AML/CFT (ICP28) - Update legislative framework for AML/CFT in line with FATF standards and enhance clarity on regulatory scope of agencies in AML/CFT supervision. ### Authorities’ response and supervisory authority observations - Authorities appreciate the IMF’s recommendations and will take them into account in developing policy agenda for further insurance reforms. - APRA and ASIC provide valuable input into policy and legislative processes; however, development and passage of legislation are subject to Government policy program constraints and priorities, so timing cannot be guaranteed. - Operational independence of regulators is important to achieve high quality prudential regulation, balanced by governance and accountability arrangements to ensure regulators follow parliamentary policy intentions when implementing legislation. *Source: _cr06372 - 68. The Government does not consider that this change will materially affect APRA’s* ### 101. The authorities consider that the power of the Treasurer to issue directions to APRA ### _cr06372 - 101. The authorities consider that the power of the Treasurer to issue directions to APRA ### Treasurer powers and APRA accountability - The Treasurer may issue directions to APRA on policies and priorities (but not particular cases); this is considered to strike an appropriate balance between accountability and transparency. - Conditions attached to this power include discussing the proposed direction with the APRA Chair and tabling the direction in parliament, providing a substantial check on its use so that a direction would only be considered as a last resort. - To date the Treasurer has not given APRA any directions under this power. ### Shift of APRA’s financial framework to the FMA Act - As part of a government wide review of statutory authorities, the Treasurer has agreed to move APRA’s financial framework to the Financial Management and Accountability Act (FMA Act) from the current Commonwealth Authorities and Companies Act (CAC Act). - The Treasurer considers prudential regulation to be a core function of government, and the FMA Act is the financial framework that most appropriately applies to agencies delivering those functions. The CAC Act is most applicable to government entities that undertake commercial operations. ### Operational independence, exemptions, and funding - The Government does not consider that this change will materially affect APRA’s operational independence or funding. - APRA’s enabling legislation (the Australian Prudential Regulation Authority Act 1998) establishes the required level of operational independence necessary to exercise statutory powers objectively. - The Government has used its powers to exempt APRA from a small number of conditions under the FMA Act that may affect its ability to fulfill its duties efficiently and effectively. - As a result, the change to the FMA Act will not affect how APRA is funded or reduce its autonomy in deciding how it spends its funding and organizes itself (including its ability to set terms and conditions of its staff) to meets its statutory obligations. ### Overall fiscal policy context - The Australian Government notes that its overall approach to fiscal policy over the last decade, in which all public sector spending is subject to robust discipline, has served Australia well, ensuring adequate funding for government services and agencies while producing a degree of sustained fiscal responsibility unmatched by many other OECD economies. ### Treasurer’s involvement in operational decisions and Financial Sector (Shareholdings) Act - The Treasury does not have any involvement in the operational decisions of APRA or ASIC. - Previously, the Treasurer’s agreement had to be sought before certain administrative actions or decisions are taken under the Insurance Act and the Life Insurance Act; the Government agreed to remove the Treasurer’s involvement in operational decisions, other than in cases where broader policy issues were involved, as part of its response to the HIH Royal Commission. - The Financial Sector (Shareholdings) Act is not administered by APRA; prudential aspects are taken into account when considering ownership change applications and the Treasurer takes account of APRA’s advice. - In certain instances, determined by monetary thresholds, the Treasurer has delegated his powers under the Financial Sector (Shareholdings) Act to senior APRA staff. ### Licensing, supervision, and enforcement (insurance and supervised entities) - Australia’s licensing regime was substantially revised in 2001, and in 2002 all existing insurers were subjected to a rigorous re-licensing process; Australia has in place a robust, well-tested licensing regime to ensure that only well-resourced and prudentially sound insurance companies are licensed. - DMFs and DOFIs are not prudentially