Combined Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Regulation Impact Statement
4.1 Regulation Impact Statements have been obtained for the Banking Act amendments relating to the 'fit and proper' requirements and the ADI reporting requirements.
Banking Act Amendments: 'Fit and Proper' Requirements
4.2 In April 2001, APRA released an Information Paper outlining its self-assessment of the Australian system of banking supervision against the Core Principles for Effective Banking Supervision, issued by the Basel Committee on Banking Supervision in October 1999. These 25 Core Principles provide an internationally accepted benchmark - the agreed set of minimum supervisory standards - against which the quality of a country's banking supervision system can be measured and assessed.
4.3 Overall, the self-assessment demonstrates that Australia's system of banking supervision is strong and stands up well against international standards (with a high level of compliance). However, a significant supervisory shortfall has been identified in the area of 'fit and proper' assessments of directors and senior management of ADIs where APRA considers Australia to be materially non-compliant with international best practice.
4.4 Among other things, the Basel Core Principles (Principle 3, essential criterion 7 and Principle 17, essential criterion 4) provide that banking supervisors should, as part of their licensing process and ongoing supervision of ADIs, evaluate ADI directors and senior management as to expertise and integrity (fit and proper test). The fit and proper criteria include: (1) skills and experience in relevant financial operations commensurate with the ADI's activities; and (2) no record of criminal activities or adverse regulatory judgements that make a person unfit to uphold important positions in an ADI.
4.5 At present, neither the Banking Act nor the ADI Prudential Standard contain any provision that addresses the 'fit and proper' status of directors and senior management of ADIs. Although APRA assesses the overall management quality of an ADI both at authorisation and in its ongoing supervision of the ADI, there is no formal 'fit and proper' test applied to individual directors or senior executives. Current arrangements require ADIs to notify APRA in advance of proposed changes of directors and to provide details of the individual's background (including qualifications, experience and associations); there are no similar requirements for changes in senior management.
4.6 In contrast, many countries (for example, US, Canada, UK and other European countries) have established minimum fit and proper criteria for bank directors and management that essentially address the competency and probity elements required by the Basel Core Principles. Further, overseas banking legislation typically contains provisions that give banking supervisors the power to: (1) require bank directors and senior management to provide relevant information as to their fit and proper status (for example, details of background, qualifications, criminal record, business associations, etc); (2) obtain information from third parties (for example, law enforcement agencies and other regulators) concerning the fit and proper status of bank directors and senior management; and (3) approve new appointments of bank directors and senior management, and remove existing directors and management from office, using a 'fit and proper' test.
4.7 The need for a more formal assessment of the fit and proper status of ADI directors and senior management has been recognised by APRA as part of its review of conglomerate supervision. In April 2000, APRA released a policy framework for the prudential supervision of conglomerate groups that include an ADI. The framework, among other things, outlined APRA's proposed approach to 'fit and proper' assessments of ADI directors and senior management (as well as directors and senior management of other members in a conglomerate group to which an ADI belongs).
4.8 Under the proposed 'fit and proper' framework, the Board of an ADI (and the Boards of other members in the conglomerate group to which the ADI belongs) is required to establish policies defining fit and proper standards for directors and senior management and to monitor compliance with those standards on an ongoing basis. These policies should be provided to APRA and disclosed in the ADI's (or the group's) full published annual reports. ADIs (and their group members) are also required to provide APRA with details of their directors and senior management and to notify it promptly of any changes in those personnel.
4.9 While the basis of the proposed approach is self-assessment, APRA reserves the right to require an ADI (or its group members) to remove any directors or senior management from their duties should it form the view that they are not 'fit and proper'.
4.10 Current supervisory practices for assessing the quality of ADI management are deficient in two key respects.
4.11 First, at present, there are no minimum fit and proper requirements for directors and senior management of ADIs. Under current arrangements, ADIs are allowed to apply their own fit and proper standards in the appointment of directors and senior management. ADIs are only required to notify APRA in advance of proposed changes of directors and to provide it with details of proposed new directors.
4.12 Since the fit and proper standards applied by ADIs vary across individual institutions, there is a risk that those occupying key roles within an ADI may not have the degree of probity and competence commensurate with their responsibilities. Without specifying any minimum fit and proper criteria for ADI directors and senior management (either in the Banking Act or in the ADI Prudential Standards), there is no explicit process by which APRA (and ADIs) can determine whether a person has met the required level of probity and competence for occupying the relevant position in an ADI. The absence of such requirements would also limit APRA's ability to disqualify certain persons (for example, those who have been convicted of an offence in respect of dishonest conduct or who have been bankrupt) from acting as directors or senior managers of ADIs and to remove any ADI directors and senior management from their duties should APRA have doubt about the fit and proper status of these personnel. The lack of a rigorous approach to 'fit and proper' assessments of ADI directors and senior management may expose depositors to greater risk of mismanagement in an ADI.
4.13 Consistent with overseas supervisory practices, APRA seeks to adopt a less prescriptive approach to the supervision of ADIs. Increasing reliance has been placed on the role of the Boards and senior management of ADIs. Consequently, it is important to ensure that directors and senior management of ADIs have the required level of probity and competence to conduct banking business with integrity, prudence and professional skills without prejudicing depositor interests.
4.14 While current arrangements have the benefit of providing ADIs with the flexibility to appoint directors and senior management by applying their own fit and proper standards, APRA cannot rely on self-assessment alone. APRA must have some reserve powers to allow it to prevent certain disqualified persons from acting as directors or senior managers of ADIs and to remove ADI directors and senior management from their duties when it has reason to doubt the probity and competence of these personnel.
4.15 Legislative support is essential for strengthening current supervisory arrangements in respect of 'fit and proper' assessments of ADI management. It would provide APRA with a stronger enforcement mechanism and greater incentive for ADIs (and the relevant personnel) to comply with the new requirements since non-compliance is an offence and would attract penalty charges.
