From APRA:
The 2008 financial crisis revealed major shortcomings in the way the global financial sector managed risk. This was not solely an issue of poor risk measurement, or weaknesses in internal control structures. It also reflected deficiencies in institutions’ attitudes towards risk. In combination, a poor risk culture and weak risk management (the former often being the root cause of the latter) led to unbalanced and ill-considered risk-taking, to significant losses and, in some cases, to institutional failures. The impact on the financial stability of affected countries was significant.
Although APRA-regulated institutions avoided the worst of the financial crisis, Australia has not been without its own examples of poor risk culture. The failure of HIH Insurance in 2001, for example, highlighted the central role that a weak organisational culture, and a dismissive attitude to risk management, had in the demise of the insurer. Similarly, foreign currency trading losses at a major bank in 2004 identified the link between the risk culture of its trading area and the scant regard given by the business to the underlying risk and management risk limits.
More recently, APRA highlighted the emergence of increased risk-taking within the life insurance industry with respect to the underwriting and pricing of, in particular, group insurance business. At its heart, this stemmed from a focus on growth without, in a number of institutions, adequate regard to the risks that came with it. Similarly, in the past few years, APRA observed that sound market practices for the origination of residential mortgage loans had, in some instances, been sacrificed to considerations of preserving market share and growth.
Unlike the earlier episodes highlighted above, which affected individual institutions, the more recent issues in group risk insurance and mortgage lending have manifested in a deterioration in general industry practices. There is nothing wrong with an institution or an industry pursuing a higher risk strategy, provided it does so consciously, and with appropriate risk management capabilities and financial capacity. In some of these cases, though, hindsight and supervisory scrutiny would suggest that the decision was not a conscious one: considerations of risk were not always front of mind in a highly competitive environment.
It is also interesting to juxtapose these recent experiences with the assertion made by most institutions that they believe they have a good, if not strong, risk culture; to the extent there are deficiencies in the industry, most institutions consider they exist within their peers. And where there have been specific problems identified within their own businesses, ‘bad apples’ are typically seen as the cause. Yet in the case of mortgage lending standards, for example, there were few lenders who could claim their risk culture was sufficient to prevent them succumbing to the weak practices that eroded industry standards.
Unfortunately, a poor risk culture can persist for some time without detection, or immediate damage. Typically, it will be when a poor risk culture is combined with adverse market conditions and/or other stresses that there is greater potential for a build-up of unbalanced and ill-considered decisions to result in significantly adverse, and potentially crippling, financial outcomes. Good times will often mask poor practices. In an Australian context, where the domestic economy has enjoyed 25 years without a serious recession, this should sound a clear note of caution against complacency.
As well as setting out global developments in risk culture, APRA highlighted the following key areas of focus.
Continue to encourage APRA-regulated institutions to focus on risk culture
APRA’s initiatives that will help maintain the prominence of risk culture within regulated institutions include:
- engaging with the broader APRA-regulated financial sector – through, for example, speeches and publications such as this one – to reinforce the need for continued focus on risk culture and, where needed, highlighting any areas of concern;
- providing information and guidance to industry, where appropriate, on approaches that can be used to assess and strengthen risk cultures;
- bilateral discussions with institutions’ senior executives and directors to highlight and seek remediation for any specific concerns that are identified through routine supervision activities; and
- conducting pilot on-site reviews at individual institutions focussing specifically on risk culture.
A more anticipatory supervisory approach to risk culture
Although APRA already considers risk culture as part of its ongoing supervisory activities, APRA intends to refine and sharpen its approach to assessing risk culture. Conducting pilot risk culture reviews will form a key component of this work.
APRA expects that this more intensive review will enable it to better anticipate potential risk issues, and strengthen its forward-looking supervisory approach. For example, where a regulated institution is found to have indicators of a poor risk culture, supervisory attention will correspondingly increase. As with APRA’s more general approach to supervision, which focusses on the prevention of problems before they materialise, the goal of these risk culture reviews will be to promote prompt corrective action to any shortcomings identified, or establish mitigating actions. In doing so, the potential for loss from unbalanced and ill-considered risk decisions is reduced, potentially adverse outcomes for depositors, policyholders and superannuation fund members can be avoided, and (in the extreme case) threats to financial stability are eliminated.
Reviewing industry remuneration practices
The remuneration requirements contained in CPS 510 were introduced in 2010 for ADIs and insurers. Requirements for superannuation were introduced in Prudential Standard SPS 510 Governance22 in 2012. The fundamental principle underlying these requirements is that performance-based components of remuneration must be designed to encourage behaviour that supports:
- the regulated institution’s long-term financial soundness; and
- the risk management framework of the institution.
Remuneration frameworks, and the outcomes they produce, are therefore important barometers and influencers of risk culture.
APRA intends to conduct a stocktake of current industry remuneration practices to gauge how well existing requirements are being implemented, and how they are interacting with the risk cultures of regulated institutions. This will include reviewing the remuneration arrangements and outcomes for some senior executives, risk and control staff, and material risk-takers at a sample of institutions.
APRA will also use this opportunity to compare its remuneration requirements with more recent international regulatory developments and supervisory practices.
This work will commence in 2016 and will continue into 2017. APRA will engage with industry participants, as well as relevant industry experts, throughout this period as it formulates its views.
So, we now have seven clowns working at cross-purposes:
- a New York court investigating BBSW rorting;
- same at ASIC;
- Parlimentary hearing into banking whatever;
- Ombudsman Small Business Loans Inquiry;
- an industry inquiry into banking remuneration;
- a new industry funded victims tribunal, and now
- APRA investigating “risk culture”.
We also have the real estate treasurer subverting the rule of the law by convicting banks in advance of any day in court (even though they’re innocent according to the same government) and ASIC powers beefed up seemingly daily even though it was the very regulator that failed to prevent any of the malfeasance in the first place (and even though they’re innocent according to the same government).
For that matter, we don’t even know what that malfeasance is yet, nor has the landscape of values, social contracts, financial architecture, profitability, behavioural drivers, culture, rules nor reform ( I could go on) been mapped out by a singular and co-ordinated inquiry.
Seven ridiculous and uncoordinated inquiries running at once all to avoid the one we should have, a royal commission.
