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---

### Executive summary — macro-financial performance and vulnerabilities
- Financial system described as "sound, resilient, and well managed."
- Australia avoided a recession during the Global Financial Crisis and continued to outperform most peers five years on.
- Drivers of resilience: strong fundamentals at the onset of the GFC, a well-coordinated crisis response, and a mining investment boom fueled by China’s demand for commodities.
- Current account and growth:
  - "The current account deficit fell to about 2½ percent of GDP in the first half of 2011 from an average of 4½ percent for the previous 15 years."
  - Growth expected "close to trend at 3-3.5 percent annually in 2012 and 2013."
  - Inflation expected to remain "within the authorities’ target band of 2-3 percent over the medium-term."
- Financial sector scale and concentration:
  - Financial sector assets exceed "more than three times the size of GDP."
  - Sector dominated by four large banks with "broadly similar business models and rely on wholesale funding."
- Household and housing risks:
  - Residential mortgages are banks’ "single largest asset."
  - "High household debt and elevated house prices increases the risk in this portfolio."
- Policy space and mitigating factors:
  - Low public debt, a flexible exchange rate, scope for monetary easing, and a well capitalized banking system.

### Financial sector size, composition, and key indicators
- Total financial sector assets:
  - "340 percent of GDP."
- Asset shares:
  - ADIs (mostly banks): "60 percent of financial sector assets."
  - Superannuation funds: "25 percent."
  - Non-life insurance sector: "3 percent."
  - Non-superannuation managed funds: "6 percent."
- Stock market capitalization: "80 percent of GDP at end-2011 (below peak of 150 percent in mid-2007)."
- Selected magnitude snapshots (in billions of AUD):
  - Total financial system assets — Dec. 2008: 4,772.3; Dec. 2009: 4,629.1; Dec. 2010: 4,734.9; Dec. 2011: 4,883.3.
  - ADIs total assets — Dec. 2011: 2,954.0 (As percent of GDP: 204.9).
  - Banks total assets — Dec. 2011: 2,818.2 (As percent of GDP: 195.5).
- Financial soundness indicators (selected series):
  - Regulatory Capital to Risk-Weighted Assets: 2008: 11.3; 2009: 11.9; 2010: 11.4; 2011: 11.6; 2012Q1: 11.6.
  - Regulatory Tier 1 Capital to Risk-Weighted Assets: 2008: 8.5; 2009: 9.3; 2010: 9.6; 2011: 10.2; 2012Q1: 10.3.
  - Non-performing Loans to Total Gross Loans: 2008: 1.3; 2009: 2.0; 2010: 2.2; 2011: 2.0; 2012Q1: 1.9.
  - Return on Assets: 2008: 0.9; 2009: 1.0; 2010: 1.1; 2011: 1.3.
  - Liquid Assets to Total Assets: 2008: 14.2; 2009: 14.5; 2010: 15.6; 2011: 16.1; 2012Q1: 16.3.
  - Liquid Assets to Short Term Liabilities: 2008: 34.6; 2009: 35.2; 2010: 38.5; 2011: 39.2; 2012Q1: 40.8.

### Banking sector structure, exposures, and funding
- Concentration and systemic importance:
  - Four major banks hold "80 percent of banking assets and 88 percent of residential mortgages."
  - Major banks are among each other’s largest counterparties; Expected default frequencies (EDFs) highly correlated.
- Overseas exposures and counterparty concentration:
  - Total foreign claims: "22 percent of consolidated assets."
  - Cross-border claims: "6 percent of consolidated assets."
  - Geographic composition of cross-border claims: New Zealand 39 percent; United Kingdom 17 percent; United States 14 percent; Asia Pacific 8 percent; Euro Area 7 percent; Other 14 percent; Other Europe 2 percent.
  - Non-performing overseas assets: "about 0.3 percent of consolidated assets (slight decline from peak of 0.4 percent in mid-2010)."
  - Of outstanding notional principal amount of foreign currency related derivatives the four major banks have with 40 counterparties, "44 percent are with the top five (Deutsche Bank, Citibank, JPMorgan, UBS and Barclays)."
- Funding structure shifts since mid-2008:
  - Deposits share rose to "53 percent of total liabilities from 40 percent in mid-2008."
  - Short-term wholesale debt fell to "19 percent from 33 percent."
  - Share of bank bonds issued off-shore fell from "78 percent of the total in 2007 to 60 percent in 2011."
  - Off-shore bonds maturing in less than a year fell from "80 percent in 2007 to 56 percent in 2011."
  - Banks’ net foreign liabilities (mostly in foreign currency): "24 percent of GDP."
  - Offshore short-term wholesale funding used by Australian banks is "below 10 percent of liabilities."
- Recommended directions:
  - Continue lengthening offshore funding maturity and increase domestic funding.
  - Support increased domestic savings via planned superannuation contribution rate rise from "9 percent to 12 percent."

### Household, housing, and mortgage risk profile
- Household debt:
  - Household debt to household disposable income is "above the average of advanced economies in the G20."
  - "90 percent of household debt is housing loans."
- Mortgage structure:
  - "Around 30 percent of new mortgages are interest-only; 55 percent of interest-only mortgages are investor loans."
  - Average loan-to-value (LTV) on outstanding owner-occupied loans: "about 50 percent."
  - About "30 percent of mortgages... have an LTV of 80 percent or more at origination and are generally covered by private mortgage insurance."
  - Prepayments equivalent to "18 months of scheduled repayments on average."
  - Mortgages are full recourse loans; some interest-only loans include mortgages with "100 percent offset accounts."
- Mitigants:
  - Household housing debt represents "only about 30 percent" of household housing assets.
  - Household financial assets (non-housing) account for "about 40 percent of household assets."
  - Value of financial assets is "more than double the value of housing debt."

### Non-financial corporate sector and commercial real estate
- Business credit:
  - Accounts for "approximately one third of total lending."
  - Business credit declined by "4.1 percent since peaking in Q4 2008."
  - Sectoral declines: construction down "14 percent"; manufacturing down "11 percent."
- Mining investment:
  - Mining sector investment expected to surge to "8 percent of GDP."
- Commercial real estate:
  - Receives "almost one-third of banks’ lending but accounts for almost half of banks’ current loan impairments."
  - Vacancy rates and pricing show early signs of stabilization.
- Leverage:
  - Leverage in agriculture, manufacturing, and services remains "above the long-term historical average."

### Stress testing: framework, scenarios, and solvency results
- Joint exercise coverage:
  - Five largest banks (ANZ, CBA, NAB, Westpac, Macquarie) — account for "80 percent of banking assets."
  - Bottom-up: bank-performed tests under APRA guidance; data as of September 2011; projection horizon "three years."
  - Top-down: IMF/APRA systemic macro-financial analyses; data as of March 2012; projection horizon "five years."
- Top-down scenario definitions:
  - Slow-growth: "one standard deviation shock to real GDP growth."
  - Mild recession: "two standard deviations."
  - Severe recession: "annual GDP growth swings from 2 percent to -5 percent during the first year," representing "a shock of more than 4 standard deviations."
  - Standard deviations based on volatility of annual GDP growth since 1960; shocks applied over first three years of a five-year horizon.
- Severe scenario projections (Year 0 baseline and trough/peaks):
  - GDP year-ended growth: "2½ percent" (Year 0); Trough: "-5 percent" (Year 1).
  - Unemployment rate: "5¼ percent" (Year 0); Peak: "12 percent" (Year 3).
  - Inflation year-ended change: "3½ percent" (Year 0); Trough: "½ percent" (Year 4).
  - Cash rate: "4¾ percent" (Year 0); Low: "1 percent (from Year 1)."
  - Total credit year-ended growth: "3 percent" (Year 0); Trough: "-3½ percent" (Year 2).
  - Equity prices: "Up to 47 percent decline (in Year 1)."
  - House prices: "35 percent decline (up to Year 3)."
  - Commercial property prices: "40 percent decline (up to Year 3)."
- Solvency outcomes:
  - Aggregate Tier 1 capital remained above regulatory minimum under all three scenarios.
  - System-wide total capital falls below the threshold of "8 percent" after the second year in the severe scenario before stabilizing from the fourth year.
  - Credit loss is the largest driver of capital loss.
  - Top-down and bottom-up results broadly consistent, with rapid capital loss in years one and two.