4.16 Second, there is a lack of information on the fit and proper status of senior management in ADIs. Current arrangements do not require ADIs to notify APRA of changes in senior management, nor to provide it with details of the individual's background. Without such essential information, APRA cannot determine whether these personnel have the degree of probity and competence commensurate with their responsibilities (which is critical since they are responsible for day-to-day management of an ADI's operations).
4.17 The objectives of the proposed remedial action are to: (1) establish a flexible and cost-effective process by which the fit and proper status of directors and senior management of ADIs (and authorised NOHCs) can be determined; (2) ensure directors and senior management of ADIs (and authorised NOHCs) have the degree of probity and competence commensurate with their responsibilities; and (3) improve current arrangements in respect of 'fit and proper' assessments of ADI management and bring them into line with international standards.
4.18 Option 1: Maintain status quo (that is, continue to rely on the fit and proper standards applied by ADIs (and authorised NOHCs) in the appointment of directors and senior management).
4.19 Option 2: Amend the Banking Act to establish a statutory fit and proper regime for directors and senior managers of ADIs (and authorised NOHCs). This includes:
- (i)
- specifying minimum fit and proper requirements for directors and senior managers of ADIs (and authorised NOHCs) in the Banking Act (that essentially address the competency and probity elements required by the Basel Core Principles);
- (ii)
- providing APRA with the statutory power to require a person to provide information as to his/her fit and proper status and to obtain information from other parties (for example, law enforcement agencies, other regulators, etc) concerning the person's fit and proper status;
- (iii)
- approving appointment of directors and senior managers of ADIs (and authorised NOHCs) by APRA; and
- (iv)
- providing APRA with the statutory power to remove directors and senior managers of ADIs (and authorised NOHCs) from their position using 'fit and proper' tests.
4.20 Option 3: Allow ADIs (and other members in a conglomerate group to which an ADI belongs) to apply their own fit and proper standards (established by their Boards) in the appointment of directors and senior management. Issue new Prudential Standards to require ADIs (and their group members) to: (1) monitor compliance with these standards on an ongoing basis; and (2) notify APRA promptly of any changes in directors and senior management and to provide it with details of these personnel. Amend the Banking Act to:
- (i)
- specify that disqualified persons (i.e. persons who have been convicted of an offence against the Banking Act or in respect of dishonest conduct or who have been bankrupt) are not allowed to act as directors or senior managers of ADIs (and authorised NOHCs) unless APRA specifically revoked the disqualification, and that failure to comply with this requirement is an offence for both the disqualified person and the ADI (or authorised NOHC) concerned;
- (ii)
- provide APRA with the statutory power to direct an ADI (and authorised NOHC) to remove a director or senior manager from office if it is satisfied that the person concerned is a disqualified person or fails to meet fit and proper criteria set out in Prudential Standards; and
- (iii)
- provide for an external mechanism by which the person and the ADI (or authorised NOHC) concerned can appeal against APRA's decision with respect to a refusal to revoke the disqualification under (i) and a direction made under (ii) above.
4.21 Groups likely to be affected by the proposed action include: (1) depositors of ADIs (in respect of potential losses due to mismanagement in an ADI); (2) ADIs and authorised NOHCs (in respect of compliance costs); (3) directors and senior managers (existing and prospective) of ADIs and authorised NOHCs (in respect of fairness of APRA's judgement); and (4) APRA itself (in respect of administering the proposed fit and proper regime).
Assessment of Costs and Benefits
4.22 Option 1: (self-assessment)
Benefits:
4.23 This option allows ADIs (and authorised NOHCs) to apply their own fit and proper standards in the appointment of directors and senior management without being subject to any minimum fit and proper criteria established by APRA. This would enable ADIs (and authorised NOHCs) to appoint directors and senior management free from regulatory interference.
4.24 Since no formal 'fit and proper' tests would be applied to directors and senior management of ADIs (and authorised NOHCs), APRA would incur no administrative costs.
Costs:
4.25 Since the fit and proper standards applied by ADIs (and authorised NOHCs) vary across individual institutions, the absence of minimum fit and proper requirements would not ensure directors and senior management of these institutions have the degree of probity and competence commensurate with their responsibilities. With the adoption of a less prescriptive approach to the supervision of ADIs, increasing reliance has been placed on the role of the Boards and senior management of ADIs. It is therefore important to ensure that ADI directors and senior management have the required level of probity and competence to conduct banking business with integrity, prudence and professional skills without prejudicing depositor interests.
4.26 Without implementing a more formal approach to 'fit and proper' assessments of directors and senior management of ADIs (and authorised NOHCs), current supervisory arrangements would remain substantially below international standards. This would also expose depositors to higher risk of mismanagement in ADIs and greater potential losses.
4.27 Option 2: (establish a statutory fit and proper regime)
Benefits:
4.28 By establishing a formal 'fit and proper' test for directors and senior management of ADIs (and authorised NOHCs), this would enable APRA to determine whether these personnel have the required level of probity and competence for occupying the relevant position in an ADI (and authorised NOHC).
4.29 Since under this option appointment of directors and senior management by ADIs (and authorised NOHCs) would require APRA's approval, this would provide greater incentive for these institutions to comply with the minimum fit and proper requirements. Consequently, this would enable APRA to ensure that directors and senior management of ADIs (and authorised NOHCs) have the degree of probity and competence commensurate with their responsibilities.
4.30 With the implementation of a more formal process for assessing the fit and proper status of directors and senior management of ADIs (and authorised NOHCs), this would reduce the risk of mismanagement in ADIs and hence potential losses to depositors.
4.31 The new arrangements would also improve current supervisory practices for assessing the quality of ADI management (particularly 'fit and proper' assessments of directors and senior management of ADIs) and bring them into line with international standards.
Costs:
4.32 Since the proposed approach requires APRA to approve every appointment of directors and senior managers in ADIs (and authorised NOHCs), this would incur substantial administrative costs to APRA. Under this approach, APRA would be required to perform detailed 'background checks' on all prospective applicants in order to determine their fit and proper status - a task which would be tremendously resource-intensive. Assuming that each ADI would submit two applications to APRA for approval each year, with over 200 ADIs at present APRA would need to process at least 500 applications a year. This option would result in an inflexible approach to the 'fit and proper' assessment of an ADI's management.
