APRA was the subject of criticism and adverse commentary throughout the Royal Commission into Banking, Superannuation and Financial Services and in the Commission’s Report.
It has been taking a more proactive approach this year and we take an opportunity to examine what initiatives APRA is taking.
1. APRA’s Remit
Ever since the Royal Commission into banking we have found a marked uptick in use of the word ‘remit’; it’s on the tip of everyone’s tongue. At this rate the word ‘remit’ will be odds on favourite to win the award in 2019 for the most used word in the finance industry!
APRA’s remit is highly relevant when discussing its approach to enforcement approach in relation to financial instructions for which it has regulatory responsibility. Unlike ASIC and the ACCC, APRA has a broader range of responsibilities. On its website APRA notes that:
Under the legislation that APRA administers, APRA is tasked with protecting the interests of depositors, policyholders and superannuation fund members.
APRA promotes financial system stability.
APRA also acts as a national statistical agency for the financial sector, collecting data both for its own uses and on behalf of the Reserve Bank of Australia and the Australian Bureau of Statistics.
APRA’s purpose and functions are described in sections 8 and 9 of the Australian Prudential Regulation Authority Act 1998 (Cth).
In any discussion about APRA’s its enforcement role, it’s remit must be borne in mind – adopt a too aggressive enforcement approach and that might jeopardise the function of ‘promoting financial system stability’!
2. APRA releases new Enforcement Approach
On 16 April 2019, APRA released its Enforcement Approach, to provide guidance regarding when it will utilise enforcement action in relation to prudential risks. Its enforcement objective is stated to be:
APRA will use enforcement where appropriate to prevent and address serious prudential risks and to hold entities and individuals to account. As a preventative, safety-based regulator, APRA may do this well before the risks (including financial, operational and behavioural risks) present an imminent threat to financial viability. APRA will use enforcement action to achieve its mandate of protecting the interests of depositors, policyholders and superannuation fund members and to deter unacceptable practices from occurring in the future – this includes taking public enforcement action for wider deterrence purposes.
The Enforcement Approach outlines criteria which may lead APRA to consider enforcement action. Criteria include where prudential risks are not being adequately addressed; concerns about the way the business is being conducted, and situations where the business is not dealing with APRA. Other important considerations to be taken into account include proportionality, history and behaviour as well as any relevant action being taken by other agencies.
The new enforcement approach essentially implements the recommendations of the Enforcement Strategy Review Final Report (“the Review”) which was released by APRA late in 2018, the conduct of the review being largely in response to the Government’s introduction of the Banking Executive Accountability Regime (BEAR), which gave APRA new and stronger powers regarding banks, their directors and senior executives.
3. APRA Issues Directions to IOOF
As an indication of APRAs more proactive enforcement approach, AFRA, in its 22 May 2019 press release, announced that it has utilised its new, broader directions powers under the Superannuation Industry (Supervision) Act 1993 (“SIS Act”) to issue directions to IOOF group companies.
Directions have now been issued by AFRA to IOOF and Australian Executor Trustees Limited to comply with a dedicated business function condition by 30 June 2019, which was determined by an independent reviewer not to have been complied with by a deadline of 31 March 2019.
The issue of directions to IOOF is in addition to the disqualification proceedings commenced APRA in the Federal Court of Australia in December 2018 against certain directors and executives of IOOF.
4. APRA Proposes Amending Guidance on Mortgage Lending
On Tuesday, 21 May 2019 the Australian Prudential Regulatory Authority (APRA) issued a media release announcing that it had begun consulting on possible revisions to its guidance on how authorised deposit taking institutions should assess residential mortgage loan applications.
This is an important development and will have a direct effect on the ability of Banks’ to lend to customers.
Currently ADIs are required to assess the capacity of borrowers to afford their repayment obligations using a minimum interest rate of at least 7%.
The proposal is that the 7% minimum be replaced by an interest rate buffer of 2.5% over and above current rates.
APRA will consult on this issue until 18 June 2019 and then release a final version of updated Australian Prudential Guidance (APG) 223 shortly thereafter.
These proposed changes will be welcomed by authorised deposit taking institutions as well as their customers.
5. APRA proposes to Update its Prudential Standard on Credit Risk Management Requirements for ADIs.
On 5 March 2019 APRA announced it had issued a paper on proposed changes to prudential standard APS220 on credit quality to recognise there has been significant changes in credit risk practices of ADIs since the APS standard was last substantially updated in 2006.
The discussion paper issued notes ASIC’s proposals in the following areas:
- Credit risk management
- Credit standards
- ASIC classification and provisioning
A copy of the discussion paper and draft prudential standard APS220 (credit risk management) can be viewed here.
6. APRA Outlines its Expectations of ADIs in Relation to Exposures to Third Party Lenders including Peer to Peer Lenders
In another development, on 25 March 2019 APRA wrote to deposit-taking institutions expressing concerns about the growing number of ADIs entering into funding arrangements with third party lenders, including with peer-to-peer (P2P) lenders without having regard to credit risk implications.
APRA’s concern with these types of arrangements is that they potentially give rise to higher credit risks for ADIs. APRA notes that many ADIs do not appear to have undertaken their own credit assessment on loans written by third-party lenders, which gives rise to a disparity between the credit risk associated with ‘on book’ and ‘off book’ loans.
ADIs are expected to ensure that they have adequate approval processes in place for such arrangements which should include mechanisms to properly identify and manage risks associated with such arrangements.
ADIs, before entering into such arrangements third party lenders, must:
I. have an approved strategy for P2P lending arrangements that is within Board-approved risk appetite settings and setting out appropriate controls and review trigger events;
II. perform due diligence on the proposed exposures which would include:
- a comprehensive assessment to understand the risk characteristics of the prospective and actual exposures;
- timely access to performance information on the exposures; and
- a comprehensive understanding of all structural features of the transaction.