### Quantifying higher loss absorbency (HLA) and EDF illustration
- Rationale: four major banks are systemically important and benefit from an implicit funding advantage.
- Funding cost advantage estimated to have risen from "80 basis points to 120 basis points during the GFC."
- EDF-based illustration (as of end-2011):
  - To maintain a one-year ahead probability of "99.9 percent" of not defaulting would require additional Tier 1 capital ranging from "-0.9 to 2.8 percent of RWA."
  - To achieve "99.95 percent" probability of not defaulting would require additional Tier 1 capital ranging from "1.4 to 5.2 percent of RWA."
  - Example: to ensure survival probability of "99.95 percent (EDF=0.05)," total Tier 1 capital would need to be "12.3 percent of risk-weighted assets" (compared to actual average of "10 percent during the first half of 2012").
- International precedents cited: Austria "3 percentage points," Singapore "2 percentage points," Sweden "5 percentage points" additional requirements for domestically important banks.

### Liquidity stress testing, RBA support, and LCR/CLF arrangements
- Implied Cash Flow Test (ICFT):
  - Simulates gradual outflow over five weeks (30-day equivalence) with asset-specific haircuts; stricter than Basel III LCR without CLF.
  - Five-week outflow assumptions by end of stress period:
    - "100 percent of unsecured short-term wholesale funding."
    - "20 percent of secured wholesale funding."
    - "10 percent of retail term deposits."
    - "20 percent of retail demand deposits."
  - Without central bank support, the five banks would be unable to withstand a Lehman-type outflow, with substantial shortfall within two weeks.
  - With RBA repo arrangements (including self-securitized RMBS accepted), "all banks would be able to counterbalance funding outflows even with significant haircuts."
  - APRA classification treated most retail deposits as demand deposits, increasing shock impact.
- Network contagion analysis:
  - Claims from United States, United Kingdom, and Japan on Australia: "$298 billion" at end-September 2011; derivatives and contingent claims from these countries: "$199 billion."
  - G7 withdrawal simulations:
    - With 10 percent haircut: impact "4 percent of Tier I capital" (Simulation 1) and "6 percent" (Simulation 2).
    - With 35 percent haircut: impact "20 percent of Tier I capital" (Simulation 1) and "30 percent" (Simulation 2).
- RBA Committed Liquidity Facility (CLF):
  - RBA will create a CLF in 2015 to help ADIs meet proposed LCR under Basel III.
  - ADIs required to pay fees for CLF assistance "currently set at 15 basis points."
  - Use of facility at RBA’s discretion; an ADI must first receive APRA approval on the amount of liquidity requirement that can be met through the CLF.

### Regulatory, supervisory, and institutional assessments
- Prudential framework and APRA:
  - Functional model: APRA (prudential), ASIC (market conduct), RBA (financial system stability), Treasury (policy advice).
  - APRA maintains conservative supervisory stance:
    - "At least 75 percent of Tier 1 capital must be common equity (vs. at least 50 percent under Basel II)."
    - Super-equivalent to Basel capital standard; higher risk weights and higher minimum LGDs for advanced banks.
  - APRA strengths: proactive, risk-based, principles-based, outcome-oriented supervision via PAIRS and SOARS; emphasis on board responsibility; provisioning typically higher than IFRS.
  - Recommendations:
    - "Devote more resources to stress testing" and increase formal on-site liquidity review time from current "3-4 days."
    - APRA should consider establishing its own macro-financial stress testing framework.
- ASIC effectiveness and resource concerns:
  - "ASIC has rightfully earned its reputation as an effective and credible enforcer of market regulation."
  - Concerns: growing share of non-core earmarked funding; reliance on desktop reviews due to resource constraints.
  - Recommendations:
    - "It is important that ASIC be given more resources and flexibility over its operational budget."
    - ASIC should conduct more proactive surveillance of insurers and intermediaries and extend certain prudential requirements (risk-based capital, periodic reporting, large exposure rules) to AFSL holders not regulated by APRA.
    - Ensure sufficiency and stability of ASIC core funding.
- Systemic oversight and the CFR:
  - CFR (RBA, APRA, ASIC, Treasury) plays key coordinating role; advisory body chaired by RBA Governor.
  - Recommendation: "Further highlight its work and enhance the transparency of its deliberative processes," e.g., through more explicit reporting in the Financial Stability Review.
  - RBA publishes a half-yearly Financial Stability Review; recommendation to incorporate regular stress testing results once RBA establishes its own stress testing framework.

### Crisis management, deposit insurance, recovery, and resolution
- Reforms since 2006 FSAP and 2008 GFC:
  - Establishment of the Financial Claims Scheme (FCS).
  - Strengthening of APRA’s resolution powers, including statutory manager appointment before insolvency.
  - MOU on Financial Distress Management among CFR agencies signed in 2008.
- FCS history and parameters:
  - October 2008: government introduced FCS guaranteeing deposits "up to A$1 million per account holder per Authorized Deposit-taking Institution (ADI)." A separate fee-based, unlimited wholesale guarantee introduced at that time.
  - Wholesale funding guarantee no longer in place.
  - Government confirmed FCS as permanent and "reduced the cap from A$1 million to A$250,000 per account holder per ADI."
  - "The new permanent cap has applied since February 1, 2012."
- Deposit insurance funding and moral hazard:
  - Current design: "ex post funded, backed by a standing budgetary authorization of up to A$20 billion per ADI," with an optional industry levy.
  - Recommendation: re-evaluate merits of converting to "an ex-ante funded scheme" to mitigate moral hazard.
  - Characteristics for ex-ante scheme suggested:
    - "A credible and adequate reserve fund built up from periodic flat-rate assessments on ADIs’ deposits initially but changing to risk-based assessments over time."
    - Fund’s investment objective should emphasize liquidity and safety over return.
  - Conclusion: "An ex ante funded deposit guarantee scheme, together with higher loss absorbency requirements..., appear to represent the best option for Australia since the infrastructure is already in place."
- Recovery and resolution planning:
  - APRA pilot in 2011 required six largest ADIs to develop recovery plans.
  - APRA plans to extend recovery planning to mid-sized ADIs (assets greater than "A$5 billion") in 2013.
  - Recommendations: extend recovery planning to all ADIs tailored to size; "APRA should also conduct annual checks"; "APRA should introduce resolution planning requirements for at least the major banks."

### High-priority FSAP recommendations (near-term implementation)
- Financial Stability:
  - "1. Develop a top down stress testing framework and publish top down stress test results in the Financial Stability Review" — Responsible: RBA
  - "2. Devote more resources to stress testing" — Responsible: APRA
  - "3. Introduce higher loss absorbency (HLA) for systemic banks" — Responsible: APRA
- Financial Sector Oversight:
  - "4. Intensify on-site supervision of bank liquidity and upgrade daily liquidity reporting requirements to ensure consistency" — Responsible: APRA
  - "5. Improve the effectiveness of conduct of business supervision for insurance companies (note recommendation 6 below)" — Responsible: ASIC
  - "6. Ensure sufficiency and stability of ASIC core funding" — Responsible: Treasury
  - "7. Extend risk based capital requirements, large exposure rules, and reporting requirements to ensure that AFSL holders are appropriately covered" — Responsible: ASIC
- Crisis Management:
  - "8. Re-evaluate the merits of ex-ante funding for the FCS with a view to converting it to an ex-ante funded scheme" — Responsible: Treasury/CFR
  - "9. Introduce HLA for systemic banks (see recommendation 3 above)" — Responsible: APRA
  - "10. Ensure ADI implementation of single customer view (SCV) on, or where possible, ahead of the agreed timetable" — Responsible: APRA
  - "11. Conduct frequent and focused crisis simulations and other forms of resolution testing" — Responsible: APRA/CFR
  - "12. Continue recovery planning and introduce resolution planning" — Responsible: APRA

### Risk Assessment Matrix — main threats, probabilities, and expected impacts
- Volatility in wholesale and external funding: Relative Probability: MEDIUM; Expected Impact: MEDIUM.
- Terms of trade shock: Relative Probability: LOW/MEDIUM; Expected Impact: HIGH.
- Collapse in housing or commercial real estate prices: Relative Probability: LOW/MEDIUM; Expected Impact: MEDIUM/HIGH.
- Contagion risk arising from bank concentration: Relative Probability: MEDIUM; Expected Impact: HIGH.
- Exposure to New Zealand: Relative Probability: LOW; Expected Impact: LOW.