4.33 The proposed approach would place the burden of proof on APRA in respect of the fit and proper status of directors and senior managers of ADIs (and authorised NOHCs). Instead, these institutions have the onus to ensure that those occupying key roles within the institution have the degree of probity and competence commensurate with their responsibilities. The approval process would increase the risk of moral hazard.
4.34 Since this option requires APRA's approval for any appointment of directors and senior managers in ADIs (and authorised NOHCs), this would incur additional compliance costs to these institutions. Assuming that each institution would need to submit two applications to APRA for approval each year, the increase in compliance costs would not be significant.
4.35 Under this option, APRA would have the power to approve appointment of directors and senior management in ADIs (and authorised NOHCs) and remove existing directors and senior managers of these institutions from office using 'fit and proper' tests. Since there is no external mechanism by which the person and the ADI (or authorised NOHC) concerned can appeal against APRA's decision, the proposed approach would undoubtedly be objected to by industry due to lack of accountability.
4.36 Option 3: (self-assessment supplemented by legislative power to disqualify unfit persons)
Benefits:
4.37 Compared to Option 2, Option 3 would provide a more flexible and cost-effective approach to 'fit and proper' assessments of directors and senior managers of ADIs (and authorised NOHCs).
4.38 APRA would incur lower administrative costs under this option than under Option 2 since there would not be any formal approval process. While ADIs (and authorised NOHCs) would be allowed to apply their own fit and proper standards in the appointment of directors and senior management, this option would provide APRA with some reserve powers to allow it to disqualify a person, where in its opinion, the person is not 'fit and proper'. This 'negative' test would enable APRA to have more flexibility to direct its resources at particular cases, rather than having to develop a systematic (and inevitably bureaucratic) process covering every relevant person of an authorised institution.
4.39 ADIs (and authorised NOHCs) would have the flexibility to appoint directors and senior managers by applying their own fit and proper standards. This would have the benefit of placing the onus on these institutions (rather than on APRA) to ensure that persons holding key positions are 'fit and proper'. This would also avoid the moral hazard associated with 'badging' people as officially approved.
4.40 The proposed approach would strengthen current supervisory practices in respect of 'fit and proper' assessments of directors and senior management of ADIs and bring them into line with international standards.
4.41 Since under this option there would be an explicit mechanism for the disqualified person and the ADI (and authorised NOHC) concerned to appeal against APRA's decision, this would adequately assure a transparent and fair 'fit and proper' regime.
Costs:
4.42 Since most institutions would have established some form of 'fit and proper' assessments of directors and senior management as part of their recruitment policies, compliance costs involved in implementing the proposed arrangements would not be significant for authorised institutions.
4.43 Key elements of the proposed 'fit and proper' regime (for example, self-assessment and APRA's power to disqualify unsuitable persons from acting as directors and senior managers of ADIs and authorised NOHCs) have been broadly agreed to by industry when APRA finalised its policy framework for the prudential supervision of conglomerate groups containing ADIs in April 2000.
4.44 Prior to the release of the policy framework, extensive industry consultations were carried out through the issue of two Policy Discussion Papers in March 1999 and November 1999 respectively. The consultation process has followed a Regulation Impact Statement like approach and focused on consumer benefits, cost-effectiveness and competitive neutrality. Numerous meetings have been held individually with institutions and industry bodies, including the Australian Bankers Association and the International Banks and Securities Association of Australia.
4.45 Option 1 would not achieve the stated objectives of the proposed remedial action. Although this option would enable ADIs (and authorised NOHCs) to appoint directors and senior management free from regulatory interference, the absence of minimum fit and proper requirements would not ensure these personnel have the degree of probity and competence commensurate with their responsibilities. The lack of a more formal approach to 'fit and proper' assessments of directors and senior management of ADIs (and authorised NOHCs) would leave current supervisory arrangements significantly below international standards. This would also expose depositors to higher risk of mismanagement in ADIs and greater potential losses.
4.46 Since APRA seeks to adopt a less prescriptive approach to the supervision of ADIs, increasing reliance has been placed on the role of the Boards and senior management of ADIs. It is therefore important to ensure that directors and senior management of ADIs have the required level of probity and competence to conduct banking business with integrity, prudence and professional skills without prejudicing depositor interests.
4.47 While Option 2 would achieve most of the stated objectives of the proposed remedial action compared to Option 1, it could not provide a flexible and cost-effective process for determining the fit and proper status of directors and senior management of ADIs (and authorised NOHCs). Since Option 2 requires APRA to approve every appointment of directors and senior managers in ADIs (and authorised NOHCs), this would incur substantial administrative costs to APRA. Obviously, implementing Option 2 would assure better protection of depositor interests. However, this assurance is based on an overly legalistic or bureaucratic approach, placing the burden of proof on APRA (rather than on the institutions themselves) to ascertain the fit and proper status of directors and senior managers of ADIs (and authorised NOHCs).
4.48 Overall, Option 3 is preferred since it represents a balanced approach compared to Option 1 and Option 2. This option would achieve all the stated objectives of the proposed remedial action. In particular, it would provide a more flexible and cost-effective process for assessing the fit and proper status of directors and senior management of ADIs (and authorised NOHCs).
4.49 Under this option, ADIs (and authorised NOHCs) would have the flexibility to appoint directors and senior management by applying their own fit and proper standards. This would have the benefit of placing the onus on these institutions (rather than on APRA) to ensure that persons holding key positions within the institution are 'fit and proper'. Since this option would not involve any formal approval by APRA, this would significantly reduce the administrative costs incurred by APRA than under Option 2. This would also avoid the moral hazard associated with 'badging' people as officially approved.
