APRA lashes longstanding mutual bank directors

In a speech delivered to the Customer Owned Banking Association CEO and Directors Forum, APRA deputy chair John Lonsdale has emphasised the sector’s governance, stating that all mutual banks will need strong leadership to position themselves for rapid change.

However, he noted, “not all mutuals are equally equipped to the task”.

The regulator sees board tenure, composition, capabilities and performance assessments as the areas that need the most improvement in the mutual sector. The top concern however is the length of board directors’ terms.

APRA has found the proportion of directors serving 10 years or more on mutual boards is almost double that of directors on the boards of their ASX-listed rivals.

“APRA has articulated its concern about excessive tenure within the prudential framework,” Mr Lonsdale stated.

“Our cross-industry prudential standard on governance (CPS 510) requires authorised deposit-taking institutions (ADIs) to have a board renewal policy that considers whether directors have served for a period that could materially interfere, or could be perceived to materially interfere, with their ability to act in the best interests of the institution.

“And yet, directors are remaining on mutual boards far longer than their ASX 200 counterparts.”

Regional mutuals and smaller mutuals tended to have the highest proportion of long-tenured board directors, with around 40 per of the segment’s directors sitting on their boards for 10 years or more.

In contrast, less than 20 per cent of ASX 200 bank directors had tenures reaching further than a decade, while a little more than 30 per cent of all mutuals did.

Mr Lonsdale reflected the finding was “not surprising” and likely to reflect the challenges for the smaller banks in attracting new directors, but the issue should not be ignored.

There are no current limits on board tenures within the ADI prudential framework, but APRA has set a guidance in superannuation, where it has recommended the maximum board tenure should only exceed 12 years in limited circumstances.

APRA board member Margaret Cole, who steers the regulator’s policing of super, has signalled a preference for a 10-year maximum.

However, if the 12-year rule were applied, more than a quarter of mutual banks would be non-compliant.

“One of APRA’s main concerns about long tenures is the erosion of a person’s capacity to exercise independent judgement,” Mr Lonsdale said.

“Long-term directors can become entrenched, too closely aligned to management or past decisions, and less likely to challenge decisions.”

Under CPS 510, boards of APRA-regulated institutions are required to have a majority of independent directors at all times.

As such, APRA is pushing for changes across banks’ policies.

It has recommended mutual banks consider fixed-term tenures for directors and board renewal planning, as well as policies on board composition to ensure appropriate experience, skills and diversity; and independent performance reviews.

In the next 12 months, APRA supervisors will be engaging with mutual banks to push for the changes, which may include requests for independent third-party assessments of board composition, capability and renewal.

Boards expected to see red flags and adjust

In the past 16 years, 100 mutuals have merged or exited the industry in Australia.

APRA has reviewed the performance metrics of each of those mutual banks one year out from their exit and it has identified the top indicators of a potential future departure.

Around half (46 per cent) of the mutual banks that left their industry had been in the bottom 20 per cent of the cohort on loan growth.

Close to half (44 per cent) had been in the bottom 20 per cent of the cohort for return on equity and 42 per cent were ranked in the bottom 20 per cent of the mutual cohort on their cost-to-income ratio.

However, being in the bottom 20 per cent of any of the metrics didn’t necessarily mean a pending demise, but it “should signal a strong warning”, Mr Lonsdale said.

“Strong, effective boards should be attuned to these warning signs and make appropriate decisions if the circumstances warrant it,” he explained.

Mr Lonsdale also noted that many mutual boards “often lack the full breadth of capability and skills required”, with almost half of boards having either only one director or no directors with contemporary banking experience.

The lack of experience was more pronounced for regional and smaller mutuals.

“The composition of mutual boards is often a product of history,” Mr Lonsdale considered.

In a number of cases, customer-owned banks were bound by longstanding constitutional rules requiring a majority of directors to be from the customer cohort, or from a particular geographic area.

Other boards were dominated by members of a single industry group or a specific regional area, narrowing their capabilities and experience.

APRA has argued that boards should reconsider whether outdated provisions in their constitutions are holding back their ability to operate effectively.

“While experience in the industry of its customer base is useful, it is arguably less useful than experience in running a bank,” Mr Lonsdale said.

Boards should also review and adapt the skills and experience of their directors, and aim to address any gaps, he added.

But, APRA has seen boards relying on management to fill knowledge gaps instead.

“APRA recognises that it can be challenging for mutuals, especially smaller ADIs operating in regional areas, to attract directors with the right skill mix. The relatively low remuneration paid to directors in the sector adds to the difficulty,” Mr Lonsdale said.

“Some approaches that could help offset these challenges include the increased use of virtual board meetings and allocating more time to the board renewal process.

“Where a skills gap exists, mutual boards also have the option to engage external consultants. This is specifically permitted under CPS 510.”

Further, APRA has criticised performance assessments in the mutuals sector, stating boards have solely relied on self-assessment and peer review, which often does not result in the right outcomes.

There had also been cases where boards had engaged independent experts to review their performance, with Mr Lonsdale stating they had failed to implement the resulting recommendations.

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