The Australian Banking Industry: APRA Prudential Standard CPS 190

Fans of the horror movie genre would be familiar with the Rules, a checklist of things characters must avoid if they want to survive to the end of the film. Whether it’s saying: “I’ll be right back”, running up the stairs instead of going out the front door, or simply not maintaining their cardio, characters in horror movies are always failing to follow the rules that will ensure their survival.

Can the same be said for the banking industry? Is our Prudential Standard CPS 190 the shield the US needed?

Wall Street Crash: The first victim

The first sign that trouble was on the horizon was the collapse of Silicon Valley Bank (SVB) on 10^th March. Led by rapid-fire social media speculation the bank was in trouble, which prompted a lightning fast run on the bank, SVB’s failure is the second largest in US banking history and the largest since the GFC.

Part of SVB’s failure can be attributed to its client-base of zombie companies. SVB was a specialist in lending for the tech sector. As global inflation began to pinch, tech stocks fell and the founders of many start-ups funded by SVB struggled to cover their debt repayments. When word spread that SVB had suffered a loss on the sale of its inflation-hit bond portfolio, the so-called zombies sprang to life and withdrew their funds before it was too late.

A similar fate befell crypto-friendly Signature Bank just three days later. Customers, unnerved by the speed of the SVB collapse, started a run on Signature Bank. Signature Bank’s customers were particularly concerned about the mid-sized institution’s exposure to cryptocurrency, especially after Silvergate – one of the few regulated financial institutions providing banking services to crypto companies and exchanges – suffered its own collapse in early 2023.

As you would expect any good bystander facing a chainsaw-wielding villain to do, customers ran screaming from these US banks. Because as one financial commentator said: “If you see a bomb disposal expert running down the street, don’t ask them what’s happened, just try to keep up.”

The Wall Street Crash Body Count Rises

While US financial regulators stepped in to stem the bleeding, the unseen threat directed its attention across the pond. Panicked investors ran screaming from Credit Suisse, Switzerland’s second-biggest bank, fearing it was the next bank to fail. Credit Suisse is far more significant globally than the US banks listed above, and it has been on shaky ground for years, with multiple scandals eroding its reputation and profitability. (And we all know what happens to the character with the bad reputation in your run-of-the-mill slasher film.)

Thankfully, rescue came at the eleventh hour, as UBS agreed to buy Credit Suisse at a bargain basement price.

What about the Australian banking industry?

The good news is that – just like in a movie where a deadly virus wipes out most of humanity – Australia seems to be immune to the contagion.

“The Australian banks are well-capitalised, have access to liquidity and have strong balance sheets,” Professor Fariborz Moshirian, a global financial stability expert, told the ABC News.

Why? It probably has a lot to do with the Rules.

1. Always pay attention to your surroundings.

Australian banks lend money at a profit. They do not have significant amounts of deposits sitting in government securities and other liquid investments. Their primary lending is mortgages, whose values move with interest rates.

By contrast, SVB had a very low reliance on sticky retail deposits, instead relying on securities which meant its balance sheet was particularly vulnerable to movements in interest rates.

2. Everyone could be a victim.

In Australia, all ADIs have to abide by the same regulatory regime – the one set by APRA. Our small, regional banks face the same capital adequacy regime as the big four banks. Yes, there are some differences which apply to significant financial institutions (SFIs) and smaller banks have a simplified set of capital requirements, however our local regulations all align to the global Basel III framework.

In the US in 2018, Donald Trump’s Republican Party rolled back part of the Dodd-Frank Act, a series of federal regulations passed in the wake of the 2008 financial crisis. When it was first introduced, the Dodd-Frank Act was met with animosity from the industry, including SVB’s CEO Gregory Becker, who thought the regulations should only apply to large institutions. Among the changes implemented in 2018 was the raising of the threshold for the size of institutions covered by the strict regulations from $50bn to $250bn. (In Australia, SFIs are ADIs with over $20bn in assets).

3. Be careful who you trust.

Australia’s banks have limited direct exposure to international markets. Immediately following the SVB collapse, the US Federal Reserve led an initiative to enable other central banks to more easily obtain US dollars that can be distributed to commercial banks in their countries (a Swap Line initiative). Australia’s central bank was not included in the initiative, because it was believed our banking system was robust enough to withstand the current issues.

In contrast, in 2021, the collapse of the US hedge fund Archegos Capital cost Credit Suisse $5.5 billion and damaged the bank. An independent external investigation later found that Credit Suisse allowed Archegos Capital to take “voracious” and “potentially catastrophic” risks that culminated in the US hedge fund’s spectacular collapse.

4. Have an exit strategy.

Prudential Standard CPS 190 shields our way

Bringing even greater confidence to the Australian financial market is the introduction of Prudential Standard CPS 190: Recovery and exit planning (CPS 190). The new Standard focuses on the ‘financial resilience’ of regulated entities, and seeks to reduce the likelihood that they will fail, by ensuring they have plans in place and resources to manage periods of stress.

 

Could the Wall Street Crash happen in Australia?

The problems that led to the fire sale at Credit Suisse are different to those that brought down the US banks. But across the board, global inflation and rising interest rates opened the door to risk, exposing the weak and vulnerable. Those vulnerabilities were ultimately what led investors and customers to take their own defensive action. Financial regulators (and other institutions) were forced to jump in and save consumers by securing their deposits.

Is the danger over? That remains to be seen. We can be reassured that Australia has held its position confidently through this current crisis. But it pays to remember that other oft-repeated rule of the horror genre: the villain always comes back to life.