*Source: Executive Summary and selected IMF staff report text from the IMF FSAP update for Australia contained in the provided PDF content.*

### Executive Summary ......................................................................................................

### Executive Summary

### Key findings on macro-financial performance and vulnerabilities
- Australia’s financial system is "sound, resilient, and well managed."
- Australia avoided a recession during the Global Financial Crisis (GFC) and continued to outperform most peers five years on.
- Drivers of resilience cited: strong fundamentals at the onset of the GFC, a well-coordinated crisis response, and a mining investment boom fueled by China’s demand for commodities.
- Current account dynamics and growth:
  - "The current account deficit fell to about 2½ percent of GDP in the first half of 2011 from an average of 4½ percent for the previous 15 years."
  - "Australia looks set to continue its two decades of uninterrupted expansion, with the economy expected to grow close to trend at 3-3.5 percent annually in 2012 and 2013."
  - Inflation expected to remain "within the authorities’ target band of 2-3 percent over the medium-term."
- Banking sector size and concentration:
  - Financial sector assets exceed "more than three times the size of GDP."
  - The sector is "dominated by four large banks" with "broadly similar business models and rely on wholesale funding."
- Household and housing risks:
  - Residential mortgages are banks’ "single largest asset."
  - "High household debt and elevated house prices increases the risk in this portfolio."
- Policy space and mitigating factors:
  - Authorities have policy space due to "low public debt, a flexible exchange rate, some scope for monetary easing, and a well capitalized banking system."

### Bank performance and stress testing outcomes
- Capital and profitability:
  - "Capital adequacy ratio rose to 11.8 percent in June 2012 from 11.4 percent in December 2008."
  - Shift toward a rising share of Tier 1 capital and lower-risk assets such as mortgages.
  - Profitability: "after-tax return on equity rising to 15 percent in the fourth quarter of 2011 from 4.5 percent in the third quarter of 2009."
- Stress testing conclusions:
  - "Stress testing by APRA and the IMF shows that the banking system is likely to withstand severe shocks."
  - Under the most severe scenario, "aggregate Tier 1 capital remains above the minimum threshold," although "total capital of some banks falls slightly below the threshold after two years."
  - Liquidity stress test results: banks "would be able to withstand a severe liquidity shock with support from the RBA under a new Basel-approved facility," with withdrawals from the United States, United Kingdom, and Japan having the largest impact.
- Institutional enhancements to testing:
  - APRA applies its own analyses and consistency checks but "needs to devote more resources to stress testing."
  - The RBA "should consider establishing its own macro-financial stress testing framework" to better identify and monitor systemic risks.

### Systemic banks and higher loss absorbency (HLA)
- Systemic importance and externalities:
  - The four major banks are "systemically important," creating a negative externality: "Significant and protracted difficulties in any one of them would have severe repercussions for the entire financial system."
- Policy prescription:
  - "A higher capital threshold for the systemically important institutions may be desirable to further bolster financial system stability."
  - Rationale: Basel Committee guidance supports "more intensive supervision and require additional capital of systemically important institutions."
  - Additional justification: "the four major banks enjoy a funding cost advantage derived from an implicit government guarantee, and should bear some of the cost of mitigating systemic risk."

### Regulatory and supervisory assessment
- Overall compliance and strengths:
  - "The financial regulatory and supervisory framework exhibits a high degree of compliance with international standards."
  - APRA’s supervisory approach is "principles-based and outcome-oriented" with strengths in "risk analyses embedded in the PAIRS and SOARS system, industry-wide risk assessments, and a focus on bank boards’ responsibility for risk management."
  - ASIC is "a highly regarded enforcer of market regulation."
- Areas for improvement:
  - "Further enhancing APRA’s formal on-site supervisory review of banks’ liquidity risk management."
  - "The adequacy and stability of ASIC’s funding is crucial" and "it is important to increase its core funding."

### Systemic oversight, coordination, and transparency
- Council of Financial Regulators (CFR):
  - The Council "plays a key role in coordinating financial regulation and stability issues" and "works well," demonstrated during the GFC response.
  - Recommendation: "further highlight its work and enhance the transparency of its deliberative processes," for example by more explicit reporting of its deliberations in the Financial Stability Review.

### Crisis management, financial safety net, and resolution
- Recent improvements since the 2006 FSAP:
  - Establishment of the Financial Claims Scheme (FCS) to protect depositors and general insurance policyholders.
  - Strengthening of APRA’s powers.
- Deposit guarantee history and parameters:
  - In October 2008 the government introduced the FCS guaranteeing deposits "up to A$1 million per account holder per Authorized Deposit-taking Institution (ADI)." A separate fee-based, unlimited wholesale guarantee was also introduced then.
  - The wholesale funding guarantee is no longer in place. The government confirmed the FCS as permanent and "reduced the cap from A$1 million to A$250,000 per account holder per ADI." "The new permanent cap has applied since February 1, 2012."
- Further crisis-management recommendations:
  - Continue to "enhance crisis preparedness through early planning."
  - Consider "some form of ex-ante funding" to mitigate moral hazard in a concentrated banking sector.
  - Two preferred options given existing infrastructure: "ex-ante funded deposit insurance" and "higher loss absorbency requirements for systemically important institutions."
  - Legislation and Memoranda of Understanding have been enacted/signed to facilitate cross-border cooperation (including with New Zealand).

### High-priority FSAP recommendations (near-term implementation)
- Financial Stability
  - "1. Develop a top down stress testing framework and publish top down stress test results in the Financial Stability Review" — Responsible: RBA
  - "2. Devote more resources to stress testing" — Responsible: APRA
  - "3. Introduce higher loss absorbency (HLA) for systemic banks" — Responsible: APRA
- Financial Sector Oversight
  - "4. Intensify on-site supervision of bank liquidity and upgrade daily liquidity reporting requirements to ensure consistency" — Responsible: APRA
  - "5. Improve the effectiveness of conduct of business supervision for insurance companies (note recommendation 6 below)" — Responsible: ASIC
  - "6. Ensure sufficiency and stability of ASIC core funding" — Responsible: Treasury
  - "7. Extend risk based capital requirements, large exposure rules, and reporting requirements to ensure that AFSL holders are appropriately covered" — Responsible: ASIC
- Crisis Management
  - "8. Re-evaluate the merits of ex-ante funding for the FCS with a view to converting it to an ex-ante funded scheme" — Responsible: Treasury/CFR
  - "9. Introduce HLA for systemic banks (see recommendation 3 above)" — Responsible: APRA
  - "10. Ensure ADI implementation of single customer view (SCV) on, or where possible, ahead of the agreed timetable" — Responsible: APRA
  - "11. Conduct frequent and focused crisis simulations and other forms of resolution testing" — Responsible: APRA/CFR
  - "12. Continue recovery planning and introduce resolution planning" — Responsible: APRA

*Source: Executive Summary (IMF FSAP update for Australia).*

### 16.      Australia’s financial sector is large and mature with assets totaling 340 percent

### 16.      Australia’s financial sector is large and mature with assets totaling 340 percent of GDP

### Overview
- Financial sector assets total 340 percent of GDP.
- Growth drivers: expansion of home mortgages and superannuation funds (mandatory employer contributions and voluntary and tax-concessional employee contributions).
- Asset shares within the financial sector:
  - ADIs (mostly banks): 60 percent of financial sector assets.
  - Superannuation funds (including investment-linked superannuation written by life insurance companies): 25 percent.
  - Non-life insurance sector: 3 percent of financial sector assets.
  - Non-superannuation managed funds: 6 percent.
- Stock market capitalization: 80 percent of GDP at end-2011 (below peak of 150 percent in mid-2007).

