What is prudential regulation?
APRA is known as Australia’s “prudential regulator”. But what does “prudential regulation” mean?
Put simply, prudential regulation is a legal framework focused on the financial safety and stability of institutions and the broader financial system.
As Australia’s prudential regulator, APRA is responsible for ensuring that the entities it regulates can, under all reasonable circumstances, meet the financial commitments they make to a core group of customers. As such, APRA is sometimes described as Australia’s financial safety regulator.
In supervising the financial services industry, APRA seeks to ensure that:
- deposits in banks, credit unions and building societies are safe and available when depositors need to access their money;
- insurance companies have the financial means to pay all legitimate claims to their policyholders; and
- superannuation fund trustees manage contributions in their members’ best financial interests.
Prudential regulators have traditionally focused on financial metrics, such as whether institutions hold enough capital and liquidity to cope with an economic downturn, and whether they are managing financial risks appropriately. Prudential regulators also seek to make sure banks have robust internal controls so that the services they offer are reliably available. Like its peers around the world, in more recent times APRA has increased its focus on non-financial issues such as poor leadership, weaknesses in remuneration practices, or a lack of accountability when things go wrong.
Importantly, prudential regulation is designed to prevent problems emerging, rather than providing a means to take action after harm is caused. The reason for this pre-emptive approach is that it’s wiser and less costly to prevent a crisis, or to mitigate its impact, than to clean up after the event.
APRA’s prudential framework
APRA’s regulatory requirements are laid out in its prudential framework, which has three pillars:
- Prudential Standards: These set out APRA’s minimum requirements in relation to capital, governance and risk management (although in most cases APRA doesn’t specify exactly how those outcomes must be achieved). They are legally binding, and APRA-regulated entities must comply with them.
- Prudential Guidelines: These provide direction to APRA-regulated entities, setting out practices and steps that entities can follow in order to comply with APRA’s prudential standards. They are not, however, legally binding.
- Reporting Standards: These dictate the data that regulated entities must report to APRA and when they must provide it. APRA’s reporting standards are legally binding.
Each industry that APRA regulates – that is, banking, insurance and superannuation – has specific prudential standards, prudential guidelines and reporting standards that apply to them. In addition, APRA has standards and guidelines that apply to multiple industries. These are known as cross-industry standards and cross-industry guidelines.
In practice, however, APRA is a supervision-led regulator, and most of its work is based on encouraging the entities it regulates to engage in better practices. You can find out more about how APRA regulates entities in the banking, insurance and superannuation industries here.
The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, private health insurers, friendly societies, and most members of the superannuation industry. APRA currently supervises institutions holding $6 trillion in assets for Australian depositors, policyholders and superannuation fund members.