The final report of the Australian Prudential Regulation Authority (APRA) Capability Review was released on Wednesday (17 July), outlining that while the prudential regulator is well respected and has had a successful track record, change is needed moving forward to ensure that it continues to effectively act as “part of an insurance policy against a costly major financial crisis in Australia”.
The capability review report reads: “APRA’s efforts to build capital requirements, strengthen balance sheets and tighten lending standards in the residential mortgage market in the past few years have made the financial system more resilient. But this is no guarantee against a financial failure or crisis.
“APRA needs to continue to enhance its preparedness for a market-wide crisis that affects multiple entities and its capacity to respond to a single distressed entity in collaboration with the Council of Financial Regulators’ members.”
As such, the review put forward 24 recommendations to strengthen its capability, expand its remit and resolve issues around “culture, variability in leadership capability and capacity to implement change, which could act as constraints and need to be addressed in their own right”.
Expanding the remit of APRA to business lending
As well as putting forward recommendations for APRA to “lift its effort on superannuation and shift its thinking and focus by developing its policy and supervision framework and by building its skills and resources dedicated to the sector”, the panel also suggested that APRA should build credit risk capacity to “simultaneously maintain high supervisory intensity in both non-retail and retail credit risk”.
The panel found that while APRA is “rigorous and effective” and has “effectively managed risks around mortgage lending”, its capacity to supervise non-retail credit risk – such as business lending – has been limited and should increase.
According to the review panel, APRA’s focus on housing risks is “entirely appropriate” given that housing represents 64 per cent of assets in the Australian banking system in dollar terms, and 36 per cent of the banking system when considered in risk-weighted asset terms.
However, the panel highlighted that APRA’s focus on credit risks outside the housing market is “comparatively less developed and intense” (excepting commercial real estate and New Zealand dairy exposures).
Indeed, the panel noted that an internal reporting had previously noted that the “recent focus on mortgages and commercial property has meant that other credit portfolios have not had the same level of regulatory scrutiny”.
Noting that APRA “pivoted to increase supervisory focus with respect to the major banks’ small and medium business lending exposures” in 2018, the capability review panel conceded that assessing risks in mortgage lending is “comparatively straightforward as products are relatively homogenous”, which is “not the case for more complex non-retail loans”.
The panel went on to outline that non-retail loans “require more intense focus and more specialist expertise” and highlighted that APRA’s specialist credit risk team was made up of just 17 people (whereas other international regulators have 45 staff in the same area).
“While APRA has appropriately taken a risk-based approach in supervising credit risk, increased capacity in non-retail credit is warranted,” it concluded.
In response to this, APRA has said that while it supported this recommendation, this would require additional resourcing to “simultaneously maintain high supervisory intensity across both non-retail and retail credit risk”.
In total, the capability review report makes 24 forward-looking recommendations that “seek to ensure that APRA is best placed to deal with its future environment and the challenges which lie ahead”.
Nineteen recommendations are made to APRA, and five recommendations reside with the government.
Among the biggest changes the review puts forward in its recommendations to APRA are:
- the creation of a competition champion within APRA
- asking APRA’s chair to relinquish his ADI-specific oversight role and adopt a broader organisation-wide role (with remaining members splitting their roles to include a mix of industry, policy and functional responsibilities)
- creating a new superannuation division, headed by an executive general manager
- making its recent GCA self-assessment process for entities a biennial requirement and rolling this out across retail and industry superannuation, insurance and ADI entities
Meanwhile, the recommendations to government include:
- giving APRA a non-objections power to veto the appointment or reappointment of directors and senior executives of regulated entities in a bid to help “pre-emptively regulate GCA risks”
- removing APRA from the application of the APS Workplace Bargaining Policy
- “reviewing the adequacy of penalties” across APRA’s legislative framework
The review concluded: “There are no simple solutions to raising APRA’s capabilities. It operates in a complex, uncertain and dynamic environment. It requires highly skilled staff with good judgment and courage. They need to be supported by strong leadership and technology. APRA also needs to use its independence, powers and authority to greater effect to shape its future.