supervised by APRA at this time but are required to comply with AFSL license requirements. Their relatively small market share and Government agreement to implement the key recommendations of the Potts Review mitigate emphasis on identified deficiencies. - Assessment of insurers’ internal controls is a routine component of APRA’s on-site prudential review. APRA released its final prudential standard in February 2006. This prudential standard will be effective from October 1, 2006. - The Government is reviewing the application of merits review to APRA decisions following recommendations of the HIH Royal Commission and the Taskforce on Reducing the Regulatory Burden on Business; the review will consider timeliness needed to protect depositors and/or other policyholders and balance timeliness with fair treatment of persons affected. - Merits review is a key element of Australia’s system of administrative review; absent merits review, persons affected would have recourse to judicial review by the courts. ### Summary assessment of implementation of the IOSCO Objectives and Principles of Securities Regulation - The assessment was completed as part of a Financial Sector Assessment Program and required review of the legal framework and detailed examination of policies and practices of institutions responsible for securities regulation. - Key institutional roles: - ASIC: market conduct regulator and administers company law for listed and unlisted companies. - APRA: prudential supervision of banks, insurers and superannuation (pension) funds. - RBA: payment system oversight and overall financial stability. - AUSTRAC: federal financial intelligence unit responsible for AML/CFT regulation and on-site verification in financial institutions. - Treasury: preparation of laws and regulation and policy advice to the Treasurer; Treasurer may issue directions to ASIC and APRA. - Attorney-General’s department: preparation of laws and regulations for AML/CFT and policy advice to the Minister for Justice and Customs. - Recent reforms and context: - Regulators and the financial services industry have been implementing change mandated by the Financial Services Reform Act 2001. - Australia adopted a modified version of International Financial Reporting Standards from January 2005. - Overall findings: - Australia has a high overall level of compliance with the IOSCO Principles. - A principles-based approach by regulators largely meets IOSCO’s detailed requirements. ### Specific observations and identified weaknesses - Principles related to the regulator: - Although operationally independent and appropriately funded, there are several issues concerning the independence of ASIC that should be resolved; consultation on new regulatory issues is extensive but could be improved. - Principles related to compliance and enforcement: - Apart from acknowledged weakness in the AML/CFT area (where legislation has failed to keep pace with the latest international developments and change is imminent), ASIC’s legal powers are generally comprehensive and effectively used. - Principles related to information sharing and cooperation: - ASIC is a signatory to the IOSCO Multilateral MOU; improvements to timeliness in responding to overseas regulators have been identified and change is imminent. - Principles related to issuers and collective investment schemes: - The mix of corporate law and securities regulation works well; ASIC facilitating takeover bids and preventing malpractice is helpful. Publication of recent ASIC advice on prospectus disclosure would be beneficial. - Operators of collective investment schemes are subject to comprehensive licensing and risk-based supervision; greater specificity could be useful regarding fund managers’ conduct when trading on behalf of clients. The ongoing record of unit pricing errors should be monitored to assess the impact of guidance published by ASIC and APRA. - Principles related to market intermediaries and secondary markets: - Market intermediaries are subject to comprehensive licensing and risk-based supervision; ASIC’s risk-based capital requirements do not fully match international best practice. - The Treasurer licenses exchanges and CSFs and may disapprove rule changes; day-to-day supervision is carried out by ASIC. It may be appropriate to review the case for the Treasurer retaining these powers. - ASIC’s risk-based capital requirements for large exposures are not sufficient for an OTC market of considerable complexity and turnover substantially exceeding that of on-exchange markets. ### Table 4 — Selected Recommended Action Plan items (Principle-by-principle) - Principles Relating to the Regulator (P 1–5) - Consider amending the ASIC Act to remove the power of the Treasurer to give directions and the power to instruct ASIC to carry out an investigation. - Consider reversing the