Structural changes will persist post-COVID, requiring that insurers adjust their underwriting accordingly and scrutinise risk models, Australian Prudential Regulation Authority (APRA) Chairman Wayne Byres says.

The key issue for risk managers is not what has happened so far, but what is yet to come, and the many valuable lessons from the past year must be built into contingency planning for the future, Mr Byres said yesterday in a speech addressing the Risk Management Association.

“With change there will inevitably be winners and losers. As risk managers, your credit risk policies, portfolio limits and underwriting practices will need to respond. Your risk models will also need to be re-examined,” he said.

Examples of changes that may persist are a fundamental shift in the value of office space, reduced attractiveness of central business districts, digitisation and business model shifts which favour some industries over others, less need for business travel, and possible population migration away from major cities.

Mr Byres said simply avoiding the risk was not the answer.

“Everyone needs to play their role to avoid the collective action problem that would arise from risk aversion taking hold across the board,” Mr Byres said. “We will all end up worse off and make the system less resilient if we all seek to avoid risk altogether.”

Mr Byres says 2020 was a year in which risk managers “proved their worth” more than ever in the face of once-in-a-century bushfires and pandemic and the most serious economic downturn since the Great Depression.

“From a Black Summer to a black swan, it’s been a very testing year,” he said.

The past year revealed opportunities for the resilience of the financial system to be further improved and Mr Byres said there were dangers in portraying negative events as incredibly rare.

“It is too easy to use it as an excuse for failing to prepare,” he said. “The regular occurrence of “black swan” events – well beyond the frequency suggested by the tail of a statistically convenient normal distribution – means we all need to be ready for the unexpected.”

Given SARS in 2003, Swine flu in 2009, and MERS in 2013, risk managers should “not have been caught off guard by the emergence of a pandemic,” he observed.

The emphasis of international regulatory reforms was moving from strengthening the global financial system to how to improve its resilience as regulators realise it is “possible to be strong, but not resilient.” Mr Byres gives the example of a car windscreen, a strong piece of glass but rendered unfit by any small crack.

“We want a system that is able to absorb shocks, even from so-called 'black swan' events, and have the means to restore itself to full health,” Mr Byres says.

The financial sector had “done a good job” this year and operated “pretty seamlessly” despite the disruption COVID-19 caused, though like a swan gliding across a lake the apparent calm on the surface had “belied a frenzy of activity below as boards, managers, technicians and frontline staff scrambled to find urgent responses to unexpected issues”.

In managing these risks at scale and at speed, many APRA-regulated firms made compromises to their normal protocols and these adjustments now need to be mitigated against.

“These short cuts and process over-rides create risks. It’s essential these gaps are identified and plugged as quickly as possible,” Mr Byres urged. “A truly resilient system should not need compromises in operational and cyber security controls to be able to continue to provide its services in the face of a crisis.”

APRA will update its prudential standards in this area.

APRA also plans to release a Prudential Practice Guide on managing climate-related financial risks, and undertake a vulnerability assessment designed to “avoid being caught off-guard on this front”.

“We most definitely see a thorough understanding of climate-related risks as essential for a resilient financial system,” Mr Byres said.

“It is impossible for these events, and the changing government policies, investor preferences and community expectations that accompany them, not to have financial consequences.

Mr Byres said people-related risks caused by the COVID disruptions were also “very real” and will impact on organisational performance.