RegCentric Webinar 8th of April 2020:
Topics covered in this webinar:
An overview of the current COVID-19 financial landscape
Recognition of Expected Credit Losses
Recent APRA supervision, policy and reporting changes
APRA update in Finance and Risk
Thank you for joining
A lot has changed over the last couple of weeks. When we provided an update on COVID-19 3 weeks ago, the world looked quite different than in does today. In our session we provided an update on the areas of focus for APRA and their focus for 2020 and beyond. Many changes have happened in the last few weeks and today we will give an update on the announcements made by APRA that are important for finance and risk departments.
The current crisis has moved very fast and we thought I’d be worth spending a few minutes on establishing the timeline of this crisis. This slide shows the timeline from the first cases of pneumonia of an unknown cause being reported in China back in December until today. We also indicated some of the key APRA activities during this time, and as you can see APRA was very much in a business as usual mode back in December.
The World Health Organisation declared a health emergency in January, after thousands of new cases were reported in China, but the focus at that time was still very much on China. The first case in Australia was recorded on the 25th of January. That is actually only 10 weeks ago. In February, the number of cases gradually increased domestically, but countries overseas were starting to see quite significant number of cases. In Australia, regulators and the government as a whole is still very much in Business As usual, although behind the scenes, APRA is taking its first steps in assessing the potential impact of the events surrounding COVID-19 and ensuring APRA itself is protecting its operations and its staff.
On March 11, the WHO declares corona a global pandemic. On March the 12th of March, the Australian government announces its first stimulus package. On March 16, travelers entering Australia need to self-isolate for 2 weeks. On March 20 the borders closes. On March 22 the government announces its second stimulus package, lifting the total to 189 billion. (this includes 90 billion from RBA). On March 30, the government announces its jobkeeper scheme, adding an additional 130 billion worth of economic stimulus. And several more targeted measures have been announced later. The pace of policy announcements has been extraordinary, as is the scale of the government interventions.
We are the 8th of April today, and Australia seems to have been quite successful and flattening the curve at this stage, which can be seen on the very useful infographic the government publishes on a a daily basis.
We know there are still many unknows. In terms of the length and extent of the lockdown. In terms of the next steps of lessening the restrictions. We don’t know when businesses will be allowed to reopen. We don’t know when we’ll be allowed to travel again, domestically; let alone internationally. We do know the economic shock is going to be big. We know there are sectors that have seen their entire revenues dry up overnight. And we do know this situation is unlikely to improve for many months, maybe even longer. We know that this will mean credit and liquidity risk event materializing. We see rating agencies adjust credit ratings. We also know the markets tend to react wildly in uncertain times and that volatility is at historic highs. We know there are many households that will experience hardship.
But we now also know that the government is acting decisively to absorb economic shock and that also the banking industry has vowed to do their part in ensuring Australia is the best possible position on the other end of this crisis so it can recover from this shock. That business can restart with their employees on the other side. We also know that the banks are not at the heart of the problem such as during the GFC, and that they are starting this crisis with strong balance sheets. We have also seen regulators shift priorities to support the industry in shifting own priorities to focus on their customers. As mentionen, in today’s session, we will cover the changes made by regulators that are most relevant to Finance and Risk departments.
I will start with some of the key packages announced by Australian Federal Government:
- The government has announced over 200 billion in direct support to businesses and households. This includes measures such as the jobkeeper payment and the measures to boost the cashflows for employers. If you want to get a detailed breakdown of all the measures for households or businesses, our friends at BDO and Deloitte provide quite good insights, especially from an accounting and tax perspective.
- CORONAVIRUS SME GUARANTEE SCHEME. Under the Scheme, the Government will provide a guarantee of 50 per cent to SME lenders for new unsecured loans to be used for working capital. SMEs with a turnover of up to $50 million will be eligible to receive these loans. The terms:
• Maximum total size of loans of $250,000 per borrower.
• The loans will be up to three years, with an initial six month repayment holiday.
• The loans will be in the form of unsecured finance, meaning that borrowers will not have to provide an asset as security for the loan.
Iggi will cover off how APRA will support the government in the execution of this scheme.
- SUPPORTING NON-ADI AND SMALLER ADI LENDERS IN THE SECURITISATION MARKET
The Government is providing the Australian Office of Financial Management (AOFM) with $15 billion to invest in structured finance markets used by smaller lenders, including non-Authorised Deposit-Taking Institutions (Non-ADI) and smaller Authorised Deposit-Taking Institutions (ADI).
This support will be provided by making direct investments in primary market securitisations by these lenders and in warehouse facilities. AOFM will also be purchasing assets that support
small business (unsecured and secured loans) and
consumer lending (including credit cards, automobiles and personal loans).
This program will assist smaller lenders, who will not benefit from the RBA’s term funding facility, to maintain access to funding and support competition in the lending market. This in turn will help keep mortgages and other borrowing costs for businesses low.
An example of this fund in action: The AOFM advises that it intends to invest the first tranche of $250 million in securities issued by a warehouse vehicle sponsored by Judo Bank, subject to satisfactory completion of the documentation process.
