The clarion call from the G-20 for an increase in the intensity and effectiveness of supervision of financial institutions — the second objective of its global reform agenda — has become loud and clear. A salient lesson from the crisis was that supervisory agencies that were focussed on process rather than on outcomes, on compliance with regulations rather than on forward-looking assessments of risk, fell short of the mark. Global policymakers are now holding supervisors to higher standards. This is evident, in particular, in the revised 'Core Principles' for effective banking and insurance supervision, where the bar against which supervisors are now being assessed under the IMF's Financial Sector Assessment Program (see page 45) has been raised.
In endorsing more effective supervision as a key pillar in global reform initiatives, 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 is well rated internationally against these requirements.
Effective supervision of a financial institution is a dynamic and multi-layered process, in which three key elements interact. One element is a robust process for bringing together the institutional knowledge, prudential data, market intelligence and financial analysis needed to assess the risk profile of the institution and its risk management capabilities. The second is relevant, timely and accurate prudential data on the institution and its industry, reinforced where it can be by rigorous research. The third and critical element is supervisory talent with the skills and experience to make astute risk assessments, and the confidence to challenge the institution and to intervene when necessary. The interaction of these elements delivers the core 'outcome' of supervision — accurate judgment about the financial soundness of the institution and its ability to withstand stress.
These three elements form the foundation of APRA's risk-based approach to supervision, and they receive considerable attention to ensure that APRA's risk-radar remains sharp, its approach is not mechanical but responsive to changing economic and market circumstances, and its supervision is delivered in a cost-effective way.
APRA's supervisory process employs a range of risk analysis techniques designed to probe for points of potential weakness in a regulated institution's operations and risk management defences. Based on this analysis, APRA takes targeted remedial actions where necessary to avert adverse outcomes. APRA's risk-based approach seeks to direct its supervisory resources and attention to those aspects of an institution's operations that pose the greatest risk to its ability to meet its financial promises to its beneficiaries or that could present a threat to the stability of the financial system as a whole. In the absence of a rigorous framework to give it structure, risk-based supervision is merely a slogan. Over the last several years — both before and over the course of the crisis — APRA has invested heavily in improving the structure of its supervisory approach to ensure that its supervisory interventions continue to be well-targeted and effective.
Firstly, following an international review of best practice in prudential supervision, the APRA Supervision Blueprint was developed, setting out the governing principles and a strategic direction for the development of supervision practices in APRA. This was published in January 2010.
Secondly, APRA established a dedicated unit, the Supervision Framework Team, to develop and maintain the supervision framework. The Team champions a risk-based approach throughout APRA and reinforces a culture aimed at identifying, refreshing and evolving good supervisory practices.
Thirdly, a revised supervision methodology was rolled-out over 2011/12 that better integrated the various pieces of supervisory analysis undertaken by APRA supervisors and facilitated a more cohesive approach to risk-based planning and response to risk issues. The revised methodology is designed to:
- better align APRA's risk identification, risk assessment and supervisory response processes to improve the currency of its risk-ratings of regulated institutions and encourage supervisors to update risk-ratings and supervisory action plans dynamically;
- strengthen planning and assessment processes around the conduct of detailed on-site reviews, with a focus on the desired outcomes of the review and improved collaboration between supervisors in achieving those outcomes, particularly when delving into more complex areas of operation with the assistance of APRA's specialist risk teams;
- reduce 'administrative noise' and streamline review and approval processes to improve efficiencies and ensure that the level of review and oversight of key supervisory outputs is commensurate with the risk profile of a regulated institution; and
- integrate the assessment of prudential data received by APRA with industry risk data and other institution-specific information to promote the early identification of risks and issues.
These changes were supported by the release of a significantly modernised suite of analytical tools used by supervisors of the general insurance, superannuation and ADI industries. These tools will be extended to the life insurance industry in 2012/13.
The fourth limb of this renewal program is the rebuilding of APRA's systems infrastructure to provide a more robust and efficient IT platform on which to run APRA's supervision processes. This will be a substantial exercise requiring a shift from APRA's current suite of internally built supervisory systems to a new suite of integrated software that will be in line with APRA's overarching IT strategy.
