Opening Statement - 25 February 2009

John Laker, Chairman - Senate Standing Committee on Economics, Canberra

I would like to begin, as has now become the custom, by providing the Committee a brief update on the global financial crisis and its implications for the work and priorities of APRA. We last met in late October in the shadow of a period of unprecedented global financial turbulence, triggered by the failure of Lehmans and the public rescue of other major financial institutions. The toll this turbulence took on consumer and business sentiment around the globe is now becoming apparent. December quarter GDP data in many countries make grim reading, showing that the major industrial economies and other economies critical to Australian exports experienced their sharpest declines or slowdowns in many years.

We last met in late October in the shadow of a period of unprecedented global financial turbulence, triggered by the failure of Lehmans and the public rescue of other major financial institutions.  The toll this turbulence took on consumer and business sentiment around the globe is now becoming apparent. December quarter GDP data in many countries make grim reading, showing that the major industrial economies and other economies critical to Australian exports experienced their sharpest declines or slowdowns in many years.

Inevitably, the global financial crisis has spilled over to the Australian economy. Economic activity is clearly slowing.  This will put pressure on the asset quality, profitability and capital of APRA-regulated financial institutions that had, until recently, been buoyed by Australia’s long run of strong economic growth.  That said, the Australian economy is not slowing at the pace of other economies and a substantial macroeconomic stimulus will be kicking-in over the year.

Though the environment has become more difficult, APRA remains confident that the fundamental strength of the Australian financial system will continue to assert itself.

And it is not all gloom!  Global credit markets are beginning to thaw in response to the range of supportive measures taken by governments, including the Australian Government, over the past six months.  Australian banks have raised over $60 billion of longer-term wholesale financing since the Australian Government’s guarantee of wholesale funding came into effect at the start of December.  This funding is expensive though, with spreads still well above pre-crisis levels.  Retail deposits have continued to grow strongly, underpinned by the introduction of the Government guarantee.

The improving tone of global credit markets is in stark contrast to that of global equity markets, where uncertainty about the solvency of major U.S. financial institutions is, as we speak, casting a heavy pall over investor confidence.

In the face of weaker economic conditions in Australia, APRA’s key focus over 2009 will be on the core strength of our supervised financial institutions — that is, on their capital.  Having weathered choppy financial seas for over 18 months, our institutions are now beating into headwinds from the real economy.  Nonetheless, provided they remain close-hauled —in APRA’s terms, prudently managed and well-capitalised — there is no reason why our institutions cannot continue to make good headway.

For our authorised deposit-taking institutions — banks, building societies and credit unions — our main priorities in 2009 are credit quality and capital strength; our earlier concerns about liquidity and funding have eased somewhat.  The level of problem loans has been rising (though from a low base) and is broadening beyond the high-profile names that have dominated the data.  We are monitoring a range of indicators of credit quality, including institutions’ own ‘watchlists’, with a particular focus on commercial property exposures.  We are also reviewing capital management plans and potential access to capital, which has become a very scarce commodity in banking systems globally.  The success of recent capital raisings by our larger banks is testament to the strong standing of the Australian banking system.

The substantial deterioration in global and domestic equity markets continues to impact on the life insurance and superannuation industries.  We have established a team to closely monitor life insurance capital and we have recently asked insurers to carry out additional detailed stress tests to ensure that the consequences of any further market deterioration are well understood and appropriate contingency plans put in place.  Since the global financial crisis began, life insurers have taken a number of steps to fortify their businesses and reduce their exposure to falling asset values, and the industry remains in a generally sound position.

Our supervision of the superannuation industry through the crisis has focussed on trustee processes rather than investment outcomes, for which APRA has no direct responsibility.  We have been closely monitoring the governance and risk management practices of trustees in areas such as liquidity management, the valuation of assets and outsourcing of service provision.  We are also reviewing the financial position of defined benefit superannuation funds.  

In the general insurance industry, which is not as exposed to the effects of the global financial crisis as our other industries, we are working closely with insurers to understand the impact of the tragic Victorian bushfires and the North Queensland floods.  Although these are material events, general insurers factor the occurrence of catastrophic events into their capital management and reinsurance arrangements.  APRA also requires general insurers to hold capital and have suitable reinsurance arrangements to protect against the impact of a concentration of claims related to a single event.  As a result, APRA does not expect the solvency of general insurers to be significantly affected by claims related to the bushfires or the floods.

On the prudential policy front, the initiatives of the Financial Stability Forum and the G20 to address weaknesses in the global regulatory framework are gathering momentum, ahead of the next G20 meeting in early April.  APRA is a participant in two working groups set up under the G20 Action Plan, one dealing with provisioning against problem loans and the other with executive remuneration.

The work for the G20 Action Plan will obviously have an important bearing on APRA’s approach to executive remuneration in our regulated institutions, which we outlined last December.  APRA is developing a principles-based framework that is focussed on the structure of executive remuneration and the incentives, explicit or otherwise, built in to act against excessive risk-taking.  The proposed framework will be an extension of the governance, risk management and capital requirements to which our regulated institutions are already subject, and would be monitored through the supervisory review processes that APRA staff undertake regularly with individual institutions.

APRA is planning to issue a discussion paper on principles for executive remuneration in the second quarter of 2009 and, subject to consultation, a final set of principles and guidance in the second half of the year.

Though not a member of the Basel Committee on Banking Supervision, APRA is also involved in various ways in the Committee’s efforts to improve risk management standards and capital requirements in the global banking system.  APRA participated in the development of the Basel Committee’s revised set of principles for sound liquidity risk management, which are shaping the overhaul of APRA’s prudential framework in this area.  The Basel Committee has recently released a set of proposals for enhancing the Basel II Framework, which will also shape any refinements to APRA’s capital adequacy requirements for deposit-taking institutions.

My colleagues and I are now happy to take the Committee’s questions.