Opening Statement - June 2009

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

My opening statement to the Committee today need not be a long one. This is not because the end of the global financial crisis is in sight. Few are willing to make that call. APRA-regulated financial institutions continue to face a testing environment but that environment has, since we last met, been less susceptible to the bouts of severe global financial turbulence we witnessed in the second half of 2008.

As a consequence, APRA’s supervisory priorities and its prudential policy agenda remain much the same as that outlined to the Committee in February.

Since that meeting, conditions in global credit markets have improved further as the range of financial policy actions taken by governments, including the Australian Government, gain traction. Spreads have reduced considerably, funding markets are re-opening to higher-rated borrowers and investor confidence in banking institutions has begun to revive. Nonetheless, sentiment remains fragile. Australian banks have raised over $80 billion of longer-term wholesale financing under the Australian Government’s guarantee arrangements. Encouragingly, some of our major banks have recently raised term wholesale funds, domestically and offshore, without recourse to the guarantee.

Global equity markets, which had plumbed new depths earlier this year, have also enjoyed an improving tone over recent months.

These positive market developments are seen as a reflection of signs that the global economy, which had been contracting sharply, might be stabilising. Over the December and March quarters of 2008/09, the declines in output in some of our major trading partners, particularly Japan and the United Kingdom, were dramatic. More recently, however, the Reserve Bank and others have commented that the global economy might have reached a turning point, in response to substantial economic policy stimuli.

The Australian economy has felt the chill winds from abroad. In contrast to global outcomes, however, the most recent data show that domestic economic activity expanded over the March quarter and Australia is expected to fare better than most other advanced countries. Nonetheless, with all the uncertainties around, and a global de-leveraging process still running its course, the environment for APRA-regulated financial institutions will continue to require very close and careful management on their part, and intense supervisory oversight on ours.

Let me emphasise that nothing in recent global and domestic developments has diminished APRA’s confidence in the fundamental strength of the Australian financial system.

In brief, our main priorities for our authorised deposit-taking institutions — banks, building societies and credit unions — remain credit quality and capital strength. Since last September, our larger banks have raised over $20 billion in equity, a strong vote of investor support. In the life insurance industry, we are continuing our focus on capital adequacy and its sensitivity to market volatility. The succession of adverse weather events is an important topic in our dealings with the general insurance industry.

In the superannuation industry, we have recently updated our prudential guidance on conflicts of interest, the use of reserves and the valuation of unlisted assets. We are continuing to review the financial position of defined benefit superannuation funds.

APRA’s prudential policy agenda continues to be shaped by the initiatives of the Financial Stability Forum (now the Financial Stability Board) and the G20 Action Plan. At their April meeting, these initiatives received strong endorsement by the Leaders of the G20 in their Declaration, Strengthening the Financial System. This Declaration confirmed the principles of strengthening transparency and accountability, enhancing sound regulation, promoting integrity in financial markets and reinforcing international cooperation.

Our involvement in global reform will intensify as a result of our recent invitation to join the Basel Committee on Banking Supervision, the global standard-setting body for banking regulation. This is a welcome development, ensuring that APRA now has a seat at each one of the major international fora for prudential regulation. The Basel Committee is developing enhancements to the Basel II Framework that would improve its coverage of risks, strengthen the quality and consistency of capital in banking systems and address the complex issue of procyclicality.

Last week, APRA delivered on a major reform initiative when it released a consultation package on remuneration for APRA-regulated institutions. These proposals give effect to the Financial Stability Forum’s tough new principles on pay and compensation, and respond to the Prime Minister’s request that APRA consider the linkages between remuneration practices and the capital adequacy requirements of regulated institutions.

As I had foreshadowed to this Committee, APRA’s proposals do not address the absolute level of remuneration — that was never our intention — but the need to align remuneration incentives with good stewardship of institutions.

APRA is taking a principles-based approach in this area. It is requiring Boards of regulated institutions to align their remuneration arrangements with the long-term financial soundness of the institution and its risk management framework. It is also proposing that regulated institutions have a Board Remuneration Committee, comprising only independent directors with the appropriate experience and expertise, to minimise any potential for conflicts of interest.

Subject to the consultation process, APRA intends to implement its proposals on remuneration through extensions to its existing governance standards and through a prudential practice guide. Within this framework, Boards would be able to design remuneration arrangements that suit the structure of their own institution. That is what ‘principles-based’ means. However, where these arrangements are likely to encourage excessive risk-taking, we in APRA will respond and that response can include the imposition of higher capital requirements as a buffer against risks.

My fellow Executive Member, Mr Trowbridge, has had carriage of the remuneration issue in APRA and would be happy to take the Committee questions on this issue. My colleagues and I are also ready to take any other questions the Committee may have.