Australia
Basel Core Principles for Effective Banking Supervision—Detailed Assessment of Observance

Australia has a very high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). The Australian banking system was more sheltered than a number of other countries and weathered the Global Financial Crisis relatively well. This was in part due to relative concentration of the system on a well performing domestic economy, but also due to a material contribution from a well-developed regulatory and supervisory structure. Notable strengths of the Australian supervisory approach rest in its strong risk analysis and on the focus of the responsibility of the Board. The Australian banking system however, is still vulnerable to continuing aftershocks of the financial crisis not least as banks? funding profiles could be a conduit of instability.

Abstract

Australia has a very high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). The Australian banking system was more sheltered than a number of other countries and weathered the Global Financial Crisis relatively well. This was in part due to relative concentration of the system on a well performing domestic economy, but also due to a material contribution from a well-developed regulatory and supervisory structure. Notable strengths of the Australian supervisory approach rest in its strong risk analysis and on the focus of the responsibility of the Board. The Australian banking system however, is still vulnerable to continuing aftershocks of the financial crisis not least as banks? funding profiles could be a conduit of instability.

I. Summary, Key Findings, and Recommendations

1. Australia has a very high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). The Australian banking system was more sheltered than a number of other countries and weathered the Global Financial Crisis relatively well. This was in part due to relative concentration of the system on a well performing domestic economy, but also due to a material contribution from a well-developed regulatory and supervisory structure. Notable strengths of the Australian supervisory approach rest in its strong risk analysis and on the focus of the responsibility of the Board. The Australian banking system however, is still vulnerable to continuing aftershocks of the financial crisis not least as banks’ funding profiles could be a conduit of instability.

2. The assessors saw many examples of high-quality initiatives and practices in the supervisory authority (APRA). APRA’s response to the global financial crisis has been to intensify its supervisory practices and to move to an early, and conservative, adoption of key aspects of the international regulatory reform agenda, especially the Basel III capital and liquidity framework. The reform agenda presents challenges of implementation for supervisors and firms alike but continued fragilities in the global system mean that continued development of supervisory standards and firm based practices in risk management and liquidity remain at a premium and continued efforts are needed to advance depth and intensity of the supervisory approach in liquidity. There are some aspects of the legislative framework which need to be addressed to ensure that APRA will be able to act in a fully effective and efficient manner should weaknesses emerge within the banking system or within individual institutions.

A. Introduction

3. This assessment of the current state of the implementation of the BCPs in Australia has been completed as part of a Financial Sector Assessment Program (FSAP) undertaken by the International Monetary Fund (IMF) during 2012. It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. Importantly, it is not intended to assess the merits of the important policy and implementation issue regarding several aspects of the international regulatory framework that are yet to be decided in international fora and in Australia. An assessment of the effectiveness of banking supervision requires a review of the legal framework, both generally and as specifically related to the financial sector, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on the major banks and banking groups, and their regulation and supervision, given their importance to the system.

B. Information and Methodology Used for Assessment

4. The Australian authorities agreed to be assessed according to the Core Principles (CP) Methodology issued by the Basel Committee on Banking Supervision (Basel Committee) in October 2006. The current assessment was thus performed according to a revised content and methodological basis as compared with the previous BCP assessment carried out in 2005. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met.

5. To assess compliance, the BCP Methodology uses a set of essential and additional assessment criteria for each principle. The essential criteria (EC) are the only elements on which to gauge full compliance with a core principle. The additional criteria (AC) are suggested best practices against which the Australian authorities have agreed to be assessed. Additional criteria are