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APRA General Manager, Regulatory Affairs and Licensing Melisande Waterford - Speech to the Future Banking Forum 2019

Regulating challenger banks: Balancing objectives and outcomes

APRA General Manager, Regulatory Affairs and Licensing Melisande Waterford - Speech to the Future Banking Forum 2019.

Thank you for the opportunity to talk to you today.

Setting up a challenger bank is – for want of a better word – challenging.  It’s challenging for the founders and it’s challenging for APRA too.  Today I’m going to examine those challenges from both perspectives.

For APRA, it’s a good time to pause and reflect back on our experiences over the last couple of years. What could be characterised as the ‘first wave’ of challenger bank applicants – Volt, Xinja, Judo and 86 400 – have now all achieved a full, unrestricted authorised deposit-taking institution (ADI) licence. Subsequent applicants are in various stages of passing through the process as I speak. What have we learned along the way? And what are our hopes for the future?

My theme for today is ‘balancing objectives and outcomes’. That’s something that’s top of mind for the APRA Licensing unit on a daily basis, and it is APRA’s standard approach to regulation generally. Indeed the Australian Prudential Regulation Authority Act (1998) states that:

“In performing and exercising its functions and powers, APRA is to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality and, in balancing these objectives, is to promote financial system stability in Australia.”

So balancing objectives is a core part of what we do. But nowhere else in APRA are the potentially competing objectives of financial safety on the one hand, and competition and contestability on the other, so stark and so obvious. Put simply: we want to encourage innovation; to welcome new entrants into the industry; to support competition. But we don’t want to lower our standards and create risks for deposit-holders in order to do so.  This is not just APRA’s view in isolation.  There is no sign that the community is willing to accept a higher risk with their deposits.  The community expects all banks to be very safe.

It’s worth reminding ourselves that the statutory obligation to obtain a licence before commencing banking business is intended by design to act as a barrier to entry. There’s a very good reason why only people with a pilot’s licence are allowed to fly an aeroplane. And there’s an equally good reason why no-one is allowed to simply set themselves up as a bank and start taking deposits. We believe that taking deposits is a weighty responsibility, and we are unapologetic about setting high standards for people who wish to do so.

Some commentators refer to APRA’s ‘licensing standards’. In fact APRA doesn’t have any licensing standards per se, except for the requirement to pay an application fee.  Applicants are assessed against APRA’s prudential standards for all ADIs. That is to say, applicants are held to precisely the same standards as incumbents. This is in itself an important foundation of competition. We don’t want to create an uneven playing field between new entrants and existing ADIs. Of course there’s a naturally high level of scrutiny inherent in the assessment process so applicants sometimes feel like they’re under the microscope. But we use the same principle of proportionality as we use for incumbents. We direct the greatest resourcing to areas of greatest potential risk.

The purpose of our prudential standards is clear. APRA’s recently-released Corporate Plan includes the following statement about our mandate:

“We protect the Australian community by establishing and enforcing prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by our institutions are kept within a stable, efficient and competitive financial system.”1 

In the case of ADIs, the main financial promise that exercises our attention is the one made to depositors: that they will get their money back when they are contractually entitled to ask for it. This is where the delicate balancing act comes in. APRA does not have a ‘zero failure’ policy – hence “under all reasonable circumstances”. But it is prudent nevertheless to avoid failures wherever and whenever you can. At best, the failure of a challenger bank would present an inconvenience to its depositors and customers. At worst, depositors might suffer a financial loss and there are other, wider impacts too. A failure of a challenger bank could tarnish the ‘bank’ brand and lower community confidence in the system. A failure might make it more difficult for other challenger banks to raise equity funding. 

So what has APRA done to facilitate new entrants, but without lowering standards? 

Firstly, we introduced a choice of routes to full ADI authorisation. Applicants may now either apply directly for an unrestricted licence, or pass through a Restricted ADI phase on the way. The Restricted ADI framework is intended to allow applicants time to build capabilities and resources, and perhaps assist in raising capital. Volt and Xinja both received a Restricted ADI licence, and both have gone on to achieve a full, unrestricted licence.