Considerable work went into preparing the ground for these systems changes during 2011/12. The systems architecture was established, a set of detailed business requirements and systems specifications prepared, a delivery schedule and release plan written and a suitably qualified systems integrator selected to assist with the design, build and implementation of the new solution.
The first wave of new systems capabilities to be rolled out in 2012/13 will deliver:
- the integration of APRA's risk assessment and response tools — PAIRS (Probability and Impact Rating System), SOARS (Supervisory Oversight and Response System) and SAPs (Supervisory Action Plans) — into a single system to facilitate greater visibility of risks, issues and supervisory activities, better manage issues to resolution and improve access to supervisory information to assist with the risk-based allocation of supervisory resources;
- improved technology support for APRA's precedents repository to allow better search capabilities and access to prior regulatory decisions made by APRA from a single 'source of truth'; and
- the foundation for a new electronic document and records management system that will support both supervision and other business processes across APRA.
The remainder of the delivery schedule will take place in stages over the next few years so as to reduce implementation risks and better manage the required business transformation. Ultimately, the renewal program will produce significant efficiency gains and sharper supervision processes, with less time spent on maintaining cumbersome legacy systems and more flexible technology support for evolving supervisory practices.
APRA has been able to build a strong workforce with the specialised knowledge, capabilities and experience needed to support its risk-based approach to supervision and its substantial prudential policy agenda. Special funding provided by the Government, which ended in 2011/12, enabled APRA to augment its staff resources to cope with demands arising from the crisis. A new four-year funding arrangement from 2012/13 is intended to ensure APRA's continued capacity to supervise the Australian financial system.
At end-June 2012, APRA's total permanent staffing was 591, while the addition of fixed-term and casual employees brought staffing levels to around 606 on a full-time equivalent basis. These numbers are very similar to the previous year. Subdued conditions in the finance industry over 2011/12 tilted the usually tough recruiting environment a little in APRA's favour; turnover fell to its lowest rate in APRA's history and APRA again brought on board a number of high calibre staff. As a consequence, the average supervisory experience of staff in APRA's operational divisions has increased to over eight and a half years, in addition to an average of around six years of relevant industry experience. Each new hire into APRA's supervisory and policy areas since the crisis began, excluding graduates, has brought an average of 11 years of industry experience into APRA.
Over the past decade, a major transformation has taken place in APRA's age profile, reflecting both the maturing of the organisation and a conscious policy of hiring more experienced staff. At the same time, APRA remains strongly committed to a graduate intake (which has provided around 13 per cent of APRA's current staff). APRA's median age has increased from 34 to 39 years, which is now in line with the general workforce. Just under 50 per cent of staff are age 40 years and over, whereas in 2002 only one-third of staff were in that age profile.
APRA has maintained a heavy investment 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, with an average annual training expenditure per employee of over $3,500. The greater bulk of APRA's recent investment in training has been targeted at enhancing the analytical skills of frontline supervisors. In conjunction with external facilitators, APRA has built a series of detailed financial analysis training programs covering each of the industries under APRA supervision. As well as teaching the techniques of sound financial analysis, these programs emphasise a forensic approach to the analysis of data and seek to equip supervisors with the capacity to challenge the data for signs of potential vulnerability. A key focus is to ensure that supervisors make the most of the tools at their disposal to identify risks, analyse their significance and ensure that appropriate remedial action is taken where needed. In this context, financial data are reviewed at an institution, peer group and industry level. Further courses are being developed to take skills to a more advanced level.
Other initiatives to improve staff development and retention include career progression, rotations and internal staff transfers, overseas and domestic secondments to regulatory agencies and enhanced recognition and rewarding of performance. Over recent years, APRA has increased its emphasis on developing leaders and managers able to guide change, and support and engage staff. APRA is also well aware of the importance of workplace flexibility as a key to attracting and retaining valued staff, and remains a recognised leader in this area.