4.50 While Option 3 allows ADIs (and authorised NOHCs) to apply their own fit and proper standards in the appointment of directors and senior management, it would provide APRA with some reserve powers to allow it to disqualify a person, where in its opinion, the person is not 'fit and proper'. This 'negative' test would enable APRA to have more flexibility to direct its resources at particular cases, rather than having to develop a systematic (and inevitably bureaucratic) process covering every relevant person of an authorised institution.
4.51 Under this option, authorised institutions would still be subject to minimal (but not zero) intervention by APRA in the management decisions of owners and shareholders without prejudicing depositor interests.
4.52 APRA will develop Prudential Standards requiring the board of an ADI (and authorised NOHC) to establish policies defining fit and proper standards for directors and senior managers and to monitor compliance with these standards on an ongoing basis. These Standards will also require ADIs (and their group members) to notify APRA promptly of any changes in directors and senior management and to provide it with details of these personnel. The standards will address APRA's expectations as to minimum fit and proper criteria, ensuring the standards by which office holders will be judged are transparent.
4.53 Similar to the issuance of other ADI Prudential Standards, APRA will conduct extensive industry consultation on the draft standards prior to their implementation. APRA intends to review the proposed 'fit and proper' regime in consultation with industry after it has been put in place for two to three years to coincide with the review of fit and proper requirements for directors and senior managers of General Insurers (same approach has recently been adopted by APRA for General Insurers).
Banking Act Amendments: ADI Reporting Requirements
4.54 In April 2001, APRA released an Information Paper outlining its self-assessment of the Australian system of banking supervision against the Core Principles for Effective Banking Supervision, issued by the Basel Committee on Banking Supervision in October 1999. These 25 Core Principles provide an internationally accepted benchmark - the agreed set of minimum supervisory standards - against which the quality of a country's banking supervision system can be measured and assessed.
4.55 While the self-assessment shows that Australia's system of banking supervision is overall strong and stands up well against international standards (with a high level of compliance), it has identified shortcomings in current supervisory practices where improvements can be made to bring arrangements closer into line with international best practice. One of these shortcomings relates to reporting requirements for ADIs.
4.56 Among other things, the Basel Core Principles (Principle 17) provide that banking supervisors must have regular contact with ADI management and a thorough understanding of the institution's operations. One of the essential criteria (Principle 17, essential criterion 3) to achieve this is to require ADIs to notify banking supervisors of any substantive changes in their activities or any material adverse developments, including breaches of legal and prudential requirements.
4.57 Under existing arrangements, ADIs are expected to advise APRA of material changes in their activities and any material adverse developments. ADIs are also expected to advise APRA of any breaches of legal and/or prudential requirements. However, at present, there are no statutory provisions in the Banking Act that require ADIs to make such reporting to APRA. Although some Prudential Standards specifically provide for ADIs to inform APRA immediately of breaches or potential breaches of prudential requirements set out in the particular Standard (such as minimum liquidity holdings specified in the Liquidity Standard) and any concerns in respect of certain specified areas (such as credit quality and liquidity), there is no formal general requirement for ADIs to notify APRA of any breaches of Prudential Standards or licensing conditions, nor any material adverse developments. To improve compliance, APRA will need to consider whether it should place a statutory obligation on ADIs to report such matters to APRA.
4.58 In April 2000, APRA released a policy framework for the prudential supervision of conglomerate groups that include an ADI. The policy framework expanded the range of organisational structures which conglomerates may adopt. In particular, the framework specified arrangements for the use of NOHCs to head groups containing an ADI. It also liberalised the range of activities that could be carried out within a conglomerate group containing an ADI. This included permitting an ADI to be a member of a conglomerate group that involved non-financial businesses.
4.59 To permit ADIs to be associated with a wider range of activities and organisational structures, the policy framework established and/or refined prudential requirements relating to: (1) ownership and structures within a conglomerate group; (2) Board composition in NOHCs and in associated ADIs; (3) the application of 'fit and proper' tests for Board members and senior management; (4) the management of group relationships (branding of financial products, sharing of infrastructure, etc); and (5) the desirability of a group-wide focus on risk and risk management in a conglomerate.
4.60 Under this framework, authorised NOHCs or ADIs that head a conglomerate group are required to notify APRA immediately of any breaches of prudential requirements (whether by an ADI in the group or by the group) and any circumstances that might reasonably be seen as having a material impact and potentially adverse consequences for an ADI in the group or for the overall group. They are also required to advise APRA in advance of any proposed changes to the composition or operations of the group with the potential to materially alter the group's overall risk profile (this should include any proposed changes to the ADI's stand-alone operations). These requirements have been incorporated in the draft Prudential Standard, APS 222 - Associations with Related Entities, issued by APRA in December 2001 for industry comment.
4.61 With the introduction of the conglomerate policy framework, it is intended that any remedial actions proposed for improving ADI reporting requirements will need to cover an ADI on a stand-alone basis as well as the conglomerate group to which the ADI belongs.
4.62 At present, there is no formal requirement (either in the Banking Act or in the ADI Prudential Standards) for ADIs to report breaches of Prudential Standards or licensing conditions to APRA, nor to notify it of any material adverse developments. The Banking Act (subsection 13(3)) only requires an ADI to immediately inform APRA where it is unable, or is likely to be unable, to meet its obligations. Other than to report to APRA breaches of certain prudential requirements specified in particular Prudential Standards, ADIs have no obligation to provide information to APRA in respect of breaches of licensing conditions or other Prudential Standards or any material adverse developments (other than those required under specific Prudential Standards).
4.63 There are risks associated with current arrangements. Since ADIs are not subject to any general requirement to report to APRA any breaches of Prudential Standards or licensing conditions and any material adverse developments, there is no incentive for ADIs to provide information to APRA above those required by the Banking Act or the ADI Prudential Standards. As a result, APRA may not be fully informed of problems or potential problems being faced by an ADI which could ultimately affect the safety and soundness of the ADI. This is highly undesirable as it could hinder APRA acting promptly to require the relevant ADI to undertake immediate remedial measures in order to limit the impact of the problem at an early stage to protect depositor interests. Since ADIs are closely linked with each other in the banking system due to interbank transactions, this could also limit APRA's ability to confine or reduce potential repercussions the problem may have on other ADIs and their depositors at an early stage.