Btw that same AOFM will also be tasked with finding 200 – 250 billion AUD in funding.
Announced 2 rate cuts in March, bringing the cash rate to 0.25%. The RBA has also started a debt securities buying program, known as quantitative easing. A practice executed in US and EU, it is a new form of market intervention by the RBA, aimed at keeping interest rates low and markets operating orderly.
Additionally, The RBA has announced a term funding facility for the banking system. Banks will have access to at least $90 billion in funding at a fixed interest rate of 0.25 per cent. This will reinforce the benefits of a low cash rate by reducing funding costs for banks, which in turn will help reduce interest rates for borrowers. To encourage lending to businesses, the facility offers additional low-cost funding to banks if they expand their business lending, with particular incentives applying to new loans to SMEs.
- Responsible lending obligations
- Ensure orderly market functioning
- Reduce the number of regulatory initiatives
- Remediation and enforcement unchanged.
Now how does all of this translate in estimates for the Australian economy? It is still early days in assessing the impact of the COVID-19 lockdown measures as well as the response from the government. Various economic models are being tested and we did want to share some updates based on our findings. Firstly, Organisation for Economic Co-operation and Development (OECD) gives a broad-brush number 20-25% decline in economic output, resulting in a 2% decline in GDP for each month of containment. That is, without compensating government actions.
The Australian Financial Review's economist survey for the March quarter showed economists are forecasting a median 3.9 per cent contraction in calendar 2020.
The expectation is that it won't be until the end of 2021 that the economy will move back into growth. The median forecast for the end of 2021 is for a rebound to 3.20 per cent.
Every economist in the survey expects the unemployment rate to rise significantly from its current level of 5.1 per cent, and the median forecast is that the rate will hit 8.5 per cent by the end of June. The jobless rate is expected to fall back slightly by the end of the year, to 8 per cent.
Inflation is expected to stay well below the Reserve Bank of Australia's 2 per cent to 3 per cent target band, the economists believe. It will hit 1.4 per cent by the end of June, according to the median economist forecast, and fall further to 1.25 per cent by the end of the year.
The Bank of international Settlements earlier this week also released a whitepaper where they estimate GDP impacts. Australia is classified under the Other Advanced Economies and the BIS provides a range of possible outcomes under less severe and more severe conditions and under a “V” shaped or “W” shaped recovery scenario. Under the V shaped recovery, the economy bounces back after the initial lockdown period, whereas under the “W” scenario, loosing of the restrictions is followed by a retightening of restrictions when the number of cases rises in response to governments loosening the initial lockdown restrictions. This scenario is becoming more plausible given the experience in Singapore, where a rise in community transmissions has been observed recently, resulting in tougher restrictions being put in place.
In all scenario’s from all these sources, a contraction of the economy by 3-5% of GDP in 2020 and a gradual recovery in 2021 are the most likely outcomes.
There are also initial signs of second order effects in the housing market, with clearance rates dropping significantly in March. Further analysis is required and at this stage we did not identify multiple sources to have a consensus view.
IFRS 9 - Accounting for Expected Credit Losses
Why is all of this important? One of the reasons is because in line with what we had flagged in our webinar on 18th of March, there is a certain amount of un-ease about the impact on the expected credit losses. Entities are required to consider historic, current and forward-looking information (including macro-economic data) which results in the earlier recognition of credit losses as it will no longer be appropriate for entities to wait for an incurred loss event to have occurred before credit losses are recognised.
The International Accounting Standards board (IASB) has issued guidance for entities preparing their financial statements, specifically around IFRS 9.
In assessing forecast conditions, consideration should be given both to the effects of covid-19 and the significant government support measures being undertaken.
IFRS 9 requires the application of judgement and both requires and allows entities to adjust their approach to determining ECLs in different circumstances. A number of assumptions and linkages underlying the way ECLs have been implemented to date may no longer hold in the current environment. Entities should not continue to apply their existing ECL methodology mechanically. For example, the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered an SICR.
To assess SICR IFRS 9 requires that entities assess changes in the risk of a default occurring over the expected life of a financial instrument. Both the assessment of SICRs and the measurement of ECLs are required to be based on reasonable and supportable information that is available to an entity without undue cost or effort.
It is likely to be difficult at this time to incorporate the specific effects of covid-19 and government support measures on a reasonable and supportable basis. However, changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings. If the effects of covid-19 cannot be reflected in models, post-model overlays or adjustments will need to be considered. The environment is subject to rapid change and updated facts and circumstances should continue to be monitored as new information becomes available.
APRA also provided some related guidance:
Where a borrower who has been meeting their repayment obligations until recently chooses to take up the offer not to make repayments as part of a COVID-19 support package, the bank need not treat the period of the repayment holiday as a period of arrears. Similarly, loans that have been granted a repayment deferral as part of a COVID-19 support package need not be regarded as restructured.
