The prudential regulator has described the risk and compliance functions of the nation’s largest financial institutions as in need of urgent overhaul, as it completes a deep dive of the systems that permitted banks to break money laundering laws millions of times and wrongly charge customers billions in fees.
Early findings from the Australian Prudential Regulation Authority’s onsite reviews of the banks’ governance, culture, risk and accountability frameworks were disappointing, said chairman Wayne Byres, and institutions found wanting could expect significant penalties.
“It’s pretty clear that an upgrade in compliance functions across the industry is needed,” Mr Byres said.
APRA’s onsite inspections are part of a strategy to strengthen and sharpen governance, culture, remuneration and accountability frameworks across the industry following widespread opinion that it needed to take a tougher line.
As the prudential regulator expands its inspections beyond the big four banks, smaller institutions are on notice that no quarter will be given when it comes to ensuring their systems are up to scratch.
“What we’ve done is set a very clear signal, and banks should expect if they have similar issues they should expect a similar response,” Mr Byres said.
APRA hit both Commonwealth Bank of Australia and Westpac with billion-dollar capital penalties in the wake of systemic failures that allowed criminals, including drug traffickers, terrorists and paedophiles, to make transactions virtually unmonitored.
Rival banks ANZ and National Australia Bank were forced to put aside an extra half a billion dollars each after conducting their own self-assessments of governance, accountability and culture in July 2018.
Reflecting on the $500 million penalty given to Westpac by APRA in July following its self-assessment and the additional $500 million handed down in December after the AUSTRAC matter emerged, Mr Byres said the right decisions were made at the time.
“We have increased it because we have new information that came to light and now we will investigate that further, as we have already announced, and see what further action is needed there.”
In addition to capital penalties, the regulator may impose licence conditions, issue infringement notices and disqualify individuals depending on the infringement. APRA says it is important the punishment fits the crime, but notes that capital penalties are an important deterrent.
“It depends on the nature of the issues you are grappling with and if there are other tools that are better placed to deal with an issue,” Mr Byres said. “In this case we thought that was the right thing to do. We wouldn’t want to rule anything out or in.”
The smallest capital penalty handed out under the new regime was a $250 million impost dished out to insurer Allianz in August last year after it was ordered to “strengthen risk management and close gaps identified in its self-assessment”.
“There is inevitably an element of judgment involved,” Mr Byres said. “You could spend a lot of time arguing whether it should be $500 million, $480 million or whether they should all be calculated more precisely, but I don’t think that really is the point.
“The point is that those quantums are sufficiently large enough to incentivise the banks to fix the problem.”
“They all have similar problems. We wanted to apply capital add-ons that gave them very clear incentives that said: ‘You have serious work to do here and we want to make sure you get on and get it done as quickly as possible’”.
Prudential standard sharpened
Behind the scenes, APRA is revising the Cross prudential standard that polices the risk management function, known as CPS 220, at banks, super funds and insurers.
APRA believes CPS 220 needs more teeth, and will begin testing the waters with a much sharper set of guidelines later in 2020.
“That standard at present has some pretty high level and fairly weak requirements, to be honest, in relation to compliance functions. There are only a couple of paragraphs about what institutions need to have by way of an effective compliance function,” Mr Byres said.
“There is a lot of scope for us to reinforce that and be clearer about the importance of having a stronger audit and compliance function. It’s essential really. It’s not just about consumer outcomes, but also our core prudential outcomes to make sure organisations stay financially sound.”
As APRA pushes ahead with its package of reforms aimed at lifting governance, culture, risk and accountability standards to a world-leading standard, chief risk officers and compliance executives can expect another testing year in 2020.
“Yes, but probably no busier than they were in 2019. I think they have all been very busy last year and I don’t think they will have any respite from that,” Mr Byres warned.
APRA last November published an information paper which spelled out its plans to transform its approach to governance, culture, remuneration and accountability.
It listed the observation of board meetings in a table of international leading practices, an inclusion which sparked fierce debate about whether such an intrusion was appropriate and attracted criticism from Treasurer Josh Frydenberg.
Mr Byres appeared perplexed at the furore, which he described as a storm in a tea cup.
“I was surprised that of all the things we said we would do in a 35-page paper, the only thing that seemed to get picked up was a reference to something that we said we didn’t have a plan to do. So the idea that we retreated from a plan is a bit odd.”
Court threat remains
Any suggestion the regulator would retreat from the opportunity to take repeat offenders to court is also given short shrift, after it attracted criticism for failing to appeal in its unsuccessful bid to have five directors and executives from the wealth manager IOOF banned from working in the superannuation industry.
Mr Byres said the threat of court action was as much of a deterrent as court action itself. If the regulator only took on open-and-shut-cases, he said, then the strategy would not be effective.
“You have to take legal advice about the merits of any appeal of a court judgment,” Mr Byres said.
“We are looking closely at that judgment and learning what we can from that [to] maximise our chances of success when we take on a similar sort of case in the future.”
“The only other thing I’d add is that there has been considerable change at IOOF since we originally launched the court action and so many of the issues that we were concerned about either have been or are being addressed and so now, there is less merit in pursuing that case.”
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