The prudential regulator is in the final stages of testing a more dynamic replacement for its secret probability of failure and supervision ratings. The legacy system – which in 2018 placed IOOF one step away from forced restructure – has been operating for 15 years.
The new analytical system for triggering financial institution restructurings has been dubbed the Supervisory Risk and Intensity model (SRI). It will replace the dual rating system known as the Probability and Impact Rating System (PAIRS) and the Supervisory Oversight and Response System (SOARS) by mid-year.
The decision to junk the old system followed criticism from the International Monetary Fund and the regulator’s capability review led by Graeme Samuel. They found that the frameworks put in place following the collapse of HIH Insurance in 2001 were no longer suitable for its mandate.
Under the new system, institutions will be divided into four tiers according to size and then five stages of supervision according to their risk rating.
Tier one entities are defined as being the largest, most complex entities that are the most deeply intertwined with the financial system. The Australian Prudential Regulation Authority says the failure of a tier one entity “would risk contagion and other material market impacts.”
APRA says tier one and tier two entities will be subject to the broadest and deepest risk assessments, while those institutions classified as tier four will be subject to a simpler form of assessment.
In line with the regulator’s stated priorities for 2020, financial institutions will be scrutinised against a number of new risk categories including cyber risk, GCRA and member outcomes in superannuation.
“The outcome of the SRI risk scoring will place each entity into a five-stage system of supervisory intensity. Stage 1 equates to what could be described as ‘routine’ supervision and ramps-up as needed in line with APRA’s revised ‘constructively tough’ enforcement approach,” APRA said.
Rankings will be known only by APRA and the institutions themselves.
Earlier this week, APRA chairman Wayne Byres told The Australian Financial Review that early findings from its sector wide review of bank risk systems were disappointing and those who came up short could expect to be penalised.
The SOARS rating of IOOF was accidentally revealed during the Hayne royal commission during one of its frequent evidence dumps. The documents added context to APRA’s bid to have IOOF’s five directors and executives banned from the superannuation industry launch in late 2018.
The cache of documents revealed the regulator’s frustration with IOOF peaked when it downgraded the company’s SOARS rating from “oversight” to “mandated improvement” leaving the company one step away from “restructure”.
APRA’s bid to disqualify the executives cost the regulator a little over $2 million and ultimately failed. But it has chosen not to appeal the decision, saying it is happy with the change it has seen in the organisation.
The authors of APRA’s capability review published in July 2019 provided detailed instructions on how to improve the framework which included discontinuing the use of PAIRS by the end of calendar 2019. The regulator is on track to roll out the final version of SRI by the end of January.
Banks have been told the impact of the new system could produce a range of outcomes from no change, to more supervision or less supervision.
“It is also expected that the new model will be more responsive to changing risks, and therefore entities may find their ratings shift more frequently than in the past,” the regulator said.
APRA says financial institutions will also have a much clearer idea about how to reduce an institution’s risk rating and see a corresponding reduction in the supervision level.
The opacity of the old system was also criticised by former APRA researcher Wilson Sy in a research paper published in 2019 titled The Farce of Fake Regulation.
Dr Sy questioned the use of the system in light of the money laundering failures at CBA, saying the issues should have been recorded in the PARIS and SOARS databases. He asked if APRA’s supervisors were asleep and called the regulator out for its lack of expertise and for operating in silos.