4.64 The objectives of the proposed remedial action are to: (1) improve current arrangements to bring them into line with international best practice; (2) enable APRA to act promptly to rectify problems; and (3) ensure the safety and soundness of the banking system.
4.65 Option 1: Maintain status quo (that is, continue to rely on the understanding between APRA and the ADI management that the latter should inform APRA immediately whenever there is any concern about the ADI's operations, including breaches of any prudential requirements).
4.66 Option 2: Issue new Prudential Standards for ADIs and for authorised NOHCs to require an ADI, authorised NOHC and their subsidiaries to notify APRA immediately of any breaches of Prudential Standards or licensing conditions, and any information with a material bearing on the safety and soundness of an ADI or a conglomerate group of which an ADI is a member.
4.67 Option 3: Amend the Banking Act to impose a statutory obligation on an ADI, authorised NOHC and their subsidiaries to notify APRA immediately of any breaches of Prudential Standards or licensing conditions, and any information with a material bearing on the safety and soundness of an ADI or a conglomerate group of which an ADI is a member.
4.68 Groups likely to be affected by the proposed action include: (1) depositors of ADIs (in respect of depositor protection); (2) ADIs, authorised NOHCs and subsidiaries of these institutions (in respect of compliance costs); and (3) APRA itself (in respect of effectiveness in administering the supervisory arrangements).
Assessment of Costs and Benefits
4.69 Option 1: (no action)
Benefits:
4.70 Since there are no new reporting requirements for ADIs, they would not be subject to any additional compliance costs.
Costs:
4.71 Since under current arrangements APRA may not be fully informed of problems or potential problems being faced by an ADI, this would limit APRA's ability to act promptly to reduce the impact of the problem on the ADI (including its depositors) and the banking system as a whole. Consequently, current arrangements would not allow APRA to effectively discharge its responsibility for the protection of depositor interests and the promotion of stability in the banking system.
4.72 Without implementing any remedial action to improve supervisory arrangements for ADI reporting, there is a risk that Australia would be judged by international banking agencies (such as IMF and World Bank) to fall short of international standards in this respect.
4.73 Since current reporting arrangements may limit APRA's ability to act promptly to deal with potentially troubled ADIs at an early stage, depositors would be exposed to greater potential losses than they need to should APRA be informed of the problem or potential problem immediately.
4.74 Option 2: (issue new Prudential Standards to specify new reporting requirements)
Benefits:
4.75 By imposing a general obligation on ADIs (and their group members) to notify APRA immediately of breaches of Prudential Standards or licensing conditions and any material adverse developments (affecting the stand-alone ADI or the group as a whole), APRA would be better informed of problems or potential problems being faced by an ADI (or the group to which the ADI belongs). This would enable APRA to act promptly to rectify problems and limit their potential adverse impact on depositors and the banking system as a whole.
4.76 The new reporting requirements would also bring current arrangements into line with international standards.
4.77 Since APRA would be able to deal with potentially troubled ADIs at an early stage under the new arrangements, the extent of a possible adverse impact on depositors could be reduced or limited as a result.
Costs:
4.78 ADIs (and their group members) would be subject to higher compliance costs due to additional reporting requirements. Since the new reporting requirements will also cover other members of a conglomerate group to which an ADI belongs, these costs would be substantial for ADIs having numerous companies within their group. Potentially, this would significantly affect five conglomerate groups (including the four major banking groups).
4.79 By implementing the new requirements, ADIs (and their group members) would be obliged to report any breaches of prudential requirements and any material adverse developments. Consequently, the number reporting to APRA would be higher than under current arrangements. With over 200 ADIs at present, this would incur additional (but potentially insignificant) administrative costs to APRA.
4.80 Given that the Banking Act only provides for APRA to make Prudential Standards for ADIs and for authorised NOHCs, the requirement for other members in a conglomerate group (other than ADIs and authorised NOHCs) to report breaches of prudential requirements and any adverse material developments may not be technically operative. APRA can only impose an obligation on ADIs and authorised NOHCs since APRA does not directly regulate other members in a conglomerate group.
4.81 Option 3: (impose a statutory obligation on ADIs and their group members to report certain matters to APRA)
Benefits:
4.82 While the benefits under Option 2 will also occur under Option 3, Option 3 would provide a stronger enforcement mechanism to APRA than Option 2. By imposing a statutory obligation on an ADI, its authorised NOHC and other members in a conglomerate group to which the ADI belongs, this could remove the doubt of applying the new reporting requirements to other group members under Option 2.
4.83 Option 3 would also provide greater incentive for ADIs (and their group members) to provide the required information to APRA than Option 2. This is because breach of a legislative requirement is an offence which would attract penalty charges and constitute grounds for revocation of an ADI (and NOHC) authority, while breach of a Prudential Standard is not an offence which would only allow APRA to issue a direction to an ADI (or authorised NOHC as appropriate).
Costs:
4.84 The compliance costs incurred by ADIs (and their group members) and the administrative costs incurred by APRA under Option 3 would be the same as Option 2.
4.85 The proposed requirements for ADIs (and their group members) to notify APRA immediately of breaches of Prudential Standards or licensing conditions and any material adverse developments (affecting the stand-alone ADI or the group as a whole) have been reflected in APRA's conglomerates policy framework released in April 2000.
4.86 Prior to the release of the policy framework, extensive industry consultations were carried out through the issue of two Policy Discussion Papers in March 1999 and November 1999 respectively. The consultation process has followed a Regulation Impact Statement like approach and focused on consumer benefits, cost-effectiveness and competitive neutrality. Numerous meetings have been held individually with institutions and industry bodies, including the Australian Bankers Association and the International Banks and Securities Association of Australia.
