John Laker, Chairman - Senate Standing Committee on Economics, Canberra
When we last appeared before this Committee in late October, I noted that the view was clearly firming that the worst of the global financial crisis was behind us. Since then, the portents have been largely positive.
The global economy has begun to rebound, commodity prices have risen significantly and conditions in global funding markets have continued to improve. These developments, and a lift in consumer and business confidence, will contribute to what the Reserve Bank of Australia has forecast as 'reasonably strong' overall growth in the Australian economy in 2010 and 2011. The improved global funding conditions are the backdrop, as well, to the Government's announcement earlier this week of the withdrawal of the Guarantee Scheme for Large Deposits and Wholesale Funding on 31 March 2010.
Nonetheless, uncertainties continue to cloud the global economic outlook. Recovery in most advanced economies — as the IMF has recently noted — is expected to be weak by historical standards, the unwinding of substantial public interventions is presenting serious challenges and banking systems in a number of economies are still 'ground under repair'. The pressure on the sovereign debt of some European issuers lately is also a harsh reminder that the global economy and global financial markets remain vulnerable to aftershocks.
Since we last met, APRA's 2009 Annual Report has been tabled. Sometimes, the narratives in such reports can become quickly dated but, in our case, the themes remain highly relevant.
Most importantly, the Annual Report confirms APRA's view that Australia's unrivalled performance during the global financial crisis has been supported by, and has in turn reinforced, the fundamentally sound condition of APRA-regulated institutions, notwithstanding two years in dangerous seas. At the same time, as I noted in my Chairman's remarks:
"Although it may now seem a case of 'steady as she goes', the operating environment for financial institutions supervised by APRA will remain testing for some time to come ... Boards and management will need to be particularly careful not to drop their guard on risk if relief at surviving the most challenging circumstances in many decades gives way, as it may, to excessive confidence that their institutions are now invulnerable."
In other words, this is not the time for 'hats in the air' by Australian financial institutions. Certainly, APRA is not ready to dial down the level of its supervisory intensity.
Since we last met, reforms to regulatory arrangements, globally and in Australia, have begun to take firmer shape. To remind the Committee, the main aspects of the G20 global reform initiatives in which APRA is actively involved are remuneration incentives, the level and quality of capital held by banking institutions, and the management of liquidity risk.
In late November, APRA released its prudential requirements on remuneration for authorised deposit-taking institutions (ADIs) and general and life insurance companies. As it always does, APRA consulted extensively before finalising its requirements, and there was broad recognition that poorly structured remuneration practices may result in excessive risk-taking by individuals and can undermine risk management systems. APRA‟s principles-based approach focuses on the structure of remuneration arrangements; it is not our role to intrude into the market and shareholder disciplines involved in determining absolute levels of remuneration. Our requirements come into effect on 1 April 2010 but APRA-regulated institutions should already be taking steps to meet them.
In mid-December, the Basel Committee on Banking Supervision, the global standard-setting body for banking institutions, released its long-awaited proposals to strengthen global bank capital requirements. The proposals aim to raise the quality, consistency and transparency of the capital base; promote the build-up of capital buffers in good times that can be drawn down in periods of stress; and strengthen capital requirements for certain counterparty credit risk exposures. The proposals also introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework.
At the same time, the Basel Committee released a set of proposals to strengthen the management of liquidity risk. They include a global minimum liquidity standard aimed at ensuring that internationally active banks have sufficient high quality liquid resources to survive acute stress lasting for one month. APRA's proposals on liquidity risk management released a few months earlier largely anticipated the Basel Committee's approach and our timetable in this area will now dovetail with that of the Basel Committee.
Finally, later in December, APRA released a consultation package on strengthening the capital requirements of ADIs for market risks arising from complex trading activities, securitisations and exposures to off-balance sheet vehicles. This consultation package responds to an earlier set of proposals by the Basel Committee, not those in December, and is not expected to have a significant impact on ADIs, which largely avoided higher-risk activities.
The next stage in the reform process, over the first half of 2010, is a global quantitative impact study to assess the impact of the Basel Committee's reform proposals and to ensure that they are calibrated appropriately. This is important work. While the need for global reform is unquestioned, prudential regulators do not wish to introduce measures that impose an overall burden greater than the sum-of-the-parts, that would thwart global recovery efforts or would have unintended consequences. APRA is participating actively in this study and will be feeding in relevant information from a number of ADIs, to ensure that we understand fully the implications of the reform proposals for Australia.
The Basel Committee's reforms are intended to be finalised by the end of 2010 and to be phased in, when global economic recovery is assured, by the end of 2012. We in APRA therefore have a considerable amount of policy work ahead of us this year. I can assure this Committee that no decisions on implementing the final Basel reforms in Australia, or on our other reform initiatives in general and life insurance, will be taken without extensive consultation.
We are now happy to take the Committee's questions.