growing dependence of ASIC on special purpose funding. - Consider whether it would be possible to fund a proportion of ASIC’s work directly from a levy on the financial services industry. - Consider measures to improve the consultation process with the private sector. - Principles for the Enforcement of Securities Regulation (P 8–10) - Consider removing the ambiguities in ASIC’s use of evidence obtained from use of a search warrant. - ASIC should satisfy itself that it has adopted a comprehensive suite of tools for identifying and prioritizing risk in the surveillance function. - Principles for Cooperation in Regulation (P 11–13) - Consider whether to give ASIC the authority to acquire information and transmit it directly to its counterparts overseas without first having to seek the Attorney General’s permission. - Principles for Issuers (P 14–16) - ASIC should issue, as planned, a comprehensive Policy Statement on guidance on prospectus disclosure. - Principles for Collective Investment Schemes (P 17–20) - ASIC should issue a Policy Statement setting out its expectations of behavior by the responsible entity for a managed investment scheme in the areas of best execution, appropriate trading and timely allocation of trades, the prevention of churning, and underwriting agreements. - Principles for Market Intermediaries (P 21–24) - Consider making reciprocal the constraints on ASIC when seeking to suspend or cancel the license of an APRA supervised entity. - ASIC should take steps to ensure that Australia’s risk-based capital requirements meet international norms. - Principles for the Secondary Market (P 25–30) - Consider transferring the power to license market operators and clearing and settlement facilities to ASIC. - ASIC should take steps to ensure that Australia’s risk-based capital requirements take proper account of the systemic risks of large exposures in OTC markets. ### Authorities’ response to the IOSCO assessment - The Australian Government welcomes the IMF’s assessment and emphasizes the high level of compliance with the IOSCO principles. - ASIC has complete independence in relation to performance of its functions and exercise of its powers under the corporations legislation; the Government does not agree that the current structure is susceptible to political interference. - The limited, and rarely used, ability of the Treasurer to issue directions is viewed as balancing transparency and accountability; the Government believes the IOSCO principle of independence should focus on independence in administration of the regulatory framework as it relates to specific cases, rather than requiring absolute strategic and financial autonomy from the executive. - Despite disciplined fiscal policy, the Government has supported ASIC through significant funding increases; the 2006-07 Budget increased ASIC funding by 25 per cent and includes additional initiatives to provide ASIC further certainty over its level of funding and to maintain its regulatory focus. - The Government is committed to updating Australia’s AML/CFT regime to reflect developments in financial crime and revised FATF standards; legislation is expected to be introduced during 2006 and reforms will bring Australia into line with the FATF recommendations. - The Australian Government remains committed to sound regulation and is actively considering the report’s recommendations in developing future policy reforms in securities regulation. ### RITS assessment and institutional context (CPSS) - The document includes the summary assessment of compliance of the Reserve Bank Information and Transfer System (RITS) with the CPSS Core Principles for Systemically Important Payment Systems. - The assessment was conducted during a mission of the IMF which visited Sydney during November 30–December 14, 2005, based on a comprehensive self-assessment prepared by the RBA and detailed discussions with RBA officials and representatives of commercial banks and the Australian Payments Clearing Association. - Legal framework and institutional roles: - The RBA operates under the Reserve Bank Act 1959, and most payments system powers derive from that Act and the Payment Systems (Regulation) Act 1998. - The power to determine the RBA’s payments system policy resides with the Payments System Board (PSB), one of two boards of the RBA established by the Reserve Bank Act; the Governor of the RBA chairs the PSB. - The PSB’s mandate is to define the RBA’s payments system policy to best contribute to controlling risk in the financial system as well as promoting efficiency and competition in the market for payment services, consistent with overall stability of the financial system. The PSB’s policy is implemented by the RBA’s Payments Policy Department. *Source: Extract from IMF Financial Sector Assessment Program document (IMF mission and assessments as provided in the supplied content).