### Key sources of risks
- Banking concentration and common exposures:
  - Four large banks dominate the banking sector.
  - Concentration and similar business models increase exposure to common shocks and funding market disruptions.
- External environment sensitivity:
  - Risks heightened by a worrying global environment and potential sharp domestic slowdown.
- Policy and structural buffers:
  - Low public debt, flexible exchange rate, scope for monetary easing, and a well capitalized banking system.
  - Commitment to implement new Basel III standards for capital from 2013 and broadly follow the timetable for liquidity.
  - Implementation of recovery planning requirements for large and medium-sized ADIs and consideration of resolution planning.
  - Financial Claims Scheme (FCS) complements depositor preference provisions.

### Banking sector characteristics and profitability pressures
- Profitability concerns:
  - Net interest margin accounts for almost two-thirds of operating income.
  - Pressure on net interest margins could encourage more risk-taking by banks.
- Multi-speed economy effects:
  - Mining boom contributed to appreciation of the Australian dollar and created a multi-speed economy.
  - Mining sector contribution to credit demand: less than 1 percent of total lending.
  - Non-mining sector generates most business credit demand but faces pressures from the strong exchange rate and weak confidence.
  - Households saving more, ending two decades of rapid retail credit expansion.

### Overseas asset exposures and counterparty risk
- Foreign claims and exposures:
  - Total foreign claims of the banking system: 22 percent of consolidated assets.
  - Cross-border claims: 6 percent of consolidated assets.
  - Geographic composition of cross-border claims (share of those claims): New Zealand 39 percent; United Kingdom 17 percent; United States 14 percent; Asia Pacific 8 percent; Euro Area 7 percent; Other 14 percent; Other Europe 2 percent.
  - About 40 percent of foreign claims are on New Zealand and a combined 26 percent on the UK and Europe.
- Non-performing overseas assets:
  - Currently about 0.3 percent of consolidated assets (slight decline from peak of 0.4 percent in mid-2010).
- Specific exposures:
  - Exposure to Euro Area banks: less than 1 percent of consolidated assets.
  - Performance: improved in New Zealand operations; remains weak for UK operations.
- Hedging and counterparty concentration:
  - Banks hedge foreign currency positions via cross-currency basis swaps and FX swaps.
  - Of outstanding notional principal amount of foreign currency related derivatives the four major Australian banks have with 40 counterparties, 44 percent are with the top five (Deutsche Bank, Citibank, JPMorgan, UBS and Barclays).
  - Main currency-related risk: counterparty risk due to downgrades since the GFC.

### Concentration, interconnectedness, and systemic importance
- Concentration metrics:
  - Australia’s four major banks hold 80 percent of banking assets and 88 percent of residential mortgages.
- Interconnectedness:
  - Major banks are among each other’s largest counterparties.
  - Expected default frequencies (EDFs) from Moody’s KMV are highly correlated across major banks.
- Competitive advantages and implications:
  - Major banks are highly profitable and enjoy a funding cost advantage derived partly from implicit government support.
  - Higher net interest margins than smaller banks and international peers.
- Policy implications:
  - Given systemic importance, recommended measures include more intensive supervision, higher loss absorbency, and robust recovery and resolution plans.

### Funding structure, costs, and offshore funding
- Shift in funding structure since mid-2008:
  - Share of deposits rose to 53 percent of total liabilities from 40 percent in mid-2008.
  - Share of short-term wholesale debt declined to 19 percent from 33 percent.
- Funding cost dynamics:
  - Shift accompanied by increased funding costs due to competition for retail deposits and larger spreads on wholesale debt and cross currency swaps since the GFC; most of the increase has been passed on to borrowers.
- Offshore funding details:
  - Share of bank bonds issued off-shore fell from 78 percent of the total in 2007 to 60 percent in 2011.
  - Maturity shift: off-shore bonds maturing in less than a year fell from 80 percent in 2007 to 56 percent in 2011.
  - Banks’ net foreign liabilities (mostly in foreign currency): 24 percent of GDP.
  - Offshore short-term wholesale funding used by Australian banks is below 10 percent of liabilities, with a considerable proportion in the form of deposits.
- Recommended directions:
  - Continue lengthening the maturity of offshore funding and increase domestic funding.
  - Longer-term solution: increased domestic savings, supported by planned increase in superannuation contribution rate from 9 percent to 12 percent.

### Household debt, housing market, and mortgage risks
- Household debt and composition:
  - Household debt as a ratio to household disposable income is above the average of advanced economies in the G20.
  - 90 percent of household debt is housing loans.
- Mortgage portfolio risk factors:
  - Strong house price gains over two decades have made Australian house prices relatively expensive.
  - Around 30 percent of new mortgages are interest-only; 55 percent of interest-only mortgages are investor loans.
- Risk mitigants:
  - Larger household assets dwarf household debt: household housing debt represents only about 30 percent of their housing assets; household financial assets (non-housing) account for about 40 percent of household assets.
  - Value of financial assets is more than double the value of housing debt.
  - Relatively low household leverage: average loan-to-value (LTV) ratio about 50 percent on outstanding owner-occupied loans.
  - About 30 percent of mortgages, primarily to first-time buyers, have an LTV of 80 percent or more at origination and are generally covered by private mortgage insurance.
  - No tax incentive for owner-occupier debt.
  - Prepayment on housing loans is prevalent and sizable (prepayments equivalent to 18 months of scheduled repayments on average).
  - Mortgages are full recourse loans.
  - Interest-only loans include mortgages with 100 percent offset accounts.

### Non-financial corporate sector vulnerabilities
- Business credit:
  - Accounts for approximately one third of total lending.
  - Business credit has declined by 4.1 percent since peaking in Q4 2008.
  - Sectoral declines: construction down 14 percent; manufacturing down 11 percent.
- Mining and investment:
  - Mining sector investment expected to surge to 8 percent of GDP.
- Profitability and leverage:
  - Below-trend growth outside mining hurting profitability; equity valuations for most sectors are below average.
  - Expected default frequencies indicate weaker firms more susceptible to failure than before the crisis.
  - Commercial real estate receives almost one-third of banks’ lending but accounts for almost half of banks’ current loan impairments; vacancy rates and pricing show early signs of stabilization.
  - Leverage in agriculture, manufacturing, and services remains above the long-term historical average.

### Stress testing and resilience assessment
- Stress testing scope and methodology:
  - Focused on credit, contagion and liquidity risks; covered five of the largest banks.
  - Combined individual bank stress tests under APRA guidance (bottom-up) and systemic macro-financial stress tests by the FSAP team (top-down).
  - Top-down modeled credit risk in three scenarios: a slow growth scenario, a mild recession scenario and a severe recession scenario.
  - Bottom-up approach used only the severe recession scenario.
  - Supplemented solvency and liquidity stress tests with a network analysis of the impact of an external funding shock using BIS data on international banking exposures.
  - Stress tests used consolidated data and included banks’ cross-border exposure.

