Opening Statement - October 2009

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

For the first time since I have appeared before this Committee under its current Chair, the view is clearly firming that the worst of the global financial crisis is behind us.

In Australia, the most compelling support for this view was the decision of the Reserve Bank of Australia, two weeks ago, to begin gradually unwinding the very expansionary setting of monetary policy. That decision was taken against the background of a recovery in consumer and business confidence and of a domestic economy that has proven its resilience. Indeed, Australia is likely to be the only advanced economy to record positive growth over 2009.

Globally, economic conditions have begun to improve and the worrying pattern we have seen since the crisis began — of continued and at times sharp downgrades of global growth forecasts — is now giving way to upward revisions, particularly for 2010. The recovery is uneven, however, with growth in the advanced economics likely to be relatively weak but growth in our Asian trading partners more robust.

Reflecting these encouraging prospects and the return of investor confidence, conditions in global credit markets have improved significantly. Risk spreads are narrowing and, at the short end at least, have regained their 2007 levels. Securitisation markets are showing early signs of a thaw. Financial institutions in a number of jurisdictions are beginning to wean themselves off the various public support arrangements introduced during the traumatic events of September and October last year. Last month, for example, almost half of the total bonds issued by Australian banks were unguaranteed.

Global and domestic equity markets have also rebounded from their depths earlier this year.

This is a positive report card. And there is an important contributing factor in Australia’s case that needs acknowledgment. Throughout the global financial crisis, the Australian banking system has been able to support economic growth and it has not acted, as in many other countries, as a dragging anchor.

For all that, we in APRA are not ready to scale back the level of our supervisory intensity. The operating environment for APRA-regulated institutions is still clouded by uncertainties. As the Reserve Bank has noted, downside risks to the domestic economy, though they have diminished significantly over recent months, cannot be ruled out. The global recovery is not yet firmly established and the balance sheets of many major global financial institutions are still burdened by poor quality assets. Unexpected set-backs could, again, jolt market sentiment.

If these uncertainties pass and the operating environment continues to improve over coming months, APRA-regulated institutions will face another challenge. In the words of the G20 Leaders’ Statement in Pittsburgh last month: ‘A sense of normalcy should not lead to complacency.’

APRA’s supervisory attention is still most sharply focussed on our authorised deposit-taking institutions (ADIs) — banks, building societies and credit unions. Credit quality problems have broadened in Australia’s economic downturn but asset quality remains solid overall. Mortgage lending portfolios in particular continue to show their soundness, with non-performing loan ratios at around one-quarter of the comparable ratio for UK banks and one-tenth that for US banks. The quality of mortgage lending portfolios would, of course, be tested if unemployment were to rise significantly from current levels. That prospect is looking much less likely but the issue remains on our radar. In general, the ADI industry continues to be profitable and well capitalised, and the larger institutions have enjoyed strong investor support.

The other industries we supervise have been less affected by recent cyclical developments. Obviously, the life insurance and superannuation industries have received a fillip from the rebound in global and domestic equity markets. The financial position of the general insurance industry remains sound overall, despite a series of severe weather-related events.

The global reform process continues apace. When we met in June, I mentioned that APRA had been invited to join the Basel Committee on Banking Supervision, the global standard-setting body for banking regulation. I have now attended my first two Basel Committee meetings and I can certainly attest to the considerable volume of work under way in the Committee and its numerous working groups to strengthen regulation, supervision and risk management in banking systems. Early fruits from that work have been a toughening of the Basel II capital requirements for securitisation and trading book activities, announced in July. The Basel Committee is now finalising a broader package of measures aimed at raising the quality, consistency and transparency of capital in banking systems, discouraging excessive leverage and introducing a framework for countercyclical capital buffers.

The Basel Committee will issue concrete proposals on this broader reform package by the end of this year and will carry out an impact assessment in the first half of next year. APRA is participating fully in this reform process.

In addition to this work on capital, APRA has taken significant steps in two other major reform initiatives since we last met.

In September, APRA released a consultation package on its proposed enhancements to the prudential framework for ADI liquidity risk management. A major lesson from the global financial crisis was that a number of global banking institutions did not accurately identify and appropriately manage their potential liquidity risks. The Basel Committee has been promoting the development of stronger liquidity buffers in the global financial system and it has issued revised principles for sound liquidity risk management. APRA’s proposals translate these principles into our prudential framework. Our aim is to strengthen the stress-testing of ADIs’ risk management systems and improve our reporting framework. Our intention is to finalise the proposals in the first half of 2010, subject to industry feedback and international supervisory developments.

Also in September, APRA released a second consultation package on remuneration for ADIs and general and life insurance companies. We have been consulting widely, including through two well-attended industry seminars, since we released our first consultation package in May and we have been reviewing the large number of submissions we received on that package. For the most part, the submissions have supported APRA’s proposed principles-based approach to encourage alignment of remuneration practices with prudent risk-taking. The second consultation package maintains that approach but involves amendments to details and drafting to ensure that our proposals are better understood.

APRA’s proposals on remuneration will be implemented through extensions to its existing governance standards and through a prudential practice guide. These are expected to be effective from 1 April 2010. In finalising its proposals, APRA will be taking into account the Financial Stability Board’s recently released Implementation Standards, aimed at strengthening adherence to its Principles for Sound Compensation Practices issued in April 2009.

Finally, I would like to draw to the Committee’s attention that in September APRA published the results of its first stakeholder survey. This survey, which was foreshadowed in APRA’s Service Charter, was undertaken by an independent survey research company to assist our understanding of the impact of our prudential framework and the effectiveness of our supervision. According to the company, the overall survey results were a strong endorsement of our framework and approach.

On that positive note, we are now happy to take the Committee’s questions.