Getting Quarantined: Insurance and Bank Dividends Under New Restrictions by APRA

Summary

• APRA has announced updated capital management guidelines for insurers as well as banks. Earlier in April, the regulator strongly recommended deferring dividend payments due to uncertainty in the near-term outlook.
• ADIs or banks would now be able to distribute up to 50% of their profits as dividends for the remainder of FY20, and counter-effective measures like dividend reinvestment plans and capital actions should be undertaken to offset the impact of dividends on capital.
• Insurers are also required to continuously stress test business scenarios prior to making any decision on capital and dividends, and capital actions and dividend reinvestment plans should be undertaken by the industry.

The Australian Prudential Regulation Authority (APRA) has provided capital management update for insurers and banks. The independent statutory authority has now eased restrictions on dividend payments, given that the institutions continue to manage the disruptions caused by the virus outbreak.

The regulator has updated its earlier guidance released in April 2020 that asked banks and insurers to consider deferring dividend payments until outlook was clear. Since uncertainties in the outlook have reduced to some extent, the APRA reviewed the financial projections and stress testing results of banks and insurers.

APRA Chairman Wayne Byres stated that the regulator now has better visibility on how COVID 19 impacts economy and financial institutions. Over the past years, the banking system has strengthened with higher capital requirements, which has given headroom in a crisis like COVID 19.

Guidance for ADIs/Banks

The regulator provided updated capital management guidance for banks, aiming to assist long-term capital planning and ensuring ADIs continue to support the economy during the economic recovery. In the last three months, it has also tested banks under a range of stress scenarios.

Given the uncertainty in duration and depth of the economic crisis, the regulator tested industry’s resilience across a range of scenarios. APRA believes that the banking system has the capacity to withstand a severe downturn, but the system would be impacted in the event of a severe downturn.

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It also stated that there remains a need for continuous assessment and planning. The uncertainty in domestic as well as international outlook continues to be present, and forward-looking analysis could have flaws.

APRA expects banks to manage capital prudently with lower dividend payments while supporting the economy during the recovery. Banks would also need to emphasise on an orderly transition of customers to normal course repayments after deferrals.

ADIs would be allowed to have lower than required ‘unquestionably strong’ capital benchmarks in the period ahead. Industry could use buffers held above minimum requirement to absorb losses and continue lending, and capital conservation buffer is available for use under deteriorating conditions.

In 2020, the regulator demands banks to retain a minimum of 50% of their earnings, meaning a maximum 50% dividend pay-out out of profits, and apply dividend reinvestment plans (DRPs) or other measures to offset the impact of dividend payments.

The industry is also required to use stress test to announce dividend, and capital actions, and assess lending capacity under different scenarios. APRA also requires industry to plan for orderly rebuild of the capital where required.

Guidance for Insurers

In April, the regulator also told insurers to defer dividend decisions and offset dividend payments with capital actions.

The regulator has also provided capital management update for insurers, aiming to assist long-term capital planning and ensuring they continue to support the economy during the economic recovery.

The regulator believes that there remains a necessity to actively plan capital management approach by insurers, which would allow to successfully navigate the uncertainty in domestic as well as international level.

APRA expects stress testing to be conducted regularly to enable decision making. Insurers are required to use stress testing for decisions on capital actions and dividends, and their ability to continue business under a range of scenarios.

The regulator demands insurers to maintain caution in distributions, including dividend payments with a measured approach, considering the underlying uncertainties. In 2020, the regulator expects moderated dividend pay-out ratios with DRPs or other measures to offset the impact on capital by distribution payments.

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Key Takeaways

Australian banks have maintained a high dividend pay-out ratio over the past decades, fuelled by an uninterrupted economic expansion. Since the economic expansion has been dusted in almost three decades, there is a greater need for banks to maintain sustainable dividend pay-out ratios.

Investors need to realise that dividends on equity shares are not guaranteed, and bond investors fall in line prior to equity investors at the time of income distribution. As the performance of the banking system is closely tied to that of economy, diminishing profits of banks also indicate deterioration in the economy.

But the regulator has not completely barred banks to pay dividends, and banks that are in a position to pay dividends could pay. There had been an upside move in the share prices of banks after APRA released its guidelines.

Perhaps the regulator has not suspended dividend payments, and investors are cherishing the action, which was assumed to be a suspension of dividends. Given the APRA has allowed banks to pay dividends, it also indicates that the economic conditions have been better than anticipated.

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