* ### 131. The RBA owns and operates RITS, which is the only systemically important payment ### _cr06372 - 131. The RBA owns and operates RITS, which is the only systemically important payment ### RITS — system description and operations - RITS launched as a real time gross settlement (RTGS) system in 1998. - Transactions are processed and settled continuously and irrevocably in real-time. - Final settlement of obligations between RITS participants is executed by entries to their exchange settlement account at the RBA. - The bulk of large value interbank transfers are channeled through the SWIFT network and a smaller number of transactions are transmitted via the proprietary network infrastructure. - RITS accepts payment instructions for: - interbank payments, - settlement of interbank obligations arising from net clearing arrangements (e.g., net balances of interbank obligations arising from low-value payments transactions on a next day basis), - transactions arising from equities settlement in CHESS, - the cash leg of securities transactions settled on a real time gross basis in the Austraclear securities settlement system. - There is no minimum amount for a payment to be made through RITS; it handles time-critical low-value payments as well as large-value transfers. ### Usage statistics and market concentration (2005) - In 2005: - RITS had 60 participants. - 24,000 transactions on average were settled daily. - Average daily value was AUD 150 billion. - Flows of payments in RITS are concentrated: - the four major banks have 67 percent of the volume and value of the total RTGS transactions. - Agency arrangements account for less than one percent by value of transactions. - No bank acts as a major settlement agent for other banks. ### Oversight, governance, and responsibilities - The RBA is the overseer of RITS and other payment and securities clearing and settlement systems operating in Australia. - Payments system policy and oversight are the responsibility of the Payments System Board (PSB). - PSB policies, procedures and practices regarding oversight are open and transparent and are published and widely circulated. - The RBA has established good cooperation with the banking sector and payment service providers. - At departmental level, there is a clear separation between staff managing the system and those supporting the PSB in policy and oversight roles. - The PSB determines payments system policy and oversight on advice of the RBA’s Payments Policy Department; implementation is the responsibility of the Payments Policy Department. - The RBA cooperates with other authorities (prudential authority, securities regulator, competition authority) via separate Memoranda of Understanding. ### Main findings — observance of CPSS Core Principles - Overall assessment: - RITS is a sound and efficient payment system and complies with all CPSS Core Principles for Systemically Important Payment Systems. - Legal basis, functionality, risk management, and governance are judged solid and appropriate. - Well-founded legal basis (CP-I): - The regulatory framework ensures design and operations of RITS have a solid legal basis and transactions are valid and enforceable. - Final settlement is protected by legislation and cannot be challenged by a third party. - Recommendation: analyze possible conflict of laws for RITS participants legally located outside Australian jurisdiction. - Understanding of system risks (CP-II): - RBA uses various channels to inform participants of features, processing, and risks; RITS Regulations identify obligations and rights; updated documents circulated when changes are made. - Risk management procedures (CP-III): - RITS is RTGS with queuing facility, settles in central bank money with finality, allows access to liquidity from central bank. - RBA protected against credit risk as the cash account held by the central bank cannot be overdrawn. - Liquidity supplied by RBA through intraday repurchase agreements and there is no limit to provision of cash as long as participants have access to eligible assets. - RBA has well-established procedures to handle crisis situations. - Final settlement and settlement assets (CP-IV, V and VI): - RITS settles in central bank money continuously during the day with intraday finality and provides prompt final settlement. - Credit risk of settlement agents is considered negligible due to lack of concentration of payments through a few direct participants. - Operating times are clearly defined and monitored. - Security and operational reliability (CP-VII): - RBA has proactive risk management for business continuity; activity and performance are analysed and monitored during the processing day. - Incidents and disruptions are logged; contingency plan addresses software/hardware defects, telecommunication and