*IMF staff report excerpt.*

### 27.      The different scenarios under the top-down approach are designed to capture a

### _cr12308 - 27.      The different scenarios under the top-down approach are designed to capture a

### Scenarios and assumptions (top-down approach)
- Slow-growth scenario: one standard deviation shock to real GDP growth from the baseline.
- Mild recession scenario: shock to real GDP increased to two standard deviations.
- Severe recession scenario: annual GDP growth swings from 2 percent to -5 percent during the first year, representing a shock of more than 4 standard deviations.
- Standard deviations are based on the volatility of annual GDP growth from 1960, and the shocks are over the first three years of a five-year horizon with positive adjustment dynamics during the subsequent two years.
- Note: using shocks of 1-3 standard deviations is standard practice in stress testing exercises; the severe scenario represents an extreme tail event (lowest recorded Australian GDP growth in the last fifty years was -3 percent).

### Top-down stress test results and key statistics
- Major banks generally well capitalized under stress tests.
- Capital ratios (total and Tier 1) remain above minimum thresholds in the slow-growth and mild recession scenarios.
- System-wide Tier 1 capital ratio remains above the threshold in the severe scenario.
- System-wide total capital falls below the threshold of 8 percent after the second year of stress in the severe recession scenario before stabilizing from the fourth year.
- Credit loss is identified as the largest driver of capital loss, reflecting contraction in GDP.
- Top-down results are broadly consistent with bottom-up results, with rapid loss of capital in years one and two in both approaches.

### Liquidity stress testing and international funding risk
- Liquidity stress tests include an Implied Cash Flow Test (ICFT) and analysis of contagion from withdrawal of offshore funding.
- ICFT simulates a gradual outflow of funding for a period of five weeks and indicates banks do not have sufficient liquid assets to withstand such a shock due to limited availability of highly-rated nonbank (mainly government) domestic securities.
- All banks can offset outflows with liquidity support from the RBA, even under stringent haircut assumptions.
- Network analysis based on bilateral exposures of 27 banking systems shows withdrawal of funding by banks in the United States, United Kingdom and Japan represents the biggest potential risk for the Australian banking system.

### RBA committed liquidity facility (CLF) and LCR implementation
- RBA will create a committed liquidity facility (CLF) in 2015 to help ADIs meet the proposed liquidity coverage ratio (LCR) under Basel III.
- ADIs will be required to pay fees for CLF assistance, currently set at 15 basis points.
- Use of the facility will be at RBA’s discretion; an ADI must first receive APRA approval on the amount of liquidity requirement that can be met through the CLF.

### Improvements needed in stress testing governance
- Banks use different stress testing models, LGD and PD estimation approaches, and data granularity levels.
- Although banks are required to apply APRA-determined credit migration matrices, PDs and LGDs, dispersion in banks’ practice complicates APRA analysis.
- Recommendations:
  - APRA should devote more resources to bottom-up stress testing to validate and cross-check individual bank results and ensure consistency.
  - RBA should develop its own top-down stress testing framework to enhance capacity to identify and monitor systemic risk and assist the next ADI industry stress test.

### Addressing systemic banks: rationale for higher loss absorbency
- Major banks enjoy implicit government support because of systemic importance (indicators: size, interconnectedness, complexity).
- Funding cost advantage estimated to have risen from 80 basis points to 120 basis points during the GFC.
- International precedent: Austria, Singapore, and Sweden have established higher loss absorbency requirements of 3 percentage points, 2 percentage points, and 5 percentage points, respectively, for domestically important banks.
- APRA’s current application of Basel II imposes higher risk weights and a more conservative definition of capital; could be complemented by explicitly requiring systemic institutions to hold a higher minimum capital requirement.

### Quantifying additional capital via Moody’s KMV EDF methodology
- EDF methodology gauges desired level of capital consistent with a certain probability of survival.
- Illustration (as of end-2011):
  - Maintaining a one-year ahead probability of 99.9 percent of not defaulting would require the four major banks to hold additional Tier 1 capital ranging from -0.9 to 2.8 percent of RWA.
  - Achieving a 99.95 percent probability of not defaulting would require additional Tier 1 capital ranging from 1.4 to 5.2 percent of RWA.
- Example: to ensure a survival probability of 99.95 percent (EDF=0.05), total Tier 1 capital would need to be 12.3 percent of risk-weighted assets (compared to an actual average of 10 percent during the first half of 2012).
- Final determination of additional capital depends on APRA’s risk tolerance and national discretion per BCBS D-SIB framework.

### Prudential and conduct supervision framework
- Australia operates a “functional” model of financial regulation:
  - APRA: prudential oversight of ADIs, insurers, and all large superannuation funds.
  - ASIC: market conduct and consumer protection; overall supervision of many market intermediaries and some prudential monitoring for key intermediaries.
  - RBA: financial system stability and payments system oversight.
  - Treasury: policy advice; Minister has legal power to direct APRA and ASIC (rarely used).
  - Other regulators: ACCC and AUSTRAC.
- APRA maintains a conservative supervisory approach:
  - Super-equivalent to Basel capital standard.
  - At least 75 percent of Tier 1 capital must be common equity (vs. at least 50 percent under Basel II).
  - Higher risk weights for certain asset classes under standardized approach; advanced banks must maintain higher minimum LGDs for some portfolios.
  - APRA intends to keep conservative stance when adopting Basel III.
- APRA strengths and practices:
  - Proactive, risk-based, principles-based, and outcome-oriented supervision via PAIRS and SOARS systems.
  - Emphasis on bank boards’ responsibility for risk management and system-wide assessment.
  - On- and off-site supervision well planned and executed; credit risk management well developed.
  - Provisioning requirements typically result in higher reserves than required under IFRS.
  - APRA conveys expectations through engagement with boards, supervisor contacts, letters, and speeches.

*Source: IMF Staff calculations and IMF staff analysis from the provided PDF content.*

### 41.      ASIC has rightfully earned its reputation as an effective and credible enforcer of

### _cr12308 - 41.      ASIC has rightfully earned its reputation as an effective and credible enforcer of

### ASIC effectiveness, resourcing, and operational constraints
- Findings:
  - "ASIC has rightfully earned its reputation as an effective and credible enforcer of market regulation."
  - ASIC’s oversight of the exchanges is effective.
  - A series of high profile and successful prosecutions, good shareholder protection, and high accounting and auditing standards have contributed to ASIC’s standing.
  - ASIC has recently expanded its surveillance of hedge funds and market intermediaries.
  - A significant amount of ASIC’s funding is non-core funding earmarked for specific projects, and the share of non-core funding has been increasing in the last few years.
  - To supervise a large number of financial services licensees, ASIC uses desk-top, rather than on-site, reviews for initial risk-based assessments, reflecting in part its resource constraints.
  - In determining the target and intensity of its supervisory actions, ASIC relies heavily on its initial risk-based assessments, self-reporting of breaches of regulatory requirements and third party notifications.
- Recommendation:
  - "It is important that ASIC be given more resources and flexibility over its operational budget."

### Supervisory gaps and specific supervisory recommendations
- Notable gaps identified:
  - Insufficient time devoted to on-site supervision for certain risk areas or entities.
  - Limited due diligence by supervisors on senior executive management, directors, controllers, or significant shareholders at the time of licensing of certain entities.
- Specific recommendations:
  - "In order for APRA to have comfort that an institution has in place the policies, practices and governance necessary to ensure effective liquidity risk management, the amount of time allocated to formal on-site review needs to increase from the current 3-4 days."
  - "ASIC should conduct more proactive surveillance of insurers and insurance intermediaries, and devote more attention to the proactive supervision of collective investment schemes and those market intermediaries that are not exchange members."
  - "ASIC should bridge regulatory gaps, and prevent potential risks, by extending risk-based capital requirements, periodic capital adequacy reporting and large exposure rules to some of the AFSLs not regulated by APRA."
  - "ASIC should be empowered to make or enforce regulation to ensure the fair treatment of insurance customers and the protection of policyholders (e.g., on group-wide market conduct, insurer’s claims handling and the servicing of life policies). The current regulatory regime dilutes the effectiveness of the conduct of business supervision."
  - "ASIC and APRA should coordinate more closely to address shortcomings in public disclosure requirements for insurers, including the exemption of small and unlisted insurers from many disclosure requirements; the limited disclosure on capital adequacy for life insurers; the lack of disclosure of sources of earnings analyses; and the lack of comprehensive disclosures of corporate governance risks and risk management."

