Australian Prudential Regulation Authority

Chapter 4 - APRA's supervisory capabilities
The second pillar of the G-20's reform agenda is effective supervision. The global financial crisis highlighted the importance of looking beyond regulatory frameworks to how effectively they were applied. Financial systems tended to fare better in countries where supervisors maintained active programs of prudential oversight, built on continuous engagement with financial institutions, comprehensive on-site reviews, extensive analysis of financial data and prompt but balanced intervention, where necessary, to address emerging risks. Australia is one such example.
The quality of supervision has now become a key focus of global policymakers, including the International Monetary Fund (IMF) and the Financial Stability Board (FSB). In November 2010, ahead of the Seoul Summit of the G-20 Leaders, the FSB set out a series of recommendations for making the supervision of financial institutions more intense, effective and reliable. The recommendations, which built on the themes of an IMF paper issued in May 2010, were primarily aimed at making systemically important financial institutions less susceptible to failure, but the FSB also saw implications for the supervision of financial institutions more generally. In endorsing those recommendations, the G-20 Leaders agreed 'that supervisors should have strong and unambiguous mandates, sufficient independence to act, appropriate resources, and a full suite of tools and powers to proactively identify and address risks, including regular stress testing and early intervention'.
APRA contributed to the IMF paper and the FSB report and APRA's risk-based approach to supervision, tested before and during the crisis, broadly satisfies the FSB's recommendations. APRA's active and interventionist style also meets the IMF's strong argument that supervisors must have both the ability and the willingness to redress instances of excessive risk-taking by financial institutions.
Supervisory approaches are not set in stone. They need to evolve in the face of changing economic and market circumstances and the emergence of new risks. There are also lessons to absorb from the crisis. APRA therefore pursues continuous improvement in its supervisory approach and the recent reports of the IMF and FSB will serve as benchmarks for that effort.
APRA's supervisory approach
Risk-based supervision is not 'rocket science' and nor is it infallible. It is simply a structured and methodical process designed to identify and assess those areas of greatest risk to a regulated institution (or to the financial system as a whole) and then direct supervisory resources and attention to those risks. Under this approach, more supervisory resources are devoted to those regulated institutions that have higher risk profiles or identified risk management weaknesses, or that pose a potential systemic threat. Faced with the unbounded nature of potential risks and limits on its resourcing, risk-based supervision enables a supervisory agency to apply its resources to maximum effect. A successful risk-based approach is characterised by high-quality and astute analysis leading to the early identification of key risks and issues, a capacity to escalate the intensity of supervision rapidly, and the ability and willingness to intervene promptly and assertively as and when required.
The essential building blocks of APRA's risk-based approach to supervision are set out in the APRA Supervision Blueprint (published in January 2010) and were elaborated on in last year's Report. The approach drives APRA's strategic planning as well as the direction and intensity of its supervisory activities. In summary, the building blocks are:
Over the course of 2010/11, APRA undertook a comprehensive strategic review of the supervisory processes and systems that support its risk-based approach. With the assistance of a firm of external consultants, working in partnership with APRA's Supervision Framework Team, each of APRA's main supervisory processes was subject to detailed examination. The review looked at ways to improve the effectiveness and efficiency of each process and, importantly, at how the conduct and outcomes of each process aligned with APRA's broader objectives. A second phase of the review examined the adequacy of the systems and tools that APRA uses to put these processes into effect. By bringing together the skills of a seasoned group of supervisors and external consultants with considerable experience in process efficiency and systems design — and an independent set of eyes able to challenge existing mindsets — the review produced a set of recommendations for improvement in APRA's supervisory processes that are focussed, practical and relevant.
The strategic review, which was completed in April 2011, has laid the foundation for progressive improvement in APRA's supervisory framework. The review recommendations identified how APRA can better organise, align and integrate its supervisory processes and systems, and these recommendations will be implemented in stages over the next few years under a substantial supervision renewal program. The streamlining of supervisory processes is now well under way and should be largely completed by the end of 2011/12. Changes to APRA's core IT systems and tools will be implemented over a longer time horizon as part of an integrated program of technology improvements.
Improvements to supervisory approaches can be both inward-looking, such as APRA's supervision renewal program, or outward-looking, dealing with the nature and intensity of interactions with regulated institutions. The FSB report flagged a number of improvements to supervisory techniques that supervisors could pursue, drawing on the lessons from the crisis. Some of these initiatives were already on APRA's agenda.
