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Stress Testing Housing Loan Portfolios: A Regulatory Case Study

Against the backdrop of sharply rising house prices and Central Bank warnings that housing credit growth was not sustainable, the Australian Prudential Regulation Authority (APRA) conducted a “stress test” to gauge the resilience of 120 Australian banks, building societies and credit unions to a substantial correction in the housing market. The stress test scenario mapped a 30 per cent fall in house prices to a substantial increase in default and loss rates. The results showed that all 120 institutions would remain solvent under the imposed conditions, however 11 institutions’ capital ratios fell below their regulatory minima. This paper details the stress testing methodology and traces through the various stages of the project, from background research, to stress test design, implementation, supervisory follow-up, public dissemination of the results and resulting policy changes. * All authors are from the Australian Prudential Regulation Authority (APRA). Corresponding author: Neil Esho, Australian Prudential Regulation Authority, GPO Box 9836, Sydney NSW 2001, Email: neil.esho@apra.gov.au. We thank Glenn Homan, Charles Littrell and Ian Sharpe for helpful comments and suggestions. The paper represents the views of the authors only, and any errors are our own.