Australia's Banking System: Resilience, Liquidity, and Prudential Standards

Australia's financial system is strong and capable of withstanding the current challenging economic climate. The country's banking system is highly resilient, profitable, and has excellent liquidity coverage. Even during times of stress in the global banking system, the Australian Prudential Regulation Authority (APRA) has increased its oversight of banks in the country. Together with other agencies on the Council of Financial Regulators (CFR), the APRA is continuously monitoring the broader financial system.

The prudential requirements for banks operating in Australia are comparable to, and in some cases even exceed, Basel III requirements. The banking system has levels of capital and liquidity that are well above these requirements. While banks expect an increase in non-performing loans due to higher interest rates and inflation putting pressure on household budgets, they are well-prepared to manage this and still provide lending opportunities to households and businesses.
Australian banks have high capital ratios and are expected to increase their Common Equity Tier 1 (CET1) ratios slightly under the new standards. Risk weights for loans to small and medium-sized enterprises (SMEs) have decreased, while risk weights for higher risk mortgages have increased.
Australian banks have been raising non-equity capital proactively to meet the loss-absorbing capacity requirement by 2026, and they are ahead of their requirements in terms of total capital against risk-weighted assets. Due to previous issuances and the structure of these instruments, they are unlikely to need significant amounts of Additional Tier 1 (AT1) capital issuance. Australian banks' AT1 instruments have shown resilience in secondary market prices compared to international counterparts.

Australian banks have a strong capital base due to retained earnings, growth in lending, low levels of non-performing loans, and modest improvements in net interest margins. However, bank profitability may decline in the coming year due to slower credit growth, increased credit losses, and heightened competition among lenders. Despite these challenges, stress-testing simulations indicate that banks would still be able to continue lending even in a severe economic downturn.
Non-performing loans (NPLs) in Australian banks remain low, although there has been a slight increase in mortgages with repayments that are 30-89 days past due, potentially due to seasonal factors. Factors such as low unemployment, high savings, and sound lending standards have contributed to strong asset quality in banks in recent years. However, there are indications of increasing financial stress for some households, likely due to higher interest rates and inflation, which may lead to an expected increase in NPLs in the coming year.

Australian banks have high levels of liquid assets well above regulatory minimums to support them during adverse liquidity conditions. They comfortably meet the Liquidity Coverage Ratio (LCR) and minimum liquidity holding ratio (MLH) requirements. The need for refinancing due to repayment of funding borrowed from the Reserve Bank's Term Funding Facility (TFF) and replacement of exchange settlement (ES) balances is manageable for Australian banks, as they have raised significant amounts of wholesale debt funding and have flexibility in their funding plans. Smaller banks also maintain ample liquidity positions and meet regulatory requirements. Overall, Australian banks are well-positioned to manage their funding needs due to their strong risk-management processes, regulatory compliance, and ability to adapt to market conditions.

Source: https://www.rba.gov.au/publications/fsr/2023/apr/australian-financial-system.html