### Legal framework and potential threats to regulatory independence
- Findings:
  - "The Minister has the legal power to give policy direction to both APRA and ASIC and decide on the change in significant ownership of an ADI."
  - "Although such power has rarely been used and may not be used in relation to a given regulated entity, its existence could potentially diminish the ability of APRA and ASIC to carry out their supervisory and regulatory functions effectively."
- Recommendation:
  - "Therefore, it is important for APRA to have the legal power to veto, on prudential grounds, any decision on changes in significant ownership."
- Authorities' view:
  - The authorities do not view the Minister’s power as undermining the independence of the regulatory agencies; they view it as providing a mechanism for transparent interaction with the government on policy grounds and as an important check and balance for accountability to Parliament and the people of Australia.

### AML/CFT assessment scheduling
- Findings and timeline:
  - "An AML/CFT assessment of Australia was last conducted by the Financial Action Task Force (FATF) on Money Laundering in March 2005."
  - "A full AML/CFT reassessment is required every five years according to the IMF Board decisions regarding the incorporation of AML/CFT into the FSAP."
  - "Country authorities have approximately 18 months from the date of the last FSAP to undergo the FATF assessment."
  - "The new FATF assessment methodology will not be published until February 2013, with the evaluations commencing in late 2013."
  - "Australia is scheduled to be one of the first jurisdictions reviewed under the revised standards in early 2014 which will fit within the policy of the FSAP."
- Process note:
  - "A ROSC will be forwarded to the Fund and subsequently circulated to the Board upon adoption of the mutual evaluation report by the FATF Plenary."

### Systemic oversight, coordination, and monitoring
- Institutional roles:
  - "Maintaining financial stability is a shared responsibility."
  - The RBA has long been responsible for financial stability, although the mandate is not provided in law; government reaffirmed this responsibility in 1998 when APRA was established.
  - "Promoting financial stability is also one of APRA’s mandates, which is carried out through prudential regulation and supervision."
  - ASIC and the Treasury also have roles: ASIC through oversight of capital markets; the Treasury through advisory role to government on financial stability issues and legislative/regulatory framework.
- APRA tools:
  - APRA’s PAIRS and SOARS system includes an element of systemic oversight by considering institutions’ systemic importance.
  - APRA’s industry risk registers identify emerging risks and necessary supervisory actions in each industry (these registers relate to four financial sectors: banking, life insurance, general insurance and superannuation).
- Coordination mechanisms and recommendations:
  - "The Council of Financial Regulators (CFR), comprising the RBA, APRA, ASIC, and the Treasury, is the primary coordinating body for the main regulatory agencies. It is chaired by the RBA Governor."
  - The CFR is advisory with no separate powers and coordinates activities via bilateral MOUs.
  - Authorities do not believe formalizing a single macroprudential authority is necessary; current arrangement is built on a "culture of cooperation, dialogue and mutual respect."
  - Recommendation to enhance CFR role: "A more explicit report of the CFR’s deliberations in the Financial Stability Review would be a first step" to make its role more prominent and enhance transparency.
- Monitoring tools:
  - The RBA publishes a half-yearly Financial Stability Review assessing health of financial institutions, corporations and households and performance of financial markets.
  - Recommendation: The Review "could be further improved by incorporating regular stress testing results on the financial system once the RBA establishes its own stress testing framework."

### Macroprudential tools stance
- Findings and authority view:
  - Authorities do not generally prescribe simple regulatory limits (e.g., caps on LTV, DTIs, and leverage) to dampen the credit cycle, preferring judgment-based approaches focused on borrower repayment capacity and lending standards, and adjusting risk weights or pillar II capital as necessary.
  - "For Australia, this approach appears to have been broadly effective."

### Crisis management and resolution: reforms and preparedness
- Legislative and institutional changes:
  - Since 2008, significant legislative changes established the Financial Claims Scheme (FCS), enabled APRA to appoint a statutory manager to an ADI before insolvency, and strengthened APRA’s powers for resolving ADIs and insurers.
- Roles in crisis management:
  - "The RBA serves as the lender of last resort, APRA is the resolution authority for prudentially supervised institutions and administers the FCS, and the Treasurer is responsible for making declarations that the FCS applies to a particular ADI."
  - An MOU on Financial Distress Management among CFR agencies signed in 2008 facilitates coordinated responses.
  - "Given the history of few bank failures, the FCS has never been activated for an ADI and the resolution powers in their current form have not been tested."
- Recommendations to enhance preparedness:
  - Continue enhancing crisis preparedness through early planning with particular attention to formulating an effective communication strategy.
  - "Simulations testing the overall framework should occur about every two years while targeted testing should be done more frequently, with a simulation of a systemic liquidity shock conducted in the near term."
  - "APRA should ensure that ADIs adopt single customer view (SCV) recordkeeping as quickly as possible, which is imperative for determining the amount of guaranteed deposits."

### Deposit insurance funding and moral hazard
- Current design and concerns:
  - The FCS is "ex post funded, backed by a standing budgetary authorization of up to A$20 billion per ADI, and enjoys a priority in claims on liquidation recoveries."
  - An optional levy on the industry provides a mechanism to make up any shortfall in recouping guaranteed depositor payment.
  - Concern: "However, ex post funding and the levy’s optional feature are not consistent with international best practices requiring banks to bear the cost of their own failures."
- Recommendation:
  - "An ex ante funded deposit insurance scheme is one of several methods that are available to mitigate the moral hazard by imposing costs on the industry."
  - Characteristics suggested for an ex ante scheme:
    - "A credible and adequate reserve fund built up from periodic flat-rate assessments on ADIs’ deposits initially but changing to risk-based assessments over time."
    - Fund’s investment objective should emphasize liquidity and safety over return.
  - Conclusion: "An ex ante funded deposit guarantee scheme, together with higher loss absorbency requirements (as discussed above), appear to represent the best option for Australia since the infrastructure is already in place."
- Contextual note:
  - Authorities considered ex-ante funding in FCS design but decided not to pursue it because of "Australia’s unique circumstances, including the lack of government securities and limited highly rated domestic corporate bonds for such a fund to invest in."

### Recovery and resolution planning
- Progress and plans:
  - APRA initiated a pilot program in 2011 requiring the six largest ADIs to develop recovery plans focused on mitigating measures to overcome impairments to capital and liquidity and re-establish viability without official support within a realistic timeframe.
  - "APRA plans to extend recovery planning requirements to mid-sized ADIs (assets greater than A$5 billion) in 2013."
- Recommendations:
  - Eventually extend recovery planning requirements to all ADIs, tailored to size.
  - "APRA should also conduct annual checks to ensure that the recovery and contingency plans are up-to-date and adequate."
  - "APRA should introduce resolution planning requirements for at least the major banks," noting APRA has had extensive discussions with the industry but no decision made so far.

### Cross-border cooperation with New Zealand and spillover assessment
- Legal and institutional cooperation:
  - In 2005-2006 both Australian and New Zealand parliaments enacted laws imposing reciprocal obligations on APRA and RBNZ to support each other in meeting statutory responsibilities for prudential regulation and financial stability.
  - APRA’s statutory obligations include: (i) supporting New Zealand authorities in meeting statutory responsibilities for financial stability in New Zealand; (ii) to the extent reasonably practicable, avoiding actions likely to have a detrimental effect on financial system stability in New Zealand; and (iii) consulting with and considering advice of New Zealand authorities when practicable before taking such action (primary obligations set out in Section 8A of the APRA Act).
  - The Trans-Tasman Council on Banking Supervision (TTBC), formed in 2005, provides a mechanism for cooperation and coordination during financial stress and has been developing crisis resolution strategies and conducted crisis simulation exercises in 2011.
- Spillover assessment:
  - "The spillover effect from Australia to New Zealand is likely to be limited."
  - "While subsidiaries of major Australian banks account for 90 percent of banking assets in New Zealand, these subsidiaries are ring-fenced."
  - Rationale: A subsidiary, as opposed to a branch, is better able to continue as a going concern because it is locally incorporated and host authorities would require sufficient capital and liquidity buffers.
  - Note: "This analysis is based on staff desk assessment as opposed to an investigation conducted in the field."