4.87 Overall, the consultation revealed broad agreement with the thrust of the conglomerates policy proposals outlined in the two Discussion Papers (including the proposed notification requirements).
4.88 Option 3 is APRA's preferred option. Compared to Option 1, Option 3 would allow APRA to be better informed of problems or potential problems being faced by an ADI (or the group to which the ADI belongs). Consequently, this would enable APRA to act promptly to rectify problems and limit their potential adverse impact on depositors and the banking system as a whole. Option 3 would also improve current supervisory arrangements for ADI reporting and bring them into line with international standards.
4.89 While both Option 2 and Option 3 could satisfy all the stated objectives of the proposed action and that the compliance costs incurred by ADIs (and their group members) and the administrative costs incurred by APRA would be the same under these two options, Option 3 is preferred since it would provide a more effective approach to address the identified problems.
4.90 Option 3 would provide a stronger enforcement mechanism to APRA than Option 2 as it would ensure applicability of the new reporting requirements to other members in a conglomerate group to which an ADI belongs. Option 3 would also provide greater incentive for ADIs (and their group members) to comply with the proposed requirements since non-compliance with a requirement of the Banking Act would attract penalty charges and constitute grounds for revocation of an ADI (and NOHC) authority, while breaches of Prudential Standards would only allow APRA to issue a direction to an ADI (or authorised NOHC as appropriate).
4.91 The proposed notification requirements (Option 3) will take immediate effect once the proposed Banking Act amendments are passed by Parliament. ADIs (and their group members) will need to exercise their own judgement in determining whether certain information that comes to their awareness would have a material bearing on the ADI (or the group as a whole) and hence warrant notification to APRA.
4.92 Since the proposed action is intended to improve current supervisory arrangements to bring them into compliance with international standards - the Core Principles for Effective Banking Supervision - developed by the Basel Committee on Banking Supervision, the proposed notification requirements will therefore be reviewed in due course in line with the review process for the Basel Core Principles.
4.93 A Regulation Impact Statement has also been obtained for the amendments relating to the Banking Act and the Insurance Act relating to the ADI and insurance entity reporting requirements. The Regulation Impact Statement follows.
Banking Act and Insurance Act Amendments: ADI and Insurance Entity Reporting Requirements
4.94 In April 2001, APRA released an Information Paper outlining its self-assessment of the Australian system of banking supervision against the Core Principles for Effective Banking Supervision, issued by the Basel Committee on Banking Supervision in October 1999. These 25 Core Principles provide an internationally accepted benchmark - the agreed set of minimum supervisory standards - against which the quality of a country's banking supervision system can be measured and assessed.
4.95 While the self-assessment shows that Australia's system of banking supervision is overall strong and stands up well against international standards (with a high level of compliance), it has identified shortcomings in current supervisory practices where improvements can be made to bring arrangements closer into line with international best practice. One of these shortcomings relates to reporting requirements for ADIs.
4.96 Among other things, the Basel Core Principles (Principle 17) provide that banking supervisors must have regular contact with ADI management and a thorough understanding of the institution's operations. One of the essential criteria (Principle 17, essential criterion 3) to achieve this is to require ADIs to notify banking supervisors of any substantive changes in their activities or any material adverse developments, including breaches of legal and prudential requirements.
4.97 In addition to international developments, it is one of APRA's goals to harmonise, where appropriate and practical, the prudential supervisory requirements of all APRA-regulated entities. For example, the Insurance Act was recently amended to introduce a legislative framework similar in structure to that applying to ADIs. To further progress this goal of harmonisation, it is also considered appropriate that any proposed amendments to the prudential framework for ADIs should be duplicated for general insurers, if it is practical to do so. It is considered appropriate that any legislative changes requiring ADIs to notify their prudential supervisors of any substantive changes in their activities or material adverse developments, including breaches of legal and prudential requirements should also be made to general insurance legislation.
4.98 Under existing arrangements, ADIs and general insurers are expected to advise APRA of material changes in their activities and any material adverse developments. ADIs and general insurers are also expected to advise APRA of any breaches of legal and/or prudential requirements. However, at present, there are no statutory requirements in the Banking Act or Insurance Act for ADIs or general insurers to make such reporting to APRA. Although some Prudential Standards specifically provide for ADIs and general insurers to inform APRA immediately of breaches or potential breaches of prudential requirements set out in the particular Standard (such as minimum liquidity holdings specified in the Liquidity Standard or reinsurance arrangements) and any concerns in respect of certain specified areas (such as credit quality and liquidity or certain whistleblowing requirements), there are no formal general requirement for ADIs or general insurers to notify APRA of any breaches of Prudential Standards or licensing conditions, nor any material adverse developments. A statutory obligation may need to be considered on ADIs and general insurers to report such matters to APRA.
4.99 In April 2000, APRA released a policy framework for the prudential supervision of conglomerate groups that include an ADI. The policy framework expanded the range of organisational structures which conglomerates may adopt. In particular, the framework specified arrangements for the use of NOHCs to head groups containing an ADI. It also liberalised the range of activities that could be carried out within a conglomerate group containing an ADI. This included permitting an ADI to be a member of a conglomerate group that involved non-financial businesses.
4.100 To permit ADIs to be associated with a wider range of activities and organisational structures, the policy framework established and/or refined prudential requirements relating to: (1) ownership and structures within a conglomerate group; (2) Board composition in NOHCs and in associated ADIs; (3) the application of 'fit and proper' tests for Board members and senior management; (4) the management of group relationships (branding of financial products, sharing of infrastructure, etc); and (5) the desirability of a group-wide focus on risk and risk management in a conglomerate.
4.101 Under this framework, authorised NOHCs or ADIs that head a conglomerate group are required to notify APRA immediately of any breaches of prudential requirements (whether by an ADI in the group or by the group) and any circumstances that might reasonably be seen as having a material impact and potentially adverse consequences for an ADI in the group or for the overall group. They are also required to advise APRA in advance of any proposed changes to the composition or operations of the group with the potential to materially alter the group's overall risk profile (this should include any proposed changes to the ADI's stand-alone operations). These requirements have been incorporated in the draft Prudential Standard, APS 222 - Associations with Related Entities, issued by APRA in December 2001 for industry comment.