“The areas of improvement identified in the review are mostly for APRA to respond. Cultural change is necessary. A culture that has facilitated success in regulating traditional financial risks can be a constraint on innovation and capability development. There needs to be more internal challenge of management to ensure that the organisation adapts with developments in the financial system and addresses the breadth of its mandate. APRA needs to be more transparently assertive in its communication. This is particularly the case with regulated entities but also applies to communication with the Parliament and the public so that APRA can better define its authority and shape its own future. These changes need to come from the top and be embraced throughout the organisation.”
It continued: “Industry benefits a great deal from a world-class regulator, and consumers need a regulator that can ensure the system is safe, robust and accountable.
“APRA is part of an insurance policy against a costly major financial crisis in Australia. Adding additional resources if needed could complement and facilitate the changes recommended by this review.”
APRA has said it supports all 19 recommendations, with APRA chair Wayne Byres stating that the report was “comprehensive and ambitious” in its views of APRA’s future remit and required capabilities.
However, he warned that these should not be at the cost of APRA’s strong capabilities in financial safety and stability.
“The report highlights the increasingly complex industry dynamics in which APRA operates and that the expectations of its role and mandate have increased.
“Appropriately, the report notes APRA has not stood still in the face of these developments, but highlights the need to accelerate the necessary changes if APRA is to remain a successful prudential supervisor into the future,” Mr Byres added.
“APRA is committed to ensuring it is fit for the future, and the panel’s recommendations support this. APRA will continue to focus on its primary responsibility to protect the financial wellbeing of the Australian community as it implements the changes that have been recommended and those APRA already has underway,” he said.
The regulator also noted that several recommendations are already being addressed in its current Corporate Plan and will include new initiatives to meet some of these recommendations in its revised Corporate Plan, set to be published in August 2019.
Mr Byres did voice some scepticism, however, of the veto-power recommendation that would give the regulator the power to reject the appointment or reappointment of directors and senior executives of regulated entities, stating: “APRA supports the objective of a strong regime for the fitness and propriety of directors and senior executives, but notes that ultimately this is a matter for government.
“APRA will engage with the government on how the objectives identified by the Capability Review can best be achieved, noting the potential for moral hazard and administrative burden.”
Treasurer Josh Frydenberg has already agreed to all five recommendations put to government in the report.
Mr Frydenberg commented: “An independent, robust and effective prudential regulator is essential for safeguarding the financial safety and the financial stability of the Australian economy.
“The government is confident that the response it has announced today, alongside action from APRA, will ensure that APRA is in a position to effectively respond to these new challenges and deliver on its mandate.
“The government would like to thank the expert panel that conducted the review.”
Capability Review background
The capability review was launched earlier this year following the release of the final report of the banking royal commission in February 2019.
The government announced that it was establishing the review to assess APRA’s capacity and capability to promote financial stability and its preparedness to address issues raised by the royal commission and “an environment of growing complexity and emerging risks for APRA’s regulated sectors”.
The review, which had also been recommended by the Productivity Commission following its inquiry into the nation’s financial system, was led by the former chairman of the Australian Competition and Consumer Commission and president of the National Competition Council, Graeme Samuel; alongside former Westpac senior executive Diane Smith-Gander, and the Reserve Bank of New Zealand’s former head of financial stability, deputy governor, and acting governor, Grant Spencer.
It reportedly involved reviewing more than 1,000 APRA documents, analysis of information from seven international “peer regulators”, meeting with APRA’s senior leaders on over 30 occasions, “extensive and insightful consultations” with more than 30 stakeholders, hosting five roundtables with “key industry experts and international prudential regulators”, evaluating 19 written submissions, as well as a “quantitative and qualitative staff survey and focus groups”.
Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.