Wayne Byres, Chairman - A50 Australian Economic Forum, Sydney
Let me start with a warm welcome to everyone.
For those of you unacquainted with APRA, we are Australia’s prudential regulator. We’re responsible for the prudential oversight of:
- deposit-taking institutions – that is, banks, building societies and credit unions;
- life, general, and private health insurers; and
- superannuation funds (other than those which are self-managed).
All up, we supervise financial firms with a little over $5.5 trillion in assets, which represents around 3.5 times Australian GDP.
Our mandate is pretty simple (at least in concept, if not in execution): we’re tasked with making sure that the firms we supervise meet their financial promises to depositors, policyholders and fund members, and that the financial system overall is sound. If you’re familiar with similar agencies in other jurisdictions, our closest comparison – in structure, mandate and supervisory philosophy – would probably be the Canadian regulator, OSFI. We also have a similar model to those of a number of the Scandinavian prudential regulators.
I’ve been asked to discuss the current regulatory agenda in Australia, and I’ll start with banking since it is the biggest sector within the financial system and where we are the busiest.
Assets of the banking sector are around $4 trillion. The sector is dominated by the four major banks – which provide a full range of services and account for around three-quarters of banking sector assets – supplemented by a range of competitors focussing on particular areas of business. At the risk of over-simplifying the picture, the landscape is one of smaller domestic banks competing with the majors for retail and smaller corporate business, and branches of foreign banks competing for larger corporate and wholesale business.
Reflecting its largely domestic focus at a time when the Australian economy has been performing relatively well – beyond a notable presence ‘across the ditch’ in New Zealand, offshore exposures are relatively limited - the Australian banking sector has generated quite high and stable returns (particularly when compared with many foreign banking systems): over the past decade, the average RoE of the sector has been slightly under 15 per cent, and the industry’s RoE stayed in double digits even in the dark days of 2008 and 2009.
In the post-crisis period, this performance has been coupled with a clear strengthening of the sector’s balance sheet:
- deposit funding has increased as a proportion of lending;
- liquidity and maturity profiles have strengthened; and
- capital adequacy ratios are at historically high levels.
Given this audience, I should note that when compared internationally, and at face value, these capital ratios might look a little on the low side. But APRA has always imposed prudential requirements on the banking sector that are stronger, in selected areas, than the minimum requirements of the Basel framework. To give some sense of the impact of these domestic measures, we published a study last year that indicated that the CET1 capital ratios of the Australian major banks would be in the order of 300 basis points higher had they been measured on a more internationally-comparable basis. Nothing that has happened in recent years has led us to think this strategy has been anything other than a success: indeed, this underlying capital strength, coupled with strong and steady profitability, has undoubtedly been one of the reasons why the majors remain amongst the handful of AA-rated banking groups in the world.
Notwithstanding that broadly positive picture, the Government’s recent Financial System Inquiry (FSI) suggested a number of policy reforms to make the banking sector both more resilient and more competitive. These twin objectives, coupled with the ongoing reforms emanating from the Basel Committee, will occupy much of APRA’s banking policy agenda in the year ahead.
The FSI noted Australia’s dependence on foreign capital, and the significant role played by the banking sector in intermediating between foreign lenders and domestic borrowers: as a result, risks to the banking sector’s access to foreign funding have the potential to be highly disruptive. The FSI’s first recommendation was therefore that capital standards for Australian banks should be set such that their capital ratios are ‘unquestionably strong’, with a view to ensuring that, even during times of market stress and turbulence:
- foreign creditors retain their faith and confidence in Australian banks; while at the same time
- the potential for a call on public sector support is reduced.
Over the year ahead, we’ll be watching how the international capital framework is finalised with a view to establishing an ‘unquestionably strong’ and robust set of domestic capital requirements for Australian deposit-takers. The result of the changes in the pipeline will, in all likelihood, lift capital requirements somewhat higher, but still well within the capacity of the banking sector to absorb in an orderly fashion over the next few years.
While APRA doesn’t have a competition objective per se, we’re also mindful of the FSI’s desire for the banking sector to be more competitive. So we’ll be looking at policy choices that, where possible, add to the competitive dynamic of the industry when this doesn’t undermine prudential outcomes. Some of the changes we’ve already made, for example to risk weights for mortgages, are consistent with the FSI’s objective.
Two other areas of important banking policy reform are also worth briefly mentioning today.
- Those of you that follow banking will know the Financial Stability Board finalised a total loss absorbing capacity (TLAC) standard applicable to global systemically important banks (G-SIBs). No Australian bank has been designated a G-SIB, but the FSI suggested that Australia should implement a similar framework to reduce the potential for public sector support in the event of a failing Australian bank. We’ve commenced work on this issue but I’ve noted previously that this is an area of policy reform that requires a lot of careful thought, so we will hasten slowly.
- APRA will also be working with the Government to strengthen our failure management powers, as recommended by the FSI. Our current framework broadly aligns with international standards, but could nevertheless be strengthened to make sure that APRA has a strong and comprehensive suite of powers to help ensure a failure can be dealt with in as orderly a fashion as possible. We’ll also be seeking to make sure banks’ own recovery plans are enhanced at the same time.
The other significant part of the financial system, at least in terms of assets, is the superannuation sector. Total superannuation assets are around $2 trillion, or 1.2 times GDP. In superannuation, APRA’s primary focus is on governance and stewardship, given the sector is heavily based on defined contribution schemes where investment risk resides with the fund members.
Until recently, the superannuation industry was notable for the compulsory nature of contributions to provide a steady accumulation of new funds, and the resulting need to find appropriate investment opportunities for a rapidly expanding pool of money. It has provided a relatively large and important pool of savings for the Australian community and, for example, was an important source of new capital (for both financial and non-financial firms) during the financial crisis.
In more recent times, the demographic profile of members is beginning to see a sizeable proportion in retirement (the decumulation stage), resulting in the need for funds to review the implications that has for their investment strategy (for example, in relation to liquidity, risk appetite, and appropriate risk/return settings). It also requires, as the FSI noted, new thinking and innovation to respond to the paucity of investment and pension/retirement income products available to the community.
Overall, we expect the assets of the superannuation sector will continue to grow strongly, albeit perhaps less quickly than in the past as more members begin to draw down on their savings. The low return environment will also impact growth, as well as placing an increasing focus on investment management and administration fees. This is an area where there would seem to be scope for enhanced efficiency, and for the benefits of economies of scale to come to the fore. At the very least, the drive for more transparency about costs and fees will increase the need for products with higher-than-average costs to demonstrate they are delivering commensurately better-than-average outcomes.
Let me finish with a quick comment on the insurance sector. Here, the regulatory agenda for APRA is fairly light. We completely overhauled the capital adequacy framework for life and general insurance a few years ago, and the industry has transitioned to the new regime fairly smoothly. Notwithstanding recent declines in equity markets, the life sector continues to operate with a sizeable buffer over minimum capital requirements; the general and health insurance sectors had limited exposure to equities to begin with. Both the life and general insurance industries have, in recent times, had to grapple with adverse claims experience – general insurance from natural catastrophes and life insurance from higher-than-expected disability claims – but in neither case has the fundamental soundness of the industry been threatened.
I’ll stop here and, once you’ve heard from my fellow panellists, I’ll be happy to take any questions.
- Of that, the APRA-regulated sector accounts for a little under two-thirds.