One aspect of APRA's supervisory approach that it has been seeking to reinforce is its engagement with boards. Boards have primary responsibility for ensuring the prudent management of regulated institutions and APRA's prudential standards make boards accountable for a range of prudential matters. As discussed earlier in this Report, APRA increased its engagement with boards over 2010/11 on matters such as risk appetite, remuneration and credit standards in housing lending. As APRA has learned, direct access to the board, and an effective relationship built on mutual trust and respect in good times, can be crucial in managing situations when times turn sour. More face-to-face contact will help to strengthen relationships and, at the same time, allow APRA to properly test board capabilities and director contributions.
A second aspect relates to APRA's capabilities for identifying quickly the next generation of risky products and businesses. Prudential supervisors can never expect to be ahead of the market in terms of new product development and innovation; however, close and continuous supervision will help supervisors to at least keep abreast of developments. APRA is stepping up its focus on the risks that might be inherent in new product trends and business activities. The crisis taught the danger of misleading positive signals from apparently well-performing business lines because underlying risks were being underestimated.
A third aspect being reinforced is the 'thematic' or industry-wide analysis of risks. One of the most powerful tools available to a supervisor is a strong 'compare and contrast' function, which enables it to readily and with confidence identify areas in which a regulated institution is an outlier. The FSB acknowledges that thematic reviews provide useful relative rankings of institutions and, certainly, APRA has found that advising a board that its institution lags its peers in a particular aspect of risk management or exposure quickly focuses that board's mind. APRA has been strengthening the capacity of its Industry Analysis Team and has recently changed its location and reporting lines to improve its visibility within APRA and its access to the frontline supervisory divisions.
A fourth aspect on which APRA is increasing its supervisory focus is stress-testing. There are three components to this work. The first is macroeconomic stress-testing. In 2009/10, APRA undertook a comprehensive stress-test of the 20 larger ADIs to test their resilience to a severe economic downturn, and it is now planning a second macroeconomic stress-test that will cover a larger group of ADIs and will add funding dislocations to a severe downturn scenario. Secondly, APRA's 'bottom up' stress-testing capabilities, either desk-based by APRA or by each institution at APRA's direction, have been expanded. This type of stress-testing gives APRA a much better understanding of a regulated institution's sensitivity to various shocks – for example, an ADI's exposure to property price falls or a life insurance company's exposure to equity and/or interest rate volatility. Such stress-testing has been valuable in enabling APRA to quickly assess the resilience of the life insurance industry, in particular, to recent financial market volatility. The third component is APRA's assessment of each regulated institution's own stress-testing capabilities and programs, which need to be robust and factored into decision-making, strategic planning and capital budgeting.
APRA's staffing
The development of a robust prudential framework and the effectiveness of a risk-based approach to supervision requires APRA to harness the collective experience and expertise of staff able to bring a range of skills and perspective to their work. In the face of strong competition from the finance industry, APRA has succeeded over time in building a cadre of high-quality staff across its policy, supervisory and corporate areas, and it has been able to augment its staff resources to cope with the crisis, in numbers and in calibre, through the four-year special funding provided by the Government. Subdued hiring conditions elsewhere also assisted APRA's recruitment efforts in the early period of the crisis.
At end-June 2011, APRA's total permanent staffing was 592, while the addition of fixed-term and casual employees brought staffing levels to around 602 on a full-time equivalent basis. Both numbers are lower than the previous year, mainly due to the transfer of APRA's role in the early release of superannuation benefits to Medicare Australia in February 2011 (see Chapter 2). APRA also experienced a pick-up in turnover from crisis-low levels as the finance industry resumed hiring programs, particularly in the areas of risk management and compliance. Notwithstanding the higher turnover, the average supervisory experience of staff in APRA's operational divisions has increased to over eight years, on top of an average of around five and a half years of relevant industry experience.
The talent pool available and suitable to a prudential regulator is unlikely ever to be a large one. For that reason, APRA has continued to invest heavily in its training and development programs to support the skills formation of its staff. In benchmark surveys, APRA consistently ranks around the 90th percentile of organisations in terms of training expenditures; over 80 per cent of staff training is targeted at the development of core supervisory skills. During 2010/11, in parallel with its strategic review of supervisory processes and systems, APRA continued to roll-out a revised training curriculum and associated training programs aimed at honing the analytic skills of frontline supervisors. This suite of training programs, which uses external facilitators with strong industry experience and knowledge, is supported by improvements to the business intelligence tools available to supervisors to access and review the financial information submitted by regulated institutions. The improved toolset will provide a superior data suite to supervisors and facilitate the in-depth analysis of risk issues.