power disruptions, inability of staff to reach primary site, and disruption in contact with external parties. - System protection through redundancy at primary site and duplication of services at remote back-up site. - Recommendation: consider arranging an external review of current business continuity plan and update it when major changes are introduced; review should include assessment of hardware, software and internal procedures. - Efficiency and practicality (CP-VIII): - RITS meets key RTGS requirements of speed, cost, and practicality. - Pricing policy recovers operating costs through a flat fee. - System practical for users in intra-day liquidity management and queuing facilities. - Recommendation: review pricing structure to ensure it promotes efficiency and effective functioning while still providing incentives to use RITS for settlement of large value payments. - Participation criteria (CP-IX): - Access rules are clear, publicly disclosed, fair and objective and do not have a restrictive impact on competition. - Rules for suspension, termination and resignation are defined in regulation. - Governance (CP-X): - RITS is owned and operated by the RBA as a functional area; governance arrangements are effective, accountable, and transparent. - Recommendation: consider re-establishing an advisory user group representing different categories of RITS participants to meet regularly on technical and business features. ### Recommended actions to improve observance (selected) - Legal foundation (CP-I): - Require entities located outside Australian jurisdiction that apply for participation in RITS either as a branch or on a remote basis to provide a legal opinion analyzing possible conflict of laws and potential legal risk for RITS and its participants. - Security and operational reliability, contingency arrangements (CP-VII): - Require security enhancement of the proprietary communication network to meet international standards regarding confidentiality, integrity and authenticity of transmitted information and data. - Consider an external review of the RBA’s business continuity plan including assessment of hardware, software and internal procedures. - Efficiency and practicality (CP-VIII): - Consider following up studies of RITS costs and pricing structure by consulting RITS users; review pricing to ensure it promotes efficient functioning. - Governance (CP-X): - Consider establishing a consultative framework with users; re-establish advisory user groups representing different RITS participant categories. - Central Bank responsibilities: - Consider whether current arrangements avoid potential conflicts of interest between policy/oversight functions (PSB) and the Bank’s role as operator of RITS. - Strengthen implementation of PSB’s oversight by developing formal methods and procedures, including regular monitoring and reporting, on-site inspections, and arranging regular meetings with payment systems providers and other stakeholders. ### Authorities’ response and planned actions - Authorities concur with IMF’s assessment that RITS complies with all Core Principles and that oversight arrangements comply with central bank responsibilities. - Planned and in-progress actions (2006 references preserved as in source): - An upgrade to the RITS user interface was well advanced at the time of the assessment and is due for implementation during 2006; this upgrade will bring confidentiality, integrity and authenticity of transmitted information up to best practice. - During 2006, the Reserve Bank will finalize a review of pricing; in determining changes to fees the Bank will consider cost recovery, system efficiency, appropriate incentives for participants, and industry feedback. - The Bank will continue to maintain appropriate delineations between oversight functions (PSB) and operational payments functions and will ensure potential conflicts of interest are properly addressed. - The Reserve Bank will give careful consideration to IMF recommendations regarding legal risk from branch participation in RITS, external review of the RITS business continuity plan, and arrangements for consultation with RITS users, and will consider how best to perform its oversight function. ### Appendix I — Stress tests (overview and results) - Three types of stress tests performed: - Macroeconomic stress scenario run by the five largest domestic banks over a three-year time period. - Single factor stress tests on interest rates run by the same banks. - APRA update of mortgage portfolio stress tests using data from two regional banks with heavy mortgage exposure. - Macroeconomic stress scenario (high-level features): - 30 percent decrease of house prices. - Sharp increase in unemployment. - Decrease in consumer demand and GDP growth in year one. - Year two: recession continues but turns around in second half. - Year