4.102 With the introduction of the conglomerate policy framework, it is intended that any remedial actions proposed for improving ADI reporting requirements will need to cover an ADI on a stand-alone basis as well as the conglomerate group to which the ADI belongs.
4.103 As part of the Insurance Act reforms enacted last year, to commence in July 2002, general insurers and their subsidiaries will also operate under a similar NOHC framework. Under the Insurance Act, an authorisation in relation to a NOHC covers the body corporate (NOHC) and any general insurers that are subsidiaries of the NOHC. However, general insurers are not subject to conglomerate regulation.
4.104 At present, there is no formal requirement (either in the Banking Act, Insurance Act or in the Prudential Standards for ADIs and general insurers) for ADIs or general insurers to report breaches of Prudential Standards or licensing/authorisation conditions to APRA, nor to notify it of any material adverse developments. The Banking Act (subsection 13(3)) only requires an ADI to immediately inform APRA where it is unable, or is likely to be unable, to meet its obligations. Other than to report to APRA breaches of certain prudential requirements specified in particular Prudential Standards, ADIs have no obligation to provide information to APRA in respect of breaches of licensing conditions or other Prudential Standards or any material adverse developments (other than those required under specific Prudential Standards).
4.105 Section 49A of the Insurance Act requires the auditor or actuary of a general insurer, authorised NOHC or subsidiary to report to APRA if the person has reasonable grounds for believing that a general insurer, NOHC or subsidiary is, among other things, insolvent or at risk of becoming insolvent, or has failed to comply with the Prudential Standards or its respective conditions of authorisation.
4.106 There are risks associated with current arrangements. Since ADIs and general insurers are not subject to any general requirement to report to APRA any breaches of Prudential Standards or licensing/authorisation conditions and any material adverse developments, there is no incentive for ADIs or general insurers to provide information to APRA above those required by the Banking Act, Insurance Act or the Prudential Standards. As a result, APRA may not be fully informed of problems or potential problems being faced by an ADI or general insurer which could ultimately affect the safety and soundness of the ADI or general insurer. This is highly undesirable as it could hinder APRA acting promptly to require the relevant ADI or general insurer to undertake immediate remedial measures in order to limit the impact of the problem at an early stage to protect depositor and policyholder interests. Since ADIs are closely linked with each other in the banking system due to interbank transactions, this could also limit APRA's ability to confine or reduce potential repercussions the problem may have on other ADIs and their depositors at an early stage.
4.107 The objectives of the proposed remedial action are to: (1) improve current arrangements to bring them into line with international best practice; (2) enable APRA to act promptly to rectify problems; and (3) ensure the safety and soundness of the financial system.
4.108 Option 1: Maintain status quo (that is, continue to rely on the understanding between APRA and the ADI and general insurer management that the latter should inform APRA immediately whenever there is any concern about the ADI's or general insurer's operations, including breaches of any prudential requirements).
4.109 Option 2: Issue new Prudential Standards for ADIs, general insurers and authorised NOHCs to require an ADI or general insurer and respective authorised NOHC and their subsidiaries to notify APRA immediately of any breaches of Prudential Standards or licensing/authorisation conditions, and any information with a material bearing on the safety and soundness of an ADI (or a conglomerate group of which an ADI is a member) or a general insurer.
4.110 Option 3: Amend the Banking Act and the Insurance Act to impose a statutory obligation on an ADI or general insurer and respective authorised NOHC and their subsidiaries to notify APRA immediately of any breaches of Prudential Standards or licensing/authorisation conditions, and any information with a material bearing on the safety and soundness of an ADI (or a conglomerate group of which an ADI is a member) or general insurer.
4.111 Groups likely to be affected by the proposed action include: (1) depositors of ADIs (in respect of depositor protection); (2) policyholders of general insurers; (3) ADIs, general insurers, authorised NOHCs and subsidiaries of these institutions (in respect of compliance costs); and (4) APRA (in respect of effectiveness in administering the supervisory arrangements).
Assessment of Costs and Benefits
4.112 Option 1: (no action)
Benefits:
4.113 Since there are no new reporting requirements for ADIs or general insurers, they would not be subject to any additional compliance costs.
Costs:
4.114 Since under current arrangements APRA may not be fully informed of problems or potential problems being faced by an ADI or general insurer, this would limit APRA's ability to act promptly to reduce the impact of the problem on the ADI or general insurers (including their depositors and policyholders respectively) and the financial system as a whole. Consequently, current arrangements would not allow APRA to effectively discharge its responsibility for the protection of depositor and policyholder interests and the promotion of stability in the financial system.
4.115 Without implementing any remedial action to improve supervisory arrangements for ADI reporting, there is a risk that Australia would be judged by international banking agencies (such as IMF and World Bank) to fall short of international standards in this respect.
4.116 Since current reporting arrangements may limit APRA's ability to act promptly to deal with potentially troubled ADIs or general insurers at an early stage, depositors and policyholders would be exposed to greater potential losses than they need to should APRA be informed of the problem or potential problem immediately.
4.117 Option 2: (issue new Prudential Standards to specify new reporting requirements)
Benefits:
4.118 By imposing a general obligation on ADIs (and their group members) and general insurers (including authorised NOHCs and subsidiaries) to notify APRA immediately of breaches of Prudential Standards or licensing/authorisation conditions and any material adverse developments (affecting the stand-alone ADI or the group as a whole or a general insurer, authorised NOHC or subsidiaries), APRA would be better informed of problems or potential problems being faced by an ADI (or the group to which the ADI belongs) or general insurer. This would enable APRA to act promptly to rectify problems and limit their potential adverse impact on depositors and policyholders and the financial system as a whole.
4.119 The new reporting requirements would also bring current arrangements into line with international banking standards.