Other initiatives to improve staff development and retention include career progression and mobility programs, overseas secondments to regulatory agencies or global standard-setting bodies, domestic secondments to other regulators and agencies, enhanced recognition and rewarding of performance, and leadership and management development. APRA is also well aware of the importance of workplace flexibility as a key to attracting and retaining valued staff, and continues to be a recognised leader in this area.
APRA's training activities in 2010/11
Training by type (%)
Internal technical training 41
External training 41
Management training 18
Studies support  
Employees undertaking formal post-graduate studies 136
Key training metrics  
Training spend per employee $3,270
Training spend as a per cent of base salary (%) 3
Per cent of staff provided with training (%) 100
Training sessions per employee 9
Training days per employee 4
Number of internal classroom courses offered 522
APRA's statistical capabilities
APRA is a central repository of statistical information on the Australian financial sector and it collects financial statistics from a wide range of financial institutions, both regulated and unregulated. APRA's statistical collections provide supervisors with access to relevant, timely and accurate data on APRA-regulated institutions and are a vital input into supervisory action plans.
APRA also collects data on behalf of the Reserve Bank of Australia (RBA), the Australian Bureau of Statistics (ABS) and the Australian Securities and Investments Commission (ASIC), and about 80 per cent of data collected are shared with other agencies. The statistics APRA publishes inform many decision-makers in the Australian financial system, including policy-makers, other regulators, market analysts, researchers and senior management of financial institutions. APRA follows international standards aimed at ensuring that users can have confidence in the integrity of the data and that statistics are made available on an impartial basis.
APRA's current priorities in the statistics area are to improve reporting from regulated institutions, reduce reporting burden on these institutions and encourage greater use of the data collected. APRA's statistics unit was restructured at the start of 2011 in recognition of these priorities.
For regulated institutions, APRA targets a rate of 95 per cent for submission of returns by the statutory due dates, and the remainder to be submitted within the following week. Over 98 per cent of APRA returns were submitted on time or within one week of the due date during 2010/11. In the interests of improving reporting, APRA stepped up its engagement with the RBA and ABS and worked with a small number of institutions on the quality of submitted data; the outcome was an enhancement to the integrity of data used in Australia's financial accounts and monetary statistics.
APRA delivered a number of improvements during 2010/11 that reduced the reporting burden on institutions. Firstly, an improved data quality assurance system was introduced for returns submitted via APRA's electronic data collection system, Direct to APRA (D2A). Institutions can now identify and fix data errors, and explain data anomalies, within D2A at the same time they submit data to APRA. Previously, they resubmitted incorrect data and explained anomalies in the days or weeks after submission, in response to email queries from APRA. As part of this improvement, APRA also revised the materiality of the data quality assurance checks to minimise any unnecessary reporting burden. APRA published details of all quality assurance checks on its website and provided guidelines on use of the new system. Over 98 per cent of regulated institutions submitted their first returns under the new system by the due date. A number of institutions noted the improvement and acknowledged the increased efficiency of reporting to APRA. As a result of the improvement, 96 per cent of all quarterly returns are now fit for use by APRA supervisors, the RBA and ABS on the due date, rather than within two weeks of the due date as was the case previously.
Secondly, APRA reduced the reporting burden on ADIs accredited to use the 'advanced' Basel II approaches by revoking a number of reporting standards linked to the transitional arrangements for the Basel II Framework. These standards required advanced ADIs from 2008 onwards to calculate and report prudential capital ratios under that Framework as well as under the original Basel Capital Accord.
Thirdly, APRA continued its active involvement in the development of the Government's Standard Business Reporting (SBR) program. This whole-of-government initiative, which went live on 1 July 2010 for a range of reports to government, seeks to eliminate duplication and reduce reporting burden by streamlining and automating reporting between businesses and government agencies. During the year, APRA incorporated all D2A reporting requirements into the single SBR taxonomy and provided clarification of the requirements in APRA's Plain English Taxonomy (PET). The Chairman of APRA is on the SBR Board and the Chief Information Officer is a member of the SBR Steering Group.
