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The Australian Prudential Regulation Authority (APRA) today released for comment a Policy Discussion Paper on the prudential supervision of conglomerates. Industry comments are invited by end May.
As prudential supervisor of the bulk of financial institutions in Australia, APRA is vitally concerned with the quality of the systems used by those institutions to identify, measure and manage the various risks which arise in their business. Amongst other things, it seeks also to ensure that capital held by financial institutions is commensurate with risk arising from their business activities. Increasingly, however, both in Australia and internationally, financial services of all types are being offered not by single, stand-alone institutions but within conglomerate or group structures containing different types of financial institutions and activities, often with differing risk profiles.
Typically, some of these activities (for instance, banking and insurance) are covered by an explicit regime of prudential regulation while other parts of groups are not. These trends have led to a vigorous international debate on the implications for prudential supervisors. A particular issue of concern to regulators is the possibility of "contagion" between different parts of a conglomerate group - where problems in some unregulated part might be transmitted to a healthy regulated entity. Contagion can occur in a variety of ways, including through reputational and financial linkages spanning a group.
Another area of interest to prudential regulators is the organisation structure of conglomerate groups. In some instances, organisational form may obscure the presence of risks across a group. Other structures may improve transparency of risk and improve the efficiency of business operations and thus work to enhance the overall prudential soundness of a group.
In its reforms following the 1996/97 Financial System (Wallis) Inquiry, the Government gave special attention to the structure of conglomerates in the financial sector and, among other things, revised the Banking Act to allow for the regulation of non-operating holding companies (NOHCs) which head conglomerate groups or sub-groups.
At the same time the Government, while continuing to support the principle of sectoral separation (which effectively prevented non-financial business from being conducted in a group containing a bank), also recognised a need to inject greater flexibility into the policy. It accepted that, in certain cases, financial activities or services could logically and efficiently be offered alongside non-financial products. In view of the risks that might arise, it was stated that a conservative approach to the application of such policy should be followed, with any proposals considered on a case-by-case basis.
The framework of prudential supervision must evolve with market developments. It is against this background that APRA's Discussion Paper seeks to address the broad set of issues raised by conglomerates. It outlines a common prudential framework in which all the activities of conglomerates with financial and other business can be considered. The proposals are broadly consistent with international trends in financial supervision, such as the guidelines being developed by the tripartite (banking, insurance and securities) Joint Forum on Financial Conglomerates, of which APRA is a member. (Joint Forum papers can be accessed on the website http://www.bis.org). The Paper canvasses new or upgraded measures in a range of areas, including: corporate governance standards (including "fit and proper' tests); controls on intra-group transactions and group large exposures; group-wide capital adequacy; and incentives for internal risk management on a group-wide basis. The proposed measures are intended to enhance transparency, limit contagion and reinforce the idea that primary responsibility for safety and soundness rests with the conglomerate itself.
Initially, the proposed policies would relate only to conglomerate groups which include a bank or other authorised deposit-taking institution (ADI). APRA will consider over time how they might be extended to financial conglomerates with no ADI members.
The policies, once finalised and adopted, will be given effect in the form of prudential standards under the Banking Act. It is recognised that the potential impact on existing institutions will vary; where existing arrangements are out of line with the policies, fair and reasonable transition arrangements will be agreed bilaterally.
For further information, contact:
Mr Brian Gray (Executive General Manager)
Policy, Research and Consulting
GPO Box 9836
Sydney NSW 2001