*Source: IMF staff report text provided in the content unit.*

### 56.      The authorities are encouraged to take steps to enhance cross-border

### _cr12308 - 56.      The authorities are encouraged to take steps to enhance cross-border

### Cross-border coordination and exposures
- Other cross-border operations of Australian ADIs account for approximately 5 percent of banking sector assets.
- Australian operations of foreign banks (mainly in the form of branches) account for around 12 percent of domestic banking sector assets.
- APRA has in place bilateral MOUs on supervisory matters with a number of foreign supervisory agencies, including those in the U.S. and the U.K.
- Discussions for the development of other MOUs focused on bank resolution and crisis management with the U.S. and other relevant jurisdictions are ongoing.

### Risk Assessment Matrix — Main threats, probabilities, and expected impacts
- Volatility in wholesale and external funding
  - Relative Probability: Staff assessment: MEDIUM
  - Expected Impact: Staff assessment: MEDIUM
  - Notes: Banks' funding profile has improved since the global financial crisis, but they continue to rely on wholesale and external funding. Banks’ foreign currency liability positions are largely hedged and explicit liquidity support from the RBA means that a reversal of capital flows would unlikely result in forced asset sales. Volatility could raise funding costs and put pressure on profit margins.
- Terms of trade shock
  - Relative Probability: Staff assessment: LOW/MEDIUM
  - Expected Impact: Staff assessment: HIGH
  - Notes: Australia’s terms of trade have benefited from strong commodities demand from Asia, especially China. A large decline would reduce GDP growth, boost unemployment, widen the current account deficit, undermine credit quality, and could lead to a reversal of capital inflows causing a funding shock.
- Collapse in housing or commercial real estate prices
  - Relative Probability: Staff assessment: LOW/MEDIUM
  - Expected Impact: Staff assessment: MEDIUM/HIGH
  - Notes: House prices declined gradually over the past year but a collapse appears unlikely. Average LTV ratio of 50 percent on mortgages provides a buffer; about a quarter of mortgages have an LTV of 80 percent or more at origination. Commercial real estate represents about 10 percent of banks’ exposures.
- Contagion risk arising from bank concentration
  - Relative Probability: Staff assessment: MEDIUM
  - Expected Impact: Staff assessment: HIGH
  - Notes: System dominated by four major banks with similar business models; stress in one could be quickly transmitted to others. The ex post funded deposit guarantee program (Financial Claims Scheme) seems inadequate to address such contagion risk.
- Exposure to New Zealand
  - Relative Probability: Staff assessment: LOW
  - Expected Impact: Staff assessment: LOW
  - Notes: About 40 percent of Australian banks’ cross-border exposure is to New Zealand; a downturn there would hamper Australian banks’ asset quality. The two countries are both net importers of capital and an external funding shock could be amplified.

### Financial system structure and selected indicators (snapshots and magnitudes)
- Total financial system assets:
  - Dec. 2008: 4,772.3 (In billions of AUD)
  - Dec. 2009: 4,629.1 (In billions of AUD)
  - Dec. 2010: 4,734.9 (In billions of AUD)
  - Dec. 2011: 4,883.3 (In billions of AUD)
- Authorized deposit taking institutions (ADIs) total assets:
  - Dec. 2008: 2,794.0 (In billions of AUD)
  - Dec. 2009: 2,704.9 (In billions of AUD)
  - Dec. 2010: 2,799.6 (In billions of AUD)
  - Dec. 2011: 2,954.0 (In billions of AUD)
  - As percent of GDP (Dec. 2011): 204.9
- Banks total assets:
  - Dec. 2008: 2,672.6 (In billions of AUD)
  - Dec. 2009: 2,582.0 (In billions of AUD)
  - Dec. 2010: 2,668.8 (In billions of AUD)
  - Dec. 2011: 2,818.2 (In billions of AUD)
  - As percent of GDP (Dec. 2011): 195.5
- Memorandum items — Total external debt:
  - Total external debt (Mar-12 context): 1,159.3; 1,160.6; 1,150.7; 1,269.2 (In billions — entries shown in table)
  - ADI external debt: 625.7; 670.5; 624.2; 633.5 (In billions — entries shown in table)
  - ADI long-term: 348.8; 366.5; 343.8; 331.5 (In billions — entries shown in table)
  - ADI short-term: 276.9; 304.0; 280.4; 301.9 (In billions — entries shown in table)

### Financial soundness indicators (selected series)
- Regulatory Capital to Risk-Weighted Assets:
  - 2008: 11.3
  - 2009: 11.9
  - 2010: 11.4
  - 2011: 11.6
  - 2012Q1: 11.6
- Regulatory Tier 1 Capital to Risk-Weighted Assets:
  - 2008: 8.5
  - 2009: 9.3
  - 2010: 9.6
  - 2011: 10.2
  - 2012Q1: 10.3
- Non-performing Loans Net of Provisions to Capital:
  - 2008: 11.2
  - 2009: 17.2
  - 2010: 20.4
  - 2011: 19.3
  - 2012Q1: 18.3
- Non-performing Loans to Total Gross Loans:
  - 2008: 1.3
  - 2009: 2.0
  - 2010: 2.2
  - 2011: 2.0
  - 2012Q1: 1.9
- Sectoral Distribution of Total Loans (selected):
  - Residents: 96.1; 97.3; 96.8; 96.9; 96.9 (series across years shown)
  - Nonfinancial Corporations: 30.2; 27.8; 26.1; 25.8; 25.7
  - Other Domestic Sectors: 59.8; 64.9; 66.7; 67.1; 67.2
  - Nonresidents: 3.9; 2.7; 3.2; 3.1; 3.1
- Return on Assets:
  - 2008: 0.9
  - 2009: 1.0
  - 2010: 1.1
  - 2011: 1.3
- Liquid Assets to Total Assets (Liquid Asset Ratio):
  - 2008: 14.2
  - 2009: 14.5
  - 2010: 15.6
  - 2011: 16.1
  - 2012Q1: 16.3
- Liquid Assets to Short Term Liabilities:
  - 2008: 34.6
  - 2009: 35.2
  - 2010: 38.5
  - 2011: 39.2
  - 2012Q1: 40.8

### Stress testing framework and methodologies
- Joint exercise: Stress testing was conducted jointly by the IMF and APRA as part of the 2012 FSAP Update for Australia.
- Coverage:
  - Five largest banks: ANZ, CBA, NAB, Westpac, and Macquarie — together account for 80 percent of banking assets in Australia.
  - Tests conducted on a consolidated basis, including cross-border exposure and credit exposure to New Zealand.
- Approaches:
  - Bottom-up: Stress tests performed by individual banks under guidance of APRA; used data as of September 2011; projection horizon three years.
  - Top-down: Systemic macro-financial analyses by the IMF in close cooperation with APRA; used data as of March 2012; projection horizon five years.
- Risks assessed: Credit, market, funding and liquidity risks.
- Metrics used: Expected losses (EL), Banks capitalization (CAR, Tier 1 Ratio), asset and liability maturity profile, asset and liability gap, positions and risk factors.
- Methodologies:
  - Top-down used balance-sheet approach of Schmieder et al. and satellite models linking NPLs and LGDs to macro indicators.
  - Banks’ RWAs under stress for credit risk simulated to reflect changes in PDs as required under Basel II; RWAs for other risks left unchanged.
  - Dividend payout assumed zero in cases of negative income and/or capital falling below the regulatory minimum.
  - Basel II hurdle rates applied: 4 percent for Tier 1 and 8 percent for total capital.

