The Australian Prudential Regulatory Authority (APRA) has decided to closely examine the banks’ capital management and stress testing practices amid the Covid-19 pandemic.

The regulatory body said that the pandemic has crippled their ability to create and retain earnings.

Hence, it has decided to decrease the capital buffers through 2020 due to the surge in bad loans as hundreds of thousands of people in the country lose their jobs.

APRA chairman Wayne Byres said: “Until there are clear signs of an economic recovery and banks are able to generate capital from retained earnings, it is reasonable to expect supervisory scrutiny of capital management and stress testing results to remain very high.”

The watchdog temporarily removed the requirement for increasing the capital for A$144bn ($95.77bn) in loan repayment holidays given to borrowers.

It expects the banks to check if the financial condition of the borrowers worsens after three months, which may lead to higher bad loan charges and ultimately dilute capital buffers.

Byres added: “Our strategy in Australia thus far has been to exercise a degree of flexibility where it is clear that rigid adherence to regulatory requirements would amplify the shock impacts.

“Measures to backstop liquidity have worked well and bought us time, but solvency pressures are mounting as credit risks come to the fore.”

Last month, APRA also urged the banks to “seriously consider” deferring dividend payouts until there is more clarity on the impact of the pandemic.