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APRA collects a broad range of financial and risk data that are essential input to its supervision of regulated institutions. The data are used by supervisors to assess compliance with prudential standards and, more importantly, to gain a comprehensive understanding of the business and risks of individual institutions. The data also assist APRA's industry-wide analysis and research into emerging risks.
In addition, APRA collects data from regulated and unregulated financial institutions to assist the Reserve Bank of Australia (RBA), the Australian Bureau of Statistics (ABS) and the Australian Securities and Investments Commission (ASIC) to fulfil their roles. Much of the data are shared between agencies to reduce unnecessary reporting burden on institutions.
Since its establishment, APRA has accumulated over a decade's worth of data into a central repository of statistical information on the Australian financial sector. APRA recognises the public value of these statistics and seeks to publish as many of the statistics as are useful, subject to APRA's confidentiality obligations. The statistics inform policymakers, other regulators, market analysts, researchers and senior management of financial institutions.
APRA's current priorities in relation to statistics are to improve the quality of data collected, reduce unnecessary burden on reporting institutions and encourage greater use of the collected data. Improvements have been guided by feedback received in the 2011 APRA Stakeholder Survey.
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 99 per cent of APRA returns were submitted on time or within one week during 2011/12. With the aim of reducing reporting burdens, while maintaining the collection of high-quality and timely data, APRA introduced a significant number of new data validation rules within APRA's electronic data collection system, Direct to APRA (D2A). These new rules help institutions identify and fix data errors, and explain anomalies, at the time they submit data to APRA; they also ensure that submitted data are immediately fit for use by APRA supervisors, the RBA and ABS. APRA also removed or relaxed a number of other validation rules that were no longer effective at identifying errors.
The considerable reduction in institutions needing to resubmit incorrect data has enabled APRA to step-up its assistance to banks providing the macroeconomic data used by the RBA and ABS in Australia's monetary statistics and financial accounts. The three agencies, led by APRA, participated in workshops hosted by the Australian Bankers' Association to improve banks' understanding of the purpose and use of the macroeconomic data collected and identify areas for improvement in the data collection. APRA shared some of the outcomes of the workshops in an APRA Insight article in April 2012. APRA also continued to work with a small number of institutions to ensure that the data they reported were appropriate.
During the year, APRA updated its data collections in line with changes to prudential standards. A revised general insurance data collection incorporating a number of refinements to the prudential and reporting framework for Level 2 insurance groups commenced from 1 July 2011. A revised ADI reporting data collection, giving effect to the Basel 2.5 enhancements to the market risk framework, became effective from 1 January 2012. APRA incorporated the revised reporting requirements into the Government's Standard Business Reporting (SBR) taxonomy, which ensured that the data collections were harmonised with other participating Government agencies and institutions can submit data in the extensible Business Reporting Language (XBRL) format. Incorporating data collections into SBR minimises the additional reporting requirements for institutions and allows them to automate their reporting to APRA. APRA also reviewed its data collections for general and life insurers to incorporate the revised capital framework from 1 January 2013. In addition, APRA considered the data it would need to collect and publish to implement the Government's Stronger Super recommendations — in particular, to improve the transparency, comparability and accountability of fees, costs and investment returns, including for MySuper products. A discussion paper on an enhanced superannuation statistics collection was released in September 2012 (see page 43).
During the year, APRA also delivered a number of improvements to its regular statistical publications (now a suite of 15 publications) to encourage the use of data collected and to address common themes in feedback provided by users. APRA brought forward the regular release date of two of the publications, and will continue to work with reporting entities to bring forward the release dates of other publications where possible, given users' desire to receive the data earlier.
APRA released the first edition of the new Intermediated General Insurance Statistics publication in March 2012. The publication provides an overview of the business placed by general insurance intermediaries with APRA-regulated general insurers, Lloyd's underwriters and unauthorised foreign insurers (UFIs). The statistics include detailed information about risks placed with UFIs, which are not regulated by APRA. The publication fills a gap in the market for this information and improves the quality of external analysis of intermediated insurance. Policymakers and regulators are able to monitor insurance business being placed offshore with UFIs, while general insurers, general insurance intermediaries, professional bodies, researchers and the public have access to more information to understand intermediated general insurance.