Secondly, just over two years ago we set up a centralised and dedicated Licensing unit. This has allowed for a much more consistent and structured process than in times past. It’s also led to a considerable speeding-up of the application assessment process, which is a particularly important point, given the inevitable capital burn incurred by start-ups.

Thirdly, APRA has challenged itself to be more open-minded towards unprecedented or unorthodox proposals that push outside the usual comfort zone. This can be characterised as a mindset of looking for a way to say ‘yes’, rather than looking for a way to say ‘no’. Of course it is not laissez faire and there are core prudential issues on which we will not compromise, governance standards being a good example, but on the whole APRA is now more actively open to innovative approaches, particularly where they may bring benefits into the banking system.

Balancing safety and competition is not the only balancing act APRA needs to perform when considering challenger bank applications. On the one hand, it’s not APRA’s role to pick winners and losers. After all, history tells us that plenty of wildly successful ideas were tipped to crash and burn when they were first suggested.  On the other hand, APRA is keen to see new entrants succeed. APRA’s licensing ‘mission’ is not to licence as many new banks as it can, as quickly as it can. Rather, our mission is to facilitate the launch of viable entities. At the risk of stating the obvious: challenger banks can only make a difference to the competitive dynamic of the Australian market if they survive and thrive. Quickly granting a licence to a challenger bank which shortly thereafter gets into trouble and fails does nothing to promote competition and serves no-one’s best interests. However, it is inevitable that some challenger banks will not survive, not because management failed to run the new bank prudently, but because their innovative ideas did not attract enough customers to be sufficiently profitable, or enough investors to fund their capital needs. 

There are industries where start-ups can make a noticeable impact without having lots of capital or a large balance sheet. To date, banking hasn’t been one of them. In simple terms: impact requires growth, growth requires a balance sheet, a balance sheet requires capital, and depositor protection requires plenty of capital. The mathematics of this are inescapable.

Size itself is no guarantee of success, particularly where asset quality is poor. But it does tend to tip the odds. To adapt the old adage: ‘Fortune favours the big balance sheets’. Scale can allow banks to reduce cost-to-income ratios, thereby improving profitability and return on equity. Scale can improve access to funding and lower its cost. Meanwhile the benefits of portfolio diversification mean that risk does not generally increase in a straight one-to-one linear fashion with size.

All of which creates a classic chicken-and-egg situation. Venture capital investors can be reticent about committing equity to an as-yet-unproven challenger bank. Yet the only way for a challenger bank to be truly successful is to have sufficient capital to achieve scale. This conundrum goes well beyond APRA’s ability to identify potentially successful applicants, but nor can we simply ignore its ramifications.

APRA’s observation is that for a challenger bank the single biggest impediment to raising capital is non-operation. Good ideas alone have not proven to be persuasive. Investors want to see proof-of-concept. Where an entity has not commenced business, it has no customers. It cannot demonstrate customer traction or the efficacy of its systems and processes. Leading-edge technology is only a market advantage when it works and is seen to work.

Consequently APRA has increasingly focused on the inter-related issues of product launch and capital raising. We believe that launching products should be a top priority for applicants. We believe that an applicant must have sufficient capital to get itself to product launch date, which in turn will provide the best prospects for raising the additional capital necessary for medium-term success. If we insist on high standards and ask challenging questions, then this is a manifestation of ‘tough love’.  With the footy Grand Finals still very fresh in the memory, it is worth noting that the road to Premiership glory started with a gruelling pre-season training regime.  At APRA, we want applicants to be fully match fit by the opening day of the season. I’m sure that those of you in the audience who’ve been through it would concur that the licensing assessment process may feel tough but the real hard work starts after you get your licence, not before. 