three: significant rebound of growth and renewed, modest increase in housing prices. - Change in sentiment by offshore investors leading to diminished access to offshore funding, leading to a 40 percent depreciation of the exchange rate and increased cost of funding. - Single factor stress tests (banking and trading books): - (i) gradual 300 basis points steepening of the yield curve out to three years; - (ii) 200 bps upward parallel shift in the yield curve; - (iii) 100 bps downward parallel shift in the yield curve. - Trading book only: (iv) 250 percent increase in volatility across the yield curve; (v) 75 percent decrease in volatility. - APRA mortgage portfolio update: - Focused on two regional banks holding more low documentation (low-doc), large-size, and investor loans than average Australian bank. - Stress test results: - Results did not expose any near-term stability issues. - Under the macroeconomic stress test, large Australian banks exhibited considerable resilience; while financial performance deteriorated, banks withstood the adverse scenario relatively well. - Single factor tests suggested limited exposure to interest rate shocks, concentrated in the banking book; banks generally do not take large positions in trading books. - APRA’s partial update indicated both regional banks would remain above their regulatory minimum capital requirements in a stress scenario. *Source: IMF assessment text provided in content unit _cr06372.* ### 156. Sensitivity analyses around the base scenario resulted in increased stress, but the ### _cr06372 - 156. Sensitivity analyses around the base scenario resulted in increased stress, but the ### Sensitivity analyses and overall system resilience - Sensitivity analyses around the base scenario resulted in increased stress, but the system remained well able to deal with the stress. - Two analyses focused on more severe shocks to unemployment by means of a deeper or more prolonged recession. - The third sensitivity analysis focused on an increased risk premium on offshore borrowing. - A deeper or more prolonged recession could lead to a tripling of unemployment to 12 percent (instead of a doubling to 9 percent under the base scenario). - Under that deeper shock, the default rate on mortgages could double compared to the base scenario, with bad and doubtful mortgage loans peaking at around 0.9 percent of tier 1 capital in year 2. - An illustrative increase in the banks’ funding costs of 10 basis points would reduce overall profits by around 1 percent. ### APRA’s Panama Project (2003 mortgage portfolio stress test) - Covered 120 ADIs including Australian banks, building societies, and credit unions. - Stress test scenario: a 30 percent fall in house prices mapped to a substantial increase in default and loss rates. - Results: - All 120 institutions would continue to have positive capital under the imposed conditions. - For 11 institutions, representing less than two percent of the banking assets, the capital ratio would fall below their regulatory minimum. - When applied to Lenders’ Mortgage Insurers (LMIs), all LMIs would breach capital solvency requirements in the stress scenario and many institutions would be insolvent. - Policy response: - APRA reviewed capital requirement regulations for LMIs. - Introduced a substantial increase in the minimum capital requirements for mortgage insurers effective January 1, 2006. - Under the new arrangement, the capital requirements against any given insured loan depend on the loan-to-value ratio, the age of the loan, and whether the loan is standard or non-standard. - For most loans, the capital charge will more than double. ### FSAP-updated mortgage portfolio stress tests (selected regional banks) - Two regional banks with heavy and unique mortgage portfolios were selected and rerun with more recent data. - Characteristics: - Both source many loans via mortgage brokers (over 80 percent in the case of one bank). - Both have embraced the low-doc loan market; one bank remains the most exposed to this product among the Australian banks. - Both rely heavily on securitization for funding. - Both grew housing loan portfolios by nearly 50 percent since 2003 and increased shares of investment loans and large-sized loans. - Results: - Loss rates remain relatively low, though larger than in the 2003 stress test. - Both banks remain above the regulatory minimum capital ratio. ### Stress Test Results (five largest banks) — main findings - Under the macroeconomic stress scenario, the banks continue to be profitable, although profitability decreases significantly compared to the baseline. - Return on equity (RoE) average falls from some 21 percent (baseline number) before the shock to 14 percent in the second year of the scenario. - Provision effects: - In year two, provision for bad debt rise to an average 3.2 percent of