### Solvency stress tests — scenarios and severe scenario projections
- Top-down simulated three macroeconomic scenarios: slow growth (one standard deviation), mild recession (two standard deviations), and severe recession (four standard deviations).
- Severe scenario projections for key economic variables (Year 0 baseline values and severe scenario paths):
  - GDP year-ended growth: 2½ percent (Year 0); Trough is -5 percent (in Year 1)
  - Unemployment rate: 5¼ percent (Year 0); Peak is 12 percent (in Year 3)
  - Inflation year-ended change: 3½ percent (Year 0); Trough is ½ percent (in Year 4)
  - Cash rate: 4¾ percent (Year 0); Low is 1 percent (from Year 1)
  - Total credit year-ended growth: 3 percent (Year 0); Trough is -3½ percent (in Year 2)
  - Equity prices: Up to 47 percent decline (in Year 1)
  - House prices: 35 percent decline (up to Year 3)
  - Commercial property prices: 40 percent decline (up to Year 3)
- Rationale and severity:
  - Severe shock is approximately 4 standard deviations based on volatility of annual GDP growth since 1960.
  - Scenario assumes disorderly resolution of European fiscal problems, sharp slowdown in China, commodity prices falling by over 50 percent from the peak, exchange rate depreciation, large domestic output decline, and prolonged high unemployment.
  - Comparison table indicates Australia, 2012 scenario is ≈ 4 s.d. over last 50 years for GDP deviations.

### Stress test inputs, assumptions, and data specifics
- Data sources: Standard supervisory returns and additional data provided by banks; financial and supervisory data as of March 2012 (top-down) and September 2011 (bottom-up).
- Exposure types covered: residential mortgages, credit cards, commercial properties, corporates, banks, and small and medium enterprises (SMEs).
- PDs and LGDs: Bank-specific inputs differ considerably; satellite models produce sector- and bank-specific PDs and LGDs. Note: March 2012 inputs are APRA estimates rather than banks’ own inputs for some items.
- Project horizon and horizons used:
  - Bottom-up: three years.
  - Top-down: five years for solvency projections; liquidity tests used (a) 5 weeks and (b) fixed period (30 days).
- Assumptions on portfolios and income: Banks’ portfolio allocation and income components kept constant during the projection period.

*Source: IMF and APRA materials contained in the provided document excerpt.*

### 7.      The results show that the Australian banking system appears to be resilient

### 7.      The results show that the Australian banking system appears to be resilient

### Capital resilience: aggregate and scenario results
- Aggregate Tier 1 capital remained above the regulatory minimum under all three scenarios.
- The Tier 1 capital ratio has increased 2.5 percentage points on average since 2008, providing a significant capital buffer that enhances system resilience.
- Total capital, which has not increased by as much as Tier 1, would fall slightly below the hurdle rate under the severe scenario.
- Results are consistent with bottom-up stress test results for the evolution of Tier 1 and total capital.

### Liquidity stress tests — Implied Cash Flow Test (ICFT)
- Methodology and assumptions:
  - ICFT assessed ability to withstand funding shocks by simulating a gradual outflow of funding for five consecutive periods within a 30 day timeframe, similar to Basel III Liquidity Cover Ratio (LCR) calculations.
  - Asset fire-sale need taken into account with asset-specific haircuts.
  - Test equivalent to requiring banks to meet the Basel III LCR several years before it comes into effect and without any use of the RBA Committed Liquidity Facility; therefore a much stricter test than the Basel III LCR as presently drafted.
  - Based on liquidity data on March 31, 2012 collected by APRA on a "Basel QIS Level 2 financial" basis.
- Five-week gradual Lehman-type outflow assumptions by end of stress period:
  - 100 percent of unsecured short-term wholesale funding
  - 20 percent of secured wholesale funding
  - 10 percent of retail term deposits
  - 20 percent of retail demand deposits
- Key findings:
  - Without alternative LCR treatments or broader central bank repo operations, the five banks would be unable to withstand Lehman-type liquidity outflows, experiencing a substantial shortfall within two weeks.
  - With RBA operations restricted to external assets for repo and an assumed average haircut of 10 percent, banks could counterbalance outflows for an additional week.
  - With the RBA’s current repo arrangements (including self-securitized RMBS accepted for repo), all banks would be able to counterbalance funding outflows even with significant haircuts on the assets.
- Data and consistency:
  - APRA’s conservative classification treated most retail deposits as demand deposits, with only 0.1 percent classified as term deposits that cannot be broken without penalty; this increased the shock impact relative to countries with smaller deposit bases.
  - Low government debt levels imply a shortage of high quality liquid assets for banks, making RBA liquidity support necessary.
  - ICFT results broadly consistent with BCBS QIS tests conducted by APRA.

### International contagion and funding-shock spillovers
- Methodology:
  - Analysis based on bilateral banking exposures across 27 countries and capital level data at end-September 2011.
  - Two simulations: (i) interbank exposures only (Simulation 1); (ii) including outstanding derivative contracts or contingent liabilities (Simulation 2).
  - Key assumptions: withdrawal of 35 percent of interbank funding and a haircut of 10-35 percent on forced asset sales.
- Exposures and impacts:
  - Claims from United States, United Kingdom, and Japan on Australia amounted to $298 billion at end-September 2011.
  - Derivatives and contingent claims from these countries totaled another $199 billion.
  - Germany, Switzerland and France are next-tier exposures but much smaller.
  - Impact of G7 countries withdrawing funding all at once:
    - With a 10 percent haircut: 4 percent of Tier I capital in Simulation 1 and 6 percent in Simulation 2.
    - With a 35 percent haircut: 20 percent of Tier I capital in Simulation 1 and 30 percent in Simulation 2.
  - Results sensitive to assumptions, but systemic countries retain relative importance.

### Market risks and sensitivity testing
- Regular single-factor stress tests required by APRA include sensitivity analyses to foreign exchange rates, interest rates and commodity prices for both banking and trading books.
- For interest rate risk, tests include instantaneous impact on economic value (equity) and delayed impact on next year’s net interest income.
- For foreign exchange risk, banks estimate impact on income (in AUD) of a range of spot rates and implied volatilities for relevant currency pairs.
- Bottom-up stress-test results (based on end-March 2012 data) show limited vulnerability to market risk:
  - FX shocks:
    - Appreciation in different currencies (+20 percent): negligible
    - Depreciation in different currencies (-20 percent): negligible
  - Interest rate shocks:
    - Parallel downward shift in the AUD yield curve by 250 basis points: negligible
    - Parallel upward shift in the AUD yield curve by 200 basis points: -0.9%
    - Steepening of the AUD yield curve, with long-term interest rates increasing by 200 bps: -1.2%
    - Inversion of the AUD yield curve (hump), with two-year rates shifting upwards by 200 bps and 10-year rates rising by 100 bps: -1.3%
    - Parallel upward shift of the USD (and other key currencies) yield curve by 100 bps: negligible
    - Downward shift of the USD (and other key currencies) yield curve by 100 bps (capped by zero): -0.1%
  - Commodity shocks:
    - 40 percent rise in the copper price: negligible
    - 40 percent rise in Chicago wheat futures, combined with a doubling of implied volatility: negligible
- APRA requires banks to hold capital for interest rate risk in the banking book as a Pillar 1 requirement, which offsets some interest rate impacts.
- Banks’ effective hedging of FX risk involved in offshore funding contributes to negligible FX impact on the system CAR.
- Direct exposure to commodity prices is smaller than exposures to interest rate and foreign exchange rate risk; exposures vary across banks and quarters, limiting aggregate exposure.

*Source: IMF Staff Calculations and APRA data as presented in the source content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12308.pdf_