APRA will be writing to all authorised deposit-taking institutions (ADIs) to advise them of the specific reporting treatment for loans subject to these support arrangements. APRA will require ADIs to report to APRA, and publicly disclose, the nature and terms of any repayment deferrals and the volume of loans to which they are applied. ADIs must also still continue to provision for these loans under relevant accounting standards.
According to S&P, business loans would contribute to most of the increase in credit losses for Australian banks, with the tourism, transportation and retail services sectors likely to be most affected by the current environment.
However, the ratings agency stated that it also expects defaults from households to rise due to income loss. However, they did not quantify at this stage.
So what are some practical considerations for accounting for expected credit losses?
- Use revised macro-economic estimates to feed into the models
- Align the scenario’s for ECL with the scenario’s used for stress testing and ICAAP
- Use internal and external sources for best available estimates
- Use a range of possible outcomes mild/severe/very severe scenario’s and assign probability’s against each.
Hi, my names Iggi and I am going to build on the scene already set – detailing APRA’s regulatory response and what that means for the regulatory pipeline and current supervision activites.
I’m also going to provide some insights into APRA’s COVID-19 related activities and help unpack what that means for those of us who work in and around the finance and risk, and data and reporting spaces.
Insights into APRA’s COVID-19 regulatory activities
APRA’s primary focus right now is monitoring the impact of COVID-19 on the financial and operational capacities of its regulated entities.
In light of recent global financial market volatility, the regulator has been working with the Council of Financial Regulators, the Australian Government and its peers like the Bank of International Settlements in coordinating a multi-lateral approach to the COVID-19 pandemic.
This includes taking BCP steps to protect its own staff and critical operations – something we can all relate to on the line today.
APRA has also been engaging with entities – using its Cross-Industry Pandemic Planning Guidance as a benchmark – to understand how COVID-19 might affect their operations. Ordinarily targeted testing of entities’ plans would follow – to assess their readiness to cope with the disruption.
APRA’s response has been swift in the last few weeks, most notably providing relief from its unquestionable strong capital requirements set in 2017. The regulator has also urged banks to seriously consider suspending their dividend payments until there is more certainty about the impact of COVID-19 – but didn’t go as far as the UK regulator in scrapping all dividends and share buy backs in 2020.
The idea behind freeing up Australian banks large capital buffers is to encourage lending in the domestic economy. It is also to encourage banks to take advantage of the RBA’s Term Funding Facility.
The regulator stated it will allow entities to include the TFF in their liquidity coverage ratio, minimum liquidity holdings ratio and net stable funding ratio calculations.
APRA will also be supporting the Governments SME scheme through additional reporting – this will most likely to be a collection similar to ARF 910, that is the Financial Claims Scheme data collection. However, the details around this are yet to be finalised..
APRA has given some advice around the treatment of COVID-19 support packages.
For example, banks should not treat repayment holidays as a period of arrears where a borrower was currently meeting their repayment obligations.
Similar-ly, loans which have been granted repayment deferrals should not be regarded as restructured loans.
This advice aligns with the announcement from the Australian Banking Association that borrowers who are granted a six-month deferral on loan repayments will not have their credit ratings affected, so long as they previously up to date with their repayments.
Interestingly, seen in that last point, APRA has flagged to ADIs and RFCs that the terms and volume of any repayment deferrals are to be reported to APRA and publicly disclosed – which means credit teams will have to be working closely with customer facing teams to identify and collected this data now.
Amendments to APRA’s regulatory pipeline
So with all the new regulatory activities, something has to give. Looking at APRA’s regulatory pipeline APRA has revised its 2020 priorities and like ASIC has suspended the majority of all its non-critical policy and supervision initiatives.
Just today APRA made an announcement that is has temporarily suspended the issuing of all new banking licenses – which is most likely to affect the neo and challenger banks.
APRA has delayed its public consultations, and the implementation of number of new policies and standards.
Most notably the implementation of Basal III capital reform by 1 year to 2023 (APS 116 Capital Adequacy: Market Risk)
It has delayed the ARS 730.1 which has an annual EFS form and ARS 722.0 until the March 2021
And it has suspended the consultation on determining ADI data non-confidential, which would see increased reporting and transparency in banks financial performance data to the public.
The APRA Connect Program has been suspended until further notice, this is the project to create a tool to replace D2A – APRA’s data collection platform.
So at this point – I would flag here to expect more changes to APRA’s regulatory pipeline in the coming months. The intention from APRA is to allow banks to dedicate time and resources to maintaining their operations and supporting their customers in keeping the economy afloat.
Recap of APRA reporting considerations
Which takes us into regulatory reporting considerations. So in periods of high uncertainty and market volatility there is an increased need for more timely and accurate data to understand the rapidly changing environment.
Consequently, APRA has announced a number of additional reporting obligations for banks and RFCs.
This includes extended some EFS parallel reporting requirements 2 extra quarters until June 2020. The idea behind this is provide the agencies (that is APRA, the RBA and the ABS) a consistent timeseries of data they are familiar with and have confidence in – because they wouldn’t have made the transition yet in terms of historical trends.