Of course, the question of how to best prepare applicants for the rigours and realities of the banking marketplace is not unique to Australia.  APRA’s peer international regulatory agencies have taken a range of approaches.  For example, in the United Kingdom the Prudential Regulation Authority (PRA) offers to hold formal ‘challenge sessions’ prior to application.  In these the PRA plays the role of Devil’s Advocate, asking robust questions about business plans, implementation plans and capital raising strategies.  The Hong Kong Monetary Authority (HKMA) received around 30 applications for ‘virtual banking’ licences, and shortlisted the 8 that best met the HKMA’s stated policy objectives. It is also interesting to note the recent announcement by the Monetary Authority of Singapore.3  It is rationing new banking licences – two Digital Full Bank (DFB) and three Digital Wholesale Bank licences will be granted in 2020. For a retail-oriented DFB, the initial minimum capital requirement at the start of the restricted period is just $15 million Singapore dollars. But in order to achieve a full, unrestricted licence the entity must have capital of at least $1.5 billion Singapore dollars – with an expectation that this amount will be raised within three to five years of commencing operations. 

At this time, APRA does not propose to go down the latter path, but it is a neat illustration of the general principle that regulators want new entrants to be successful, even if the definition of ‘success’ can vary from jurisdiction to jurisdiction.  It seems that in order to be successful, new entrants to the Australian banking industry need to grow, and grow quickly. Rapid growth is a challenge, even when you have a good customer proposition. The experience of new bank entrants in Australia over the last 40 years has shown that it’s very difficult to rapidly build scale, even with an innovative idea, and the capital question never goes away.

What about the future? Of course none of us knows what it will hold, but I can tell you what APRA hopes that it holds. Challenger banks don’t need to become a ‘fifth pillar’ to serve the Australian community. Their existence alone can force incumbents to up their game. APRA would like to see a steady stream of serious ADI licence applicants that enter the market and 10 years later are still there, large enough to be significant, competing hard and providing innovative solutions to Australia’s financial needs. I might take this opportunity to give aspiring applicants some advice based on our insights and experiences so far, gleaned from successful applicants, those still going through the process, and those that never made it past the concept phase.

First, do your research thoroughly. It’s not enough just to know what you want to do, you have to have a clear idea how you’re going to do it in practice. Be careful what you wish for: setting up a challenger bank is a huge and complex logistical challenge. Don’t assume that problems will solve themselves or that solutions will present themselves to you along the way. Make sure that you know what you’re getting into and that you’ve identified the key issues before you encounter them.

Second, get people with relevant banking experience involved as early as you can. Banking may superficially seem simple to those unfamiliar with it, but it has some important idiosyncrasies. 

Third, don’t underestimate how hard it will be to get the technology to work in a secure, reliable and stable manner.  No off-the-shelf solution is genuinely ‘plug and play’.  Nor can key IT risks be fully outsourced to vendors. Using a cloud platform still entails risk and these risks need to be managed, the same as any other. Sleep with a copy of Prudential Standard CPS 234 Information Security on your bedside table! 

Fourth, make reaching product launch date your primary initial goal. If that means scaling back your ambitions regarding product range so be it. 

Fifth, be realistic about timeframes. Implementation projects rarely run to their originally planned timetable. Applicants should also factor in the need to respond to APRA’s feedback on their original submission. This process can take a while.

Sixth, successful marketing is crucial. Even if you have some great ideas, the bulk of Australian consumers do not actively switch financial service providers, so it takes a while (and often significant financial incentives) to win many of them over to a new concept. You should also be very clear about what makes you unique. Many challenger banks target similar customer segments.  Be aware that you are competing not just against incumbent banks, but also against emerging non-bank players such as digital wallet providers.

Finally, don’t ignore the capital elephant in the room. Time is not your friend. Don’t presume that investors will believe in your project as passionately as you do. Optimism is not a capital management plan. Take a pragmatic approach and raise what you can, when you can, at a price investors will accept.

If you do all of the above, we think you have a decent chance of success and you would go with APRA’s best wishes for a bright future.

Thank you for your attention.


1. APRA corporate plan



The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, mutuals, general insurance and reinsurance companies, life insurance, private health insurers, friendly societies, and most members of the superannuation industry. APRA currently supervises institutions holding around $9 trillion in assets for Australian depositors, policyholders and superannuation fund members.