The letter also makes it clear that:
- ADIs must consult with APRA before entering into such arrangements;
- any funding arrangements need to require that the third-party funder seek and obtain APRAs prior consent before changing underwriting standards;
- ADIs need to classify these exposures as “loan exposures” in terms of ARF 320.0 rather than as “investment securities”; and
- there must be adequate provisioning for P2P exposures.
7. APRA Demands Life Insurers Improve Sustainability of Income Protection Policies
In a letter to life insurers dated 2 May 2019, APRA has demanded that life insurers improve the sustainability of their product offering in relation to individual disability income insurance. This does not include group cover.
Disability insurance is more often known as income protection insurance.
A review was conducted of the eight largest providers of individual income protection insurance and found shortcomings in strategies, risk assessment, governance, pricing and product design on the part of insurers.
What APRA is basically saying is that life insurers have focused too much on attracting policy holders through pricing and product features and have not had sufficient focus on ongoing sustainable profitability.
8. New ADI Licenses
APRA has been busy in the last six months issuing new banking and ADI licenses. Under the Banking Act 1959 (Cth) technically APRA ‘authorises’ rather than ‘licenses’ an organisation to carry on banking business in Australia under subsection 9(3) of the Banking Act. We note:
- Xinja Bank Limited was granted a ‘restricted authority‘ to to carry on banking business in Australia on 17 December 2018;
- China Everbright Bank Co., Ltd was granted a ‘restricted’ authority to operate as a foreign ADI on 20 December 2018;
- Volt Bank Limited was granted an ‘unrestricted’ authority to operate as an ADI on 21 January 2019 (previously it held a restricted authority);
- Lutheran Laypeople’s League of Australia was granted an ‘unrestricted’ authority to to carry on banking business in Australia on 1 February 2019
- Judo Bank Pty Ltd was granted an ‘unrestricted’ authority to to carry on banking business in Australia on 24 April 2019
- Societe Generale was granted a ‘restricted’ authority to operate as a foreign ADI commencing on 16 May 2019
9. Restricted ADI Authorisations
The difficult path that has to be trodden by applicants for new banking licenses was made easier for aspirational organisations when APRA released its Information Paper on the Restricted ADI Framework in May 2018.
Volt Bank took this route initially, as has Xinja Bank. Eleven conditions were imposed on the grant of authority to Xinja Bank. We extract four of the more important conditions below. During the ‘restricted period’ Xinja Bank agreed that it will:
- only accept deposits where:
(a) the aggregate balance of all protected accounts held with the ADI does not exceed $2 million; and
(b) the aggregate balance of all protected accounts held by each account-holder with the ADI (calculated using a single customer view) does not exceed $250,000; - maintain, at all times, Common Equity Tier 1 Capital equal to the greater of:
(a) $3 million plus the resolution reserve, which is $1 million unless otherwise determined by APRA; or
(b) 20 per cent of adjusted assets of the ADI; - hold, at all times, liquid assets equal to the greater of:
(a) 20 per cent of total liabilities; or
(b) the aggregate balance of all protected accounts held with the ADI plus an amount equal to the resolution reserve; - limit the value of assets held on its balance sheet to $100 million, unless otherwise approved in writing by APRA;
While the restricted authorisation route contains significant limits on what a restricted ADI is able to do, at least it provides a transitional pathway to a full banking license and is a pathway being used. This has been a positive development.
10. APRA Begins Consultation on Financial Sector (Shareholdings) Rules 2019
With the possibility of new banking licenses being issued, it is understandable that the shareholding rules be reviewed.
On 2 April 2019, APRA released the proposed Financial Sector (Shareholdings) Rules 2019 (Draft) (‘the Draft Rules’), made under subsection 45A(1) of the Financial Sector (Shareholdings) Act 1998 (‘the FS Act’), and provided for an eight week consultation period.
The Draft Rules prescribe matters to be considered when determining whether a person is a fit and proper for the purposes of the FS Act as well as other matters.
Rule 7 of the Draft Rules outline the following considerations for determining whether an applicant is fit and proper for the purpose of the Act:
(a) the honesty, integrity and reputation of the person;
(b) the competence and capability of the person, regarding the degree of control or influence they have over the company;
(c) the financial soundness of the person;
(d) whether there are any conflicts of interest that is likely to give rise to a material risk;
(e) whether there are reasonable grounds for suspecting the person has committed, or may commit a financial crime;
(f) the ability and willingness to comply with prudential requirements and APRA’s ability to supervise the company;
(g) whether persons who direct the company are also fit and proper persons;
(h) the potential to be Influenced by other persons, such as a business partner or family member, who are not fit and proper persons to hold a stake of more than 20% in the company.
Draft rules 8-11 also revise the definition of ‘total resident assets’.
Additionally, the Treasury Laws Amendment (Financial Sector Regulation) Act 2018 introduces a new approval path into the FS Act allowing applicants to hold a 20% (up from 15%) or more stake in a new or recently established ADI, where assets are below the relevant threshold.
11. Conclusion
These are challenging times for APRA.
Will APRA get the balance right? Too tough and there is a risk of jeopardising the stability of the financial system – too lenient and financial intuitions will not be held accountable.
Perhaps the solution to getting the balance right lies in implementing Recommendation 6.14 of the Royal Commission.
Recommendation 6.14 – A new oversight authority
A new oversight authority for APRA and ASIC, independent of Government, should be established by legislation to assess the effectiveness of each regulator in discharging its functions and meeting its statutory objects.
The authority should be comprised of three part-time members and staffed by a permanent secretariat.
It should be required to report to the Minister in respect of each regulator at least biennially
Time will tell.