capital (minimum across the banks 0.9 percent, maximum 8.1 percent), of which 0.6 percent is related to residential mortgages. - Mortgage portfolio impact limited because consumers default on other personal loans and credit cards first, and because many consumers have “prepaid” part of mortgage debt by maintaining payments when interest rates decreased. - Net interest income: - Decreases by an average 1 percent of capital (ranging from 0.5 to 3 percent across the banks). - Loss primarily due to adverse impact on volume of lending; partially offset by higher mismatch income and, to a limited extent, higher margins. - Funding costs: - If banks do not alter funding mix, cost increases range from 3.6 percent of total liability to 6.6 percent of total liability on average in year three. - Most banks claim they would change funding mix toward short-term funding and retail deposits and away from offshore funding, which would considerably modify increase in funding costs. - Exchange rate effects: - Offset effects of exchange rate movement strengthen balance sheets of corporates in export or import-substituting lines; realistic for a small open economy like Australia. - Single-factor stress tests indicated limited interest rate risk concentrated in the banking book, most pronounced for yield curve steepening (average loss equivalent to 1.8 percent of tier 1 capital, primarily valuation effects). - Volatility shocks on the trading book yield very small losses because banks hold only small positions. - Overall, results consistent with risk managers’ and supervisors’ views of main strengths and vulnerabilities in Australian banks. ### Macroeconomic Stress Scenario (Table 6) - Q4 2006: Real GDP growth (%) -1; Nominal TWI (%change) -40; House Price Growth (%) -30; Equity Price Growth (%) -27; Consumption Growth (%) -2½; Unemployment Rate (5% 2005) 7; Nominal Cash Rate (5.5% 2005) 5½ - Q4 2007: Real GDP growth (%) 2; Nominal TWI (%change) 10; House Price Growth (%) 0; Equity Price Growth (%) 8; Consumption Growth (%) 0; Unemployment Rate (5% 2005) 9; Nominal Cash Rate (5.5% 2005) 5½ - Q4 2008: Real GDP growth (%) 4; Nominal TWI (%change) 7; House Price Growth (%) 2½; Equity Price Growth (%) 10; Consumption Growth (%) 2¼; Unemployment Rate (5% 2005) 8¾; Nominal Cash Rate (5.5% 2005) 5½ ### Results under Stress Scenario (Five Major Banks) — selected figures (Table 7) - Profit Before Tax (annualized, percent of Tier 1 capital): - Q4 2005 Ave 30.6 Max 35.7 Min 22.3 - Q4 2006 Ave 18.0 Max 27.8 Min 7.4 - Q4 2007 Ave 16.9 Max 24.4 Min 7.6 - Q4 2008 Ave 23.2 Max 29.7 Min 17.8 - Bad and Doubtful debts (percent of Tier 1 capital): - Q4 2005 Ave 1.1 Max 1.4 Min 0.6 - Q4 2006 Ave 2.6 Max 5.5 Min 0.9 - Q4 2007 Ave 3.2 Max 8.1 Min 0.9 - Q4 2008 Ave 2.3 Max 7.8 Min 0.3 - On residential mortgage (percent of Tier 1 capital): - Q4 2005 0.1 0.3 0.0 - Q4 2006 0.6 1.7 0.1 - Q4 2007 0.6 1.3 -0.1 - Q4 2008 0.4 1.3 0.0 - Return On Equity (%) 3/: - Q4 2005 Ave 20.7 Max 23.8 Min 16.4 - Q4 2006 Ave 16.8 Max 25.7 Min 9.8 - Q4 2007 Ave 13.7 Max 22.4 Min 3.9 - Q4 2008 Ave 17.7 Max 26.4 Min 9.2 - Net Interest Income (percent of Tier 1 capital): - Q4 2005 9.1 11.1 6.4 - Q4 2006 8.2 10.9 5.0 - Q4 2007 8.1 10.4 5.9 - Q4 2008 8.5 10.7 6.0 - Total Tier One Capital (% of risk-weighted assets): - Q4 2005 7.4 8.7 6.6 - Q4 2006 7.4 8.9 6.6 - Q4 2007 7.3 8.4 6.4 - Q4 2008 7.1 8.4 6.0 ### Single Factor Stress Testing Results (Table 8) — impact as percent of Tier 1 capital - Banking book / Trading book (Average / Minimum / Maximum as provided): - 300 bps steepening: Banking book Average -1.8 Minimum -7.2 Maximum 1.5; Trading Book Average 0.5 Minimum -1.1 Maximum 3.2 - 200 bps upward shift: Banking book Average -1.0 Minimum -3.6 Maximum 1.9; Trading Book Average 0.2 Minimum -0.8 Maximum 1.5 - 100 bps downward shift: Banking book Average 0.5 Minimum -1.1 Maximum 3.6; Trading Book Average -0.3 Minimum -0.6 Maximum -0.1 - 250 percent increase in volatility: Trading Book Average 0.1 Minimum 0.0 Maximum 0.1 - 75 percent decrease in volatility: Trading Book Average 0.0 Minimum -0.1 Maximum 0.0 ### Policy and supervisory implications - APRA increased minimum capital requirements for LMIs effective January 1, 2006, with capital charges depending on loan-to-value ratio, age of the loan, and loan standardness; for most loans the capital charge will more than double. - Banks indicated potential funding mix adjustments (toward short-term funding and retail deposits and away from offshore funding) to mitigate funding-cost stress. - Stress tests validated risk managers’ and supervisors’ assessments of strengths and vulnerabilities in Australian banks and informed regulatory responses for mortgage insurers. *Source: IMF staff summary of APRA and bank stress-testing exercises and tables as provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06372.pdf_