In March 2012, APRA ceased publication of the Half Yearly General Insurance Bulletin and transferred the statistics into other statistical publications. APRA added statistics to the Quarterly General Insurance Performance Statistics publication and introduced a new annual publication, General Insurance Supplementary Statistical Tables. The statistics transferred to the quarterly publication are now available three months earlier than previously.
APRA also introduced an additional database version of the Quarterly General Insurance Performance statistics. APRA continues to publish the PDF and Excel versions of publications, with the additional database version intended to be easily imported into various tools to allow users to conduct more in-depth analysis. APRA had earlier introduced a database version of the Monthly Banking Statistics. Each month, this version of the publication incorporates revisions to data submitted by banks after publication. This is a change from APRA's previous practice of consolidating the back issues of the publication once a year and not including revisions. Publishing a time series, as requested by users, will facilitate analysis of the statistics and improve the accuracy and reliability of the data. APRA will continue to work with banks to minimise the need for data revisions.
APRA released the first edition of its revised Insight publication in April 2012. Since it was first published in 2001, Insight has provided a raft of important statistics, but few significant changes have been made to the types of statistics published. With ongoing enhancements to APRA's data collections, most of the statistics in Insight have been incorporated into APRA's suite of statistical publications. APRA is transferring the remaining ADI statistics not already published elsewhere into its statistical publications.
APRA began an upgrade of the National Claims and Policy Database (NCPD) to new hardware and current versions of software. Following industry consultation, APRA determined that data in NCPD reports are nonconfidential and it is removing masking from reports during the upgrade. By publishing unmasked data, APRA will increase the usefulness of the NCPD reports and the value of the NCPD data collection. APRA will take steps to protect the privacy of individuals in claims reports but does not expect that this will reduce the usefulness of these reports. The upgrade will also reduce operating support effort and costs for APRA. When the new system goes live in 2012/13, APRA intends to publish detailed reports that will enable contributors and subscribers to analyse the data using risk factors such as industry or occupation group and variations to product or policy coverage.
APRA has a small research unit that supports APRA's activities by conducting rigorous analysis of issues relating to prudential policy development and supervisory practices. The unit's research is published as working papers on the APRA website, presented at academic and industry conferences, and also often published in academic and international journals.
In 2011/12, the unit focussed its resources on research into aspects of the superannuation and ADI industries. Two superannuation-related working papers were published on the APRA website, one exploring the impact of illiquid investments on fund returns and the other investigating the effect of fund size on fund performance. The first paper was presented at the International Centre for Pension Management Discussion Forum in Toronto and the Netspar International Pension Workshop in Paris. Both papers have also been selected for two future domestic conferences. A third working paper, on the cost of insurance within superannuation funds, was presented at the Colloquium for Superannuation Researchers hosted by the University of New South Wales (UNSW). The unit has also continued to contribute to APRA's preparations for revising its regular data collections under the Stronger Super reforms.
On the ADI front, a paper published last year on the APRA website relating to funds transfer pricing was republished as an Occasional Paper by the Financial Stability Institute of the Bank for International Settlements (BIS) — only the tenth paper so recognised over the past 12 years. A working paper on stochastic stress testing was also presented in Kuala Lumpur at the BIS-hosted Asian Research Network Workshop held for central banks and bank regulators in the region.
The unit's full-time staff is supplemented by up to four PhD candidates whom APRA co-sponsors 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.
APRA also funded three external research teams under its inaugural Research Grants Program. One team has published a paper in Accounting and Finance on the strategic underestimation of market risk by large banks. A second team has conducted workshops on its study of the Australian syndicated loan market, which is likely to lead to two journal articles in the current year. The third grant was used to purchase a database that is supporting several studies of the factors relating to Australian banks' decisions to raise wholesale funds.