4.120 Since APRA would be able to deal with potentially troubled ADIs and general insurers at an early stage under the new arrangements, the extent of possible adverse impact on depositors and policyholders could be reduced or limited as a result.
Costs:
4.121 ADIs (and their group members) and general insurers (authorised NOHCs and subsidiaries) would be subject to higher compliance costs due to additional reporting requirements. Since the new reporting requirements will also cover other members of a conglomerate group to which an ADI belongs, these costs would be substantial for ADIs having numerous companies within their group. Potentially, this would significantly affect five conglomerate groups (including the four major banking groups). By implementing the new requirements, ADIs (and their group members), general insurers (authorised NOHC's and subsidiaries) would be obliged to report any breaches of prudential requirements and any material adverse developments. Consequently, the number reporting to APRA would be higher than under current arrangements. With over 200 ADIs and 152 general insurers at present, this would incur additional (but potentially insignificant) administrative costs to APRA. As general insurers do not operate under a conglomerate framework it would be expected that the compliance cost would be much lower than for ADIs. Given that the Banking Act only provides for APRA to make Prudential Standards for ADIs and for authorised NOHCs, the requirement for other members in a conglomerate group (other than ADIs and authorised NOHCs) to report breaches of prudential requirements and any adverse material developments may not be technically operative. APRA can only impose an obligation on ADIs and authorised NOHCs since APRA does not directly regulate other members in a conglomerate group.
4.122 Option 3: (impose a statutory obligation on ADIs and their group members and general insurers, authorised NOHCs and subsidiaries to report certain matters to APRA)
Benefits:
4.123 While the benefits under Option 2 will also occur under Option 3, Option 3 would provide a stronger enforcement mechanism to APRA than Option 2. With regards to ADIs, by imposing a statutory obligation on an ADI, its authorised NOHC and other members in a conglomerate group to which the ADI belongs, this could remove the doubt of applying the new reporting requirements to other group members under Option 2.
4.124 Option 3 would also provide greater incentive for ADIs (and their group members) and general insurers (including authorised NOHCs and subsidiaries) to provide the required information to APRA than Option 2. This is because breach of a legislative requirement is an offence which would attract penalty charges and constitute grounds for revocation of an ADI and general insurer (and NOHC) authority. A breach of a Prudential Standard is not an offence and would only allow APRA to issue a direction to an ADI or general insurer (or authorised NOHC as appropriate).
Costs:
4.125 The compliance costs incurred by ADIs (and their group members) and general insurers (authorised NOHCs and subsidiaries) and the administrative costs incurred by APRA under Option 3 would be the same as Option 2.
4.126 The proposed requirements for ADIs (and their group members) to notify APRA immediately of breaches of Prudential Standards or licensing conditions and any material adverse developments (affecting the stand-alone ADI or the group as a whole) have been reflected in APRA's conglomerates policy framework released in April 2000.
4.127 Prior to the release of the policy framework, extensive industry consultations have been carried out through the issue of two Policy Discussion Papers in March 1999 and November 1999. The consultation process has followed a Regulation Impact Statement like approach and focused on consumer benefits, cost-effectiveness and competitive neutrality. Numerous meetings have been held individually with institutions and industry bodies, including the Australian Bankers Association and the International Banks and Securities Association of Australia.
4.128 Overall, the consultation revealed broad agreement with the thrust of the conglomerates policy proposals outlined in the two Discussion Papers (including the proposed notification requirements).
4.129 At this stage, there has been no consultation with the general insurance industry on these proposals.
4.130 Statutory requirements under section 33 of the amended Insurance Act (commencing 1 July 2002) require industry consultation before making a Prudential Standard. This requirement could be met with the release of a draft Prudential Standard if option 2 was chosen.
4.131 If option 3 was chosen, draft legislation could be released for industry comment if this was deemed necessary.
4.132 Option 3 is APRA's preferred option. Compared to Option 1, Option 3 would allow APRA to be better informed of problems or potential problems being faced by an ADI (or the group to which the ADI belongs) or general insurers (as well as authorised NOHCs and subsidiaries). Consequently, this would enable APRA to act promptly to rectify problems and limit their potential adverse impact on depositors, policyholders and the financial system as a whole. Option 3 would also improve current supervisory arrangements for ADI reporting and bring them into line with international standards.
4.133 While both Option 2 and Option 3 could satisfy all the stated objectives of the proposed action and that the compliance costs incurred by ADIs (and their group members) and general insurers (including authorised NOHCs and subsidiaries) and the administrative costs incurred by APRA would be the same under these two options, Option 3 is preferred since it would provide a more effective approach to address the identified problems.
4.134 Option 3 would provide a stronger enforcement mechanism to APRA than Option 2 as it would ensure applicability of the new reporting requirements to other members in a conglomerate group to which an ADI belongs. Option 3 would also provide greater incentive for ADIs (and their group members) and general insurers (and NOHCs) to comply with the proposed requirements since non-compliance with a requirement of the Banking Act and Insurance Act would attract penalty charges and constitute grounds for revocation of an ADI and general insurer (and NOHC) authority, while breaches of Prudential Standards would only allow APRA to issue a direction to an ADI or a general insurer (or authorised NOHC as appropriate).
4.135 With respect to the Banking Act the proposed notification requirements (Option 3) will take effect once the proposed amendments are passed by Parliament. Likewise, with respect to the Insurance Act the proposed notification requirements (Option 3) will take effect once the proposed amendments are passed by Parliament.
4.136 ADIs (and their group members) and general insurers (including authorised NOHCs and subsidiaries) will need to exercise their own judgement in determining whether certain information that comes to their awareness would have a material bearing on the ADI (or the group as a whole) or general insurer and hence warrant notification to APRA.
4.137 Since the proposed action is intended to improve current supervisory arrangements to bring them into compliance with international standards - the Core Principles for Effective Banking Supervision - developed by the Basel Committee on Banking Supervision, the proposed notification requirements will therefore be reviewed in due course in line with the review process for the Basel Core Principles.