APRA produces a suite of 13 statistical publications that provide regular updates on the financial performance of APRA-regulated industries. To encourage greater use of the data collected, APRA brought forward the regular release date of four of these publications.
In July 2010, APRA introduced a new Half Yearly Life Insurance Bulletin, its second statistical publication dedicated to life insurers. The publication was developed in consultation with the life industry and a wide range of other stakeholders. The Bulletin provides industry data as well as individual life insurer data, allowing users to make their own assessments of individual life insurers and the industry as a whole.
During 2010/11, APRA updated its general insurance statistics to incorporate the simplified reporting framework that came into effect on 1 July 2010. Accordingly, statistics in the Quarterly General Insurance Performance Statistics are now aligned with accounting standards set out in AASB 1023 General Insurance Contracts. In response to feedback from industry, APRA also added two tables of additional statistics to the publication, which provide users with information on premiums and claims by class of business, and the solvency of the industry.
During the year, APRA also established a data collection on general insurance business handled by insurance intermediaries. Under this new reporting regime, general insurance intermediaries are required to provide aggregate data on all insurance contracts with APRA-authorised general insurers, Lloyd's underwriters and unauthorised foreign insurers (UFIs). APRA collects these data on behalf of ASIC. For the first data collection, covering the six months to June 2010, some 87 per cent of returns were submitted on time or within one week of the due date; that figure has now risen to 97 per cent. In June 2011, APRA released a discussion paper on how its statistical publications could be expanded to include information on intermediated general insurance from the new data collection. By publishing such information, APRA's aim is to provide a central source of complete, useful and trusted intermediated general insurance statistics. These statistics will fill a gap in the market for this information and will improve the quality of external analysis of intermediated general insurance. They will also help identify inappropriate use of UFIs. The first release of the new statistics is expected later in 2011.
APRA's statistics unit fulfilled over 200 requests for customised statistics over the past year. These statistics give more detailed insight into particular aspects of the financial system than APRA's regular publications. The statistics are provided to external users such as government agencies, including the Treasury, to assist in the provision of advice and policy formulation. The statistics are also provided to international agencies such as the Organisation for Economic Co-operation and Development (OECD), the IMF and the Bank for International Settlements (BIS), for inclusion in international statistics that facilitate comparisons of various aspects of the Australian financial system with those of other countries.
APRA's research capabilities
APRA has a small research unit that undertakes empirical research into matters relevant to APRA's mandate. The unit's principal output consists of working papers published on the APRA website, which are presented at academic and industry conferences and often published in reputable journals. The unit also supports other divisions within APRA by conducting rigorous analysis of issues relating to prudential policy development and supervisory practices.
In 2010/11, the unit's primary focus was on superannuation. Two working papers on superannuation outsourcing were published in July 2010 and presented at the 2010 Superannuation Colloquium of the University of New South Wales (UNSW) and at the annual conference of the Accounting and Finance Association of Australia and New Zealand. Four more superannuation-related papers – on issues ranging from trustee governance to whether larger funds realise economies of scale – are nearing completion. The unit has also contributed to APRA's preparations for the implementation of the Government's Stronger Super reforms by identifying the types of data that could be used to assess whether the Government's policy objectives in this area have been met.
On other fronts, a working paper published in November 2010 explored the interconnectedness between directors of US banks receiving public injections of capital; this paper was presented at the 2010 Australian Centre for Financial Studies Banking Conference and the 2010 Australasian Finance and Banking Conference organised by UNSW. Another working paper on internal transfer pricing for bank liquidity published in March 2011 grew out of APRA's participation in the Basel Committee's Working Group on Liquidity. The paper was presented in March at an Asian research network workshop hosted by the BIS and has now been accepted in the Occasional Paper series by the Financial Stability Institute of the BIS.
The unit's full-time staff is supplemented by up to four PhD candidates whom APRA cosponsors through the Capital Markets Cooperative Research Centre. APRA also supports other university research relevant to prudential regulation. A four-year Australian Research Council (ARC) Linkage Grant, partly funded by APRA, supports a team of academics from the Centre of Excellence in Population Ageing Research at UNSW to research longevity risk. Under its Research Grants Program, APRA also funds external researchers directly. Three studies relating to Australian banks are in progress, addressing wholesale funding, syndicated lending and so-called 'VaR violations' when a bank's trading losses exceed the Value-at-Risk.