APRA stress test reveals super and banking vulnerabilities

The Australian Prudential Regulation Authority (APRA) has provided a glimpse of the early results of its stress testing of Australian financial markets revealing just how they would cope with a severe shock in financial markets and the domestic economy.

The results, outlined in APRA’s newly-published System Risk Outlook, have proved to be both worrying and reassuring in the manner in which they measured superannuation funds, banks and others market participants.

It suggests that while superannuation funds, banks and insurers have robust systems in place, they are not immune and some might struggle.

The findings served to underline the broader findings of the APRA report about the increasing inter-connectedness of the Australian financial services sector.

APRA explained that the participants in the stress test were asked to consider the impact of a ‘severe but plausible’ shock in financial markets and the domestic economy, as well as an operational disruption. The scenario also included some idiosyncratic factors that affected banks and super funds differently. The stress scenario itself was 12 months in duration and was designed in consultation with industry. It assumed no change in government policy or exceptional support.

The following represent the key findings:

1. The superannuation industry was able to maintain enough cash and liquid assets to meet requests from members and other obligations during the stress. However, in doing so super funds needed to make significant changes to their asset portfolios, and this rebalancing had a disproportionate impact on some members.
2. Banks experienced significant liquidity stress because of a large and sudden withdrawal of deposits and other forms of funding. This included withdrawals by super funds. However, each bank was able to demonstrate actions that ensured they could restore liquidity levels and continue to meet their financial obligations when due.
3. Participants’ responses to restore liquidity levels had some impact on markets. For super funds this included large transactions in international and domestic listed assets, with limited transactions in unlisted assets. There was also a relatively modest impact on foreign exchange margins and settlement in the scenario.
4. Despite experiencing their own financial pressures, super funds were able to continue to provide capital needed to support the solvency of banks in the scenario. The methods and approaches of responding differed across super funds depending on their business models and internal structures.
5. The operational shock exacerbated the impact of the stress. The shock meant that banks and super funds were unable to trade securities for a period of time. The impact was greater on banks as it coincided with their liquidity stress in the scenario. Super funds were relatively less impacted, but the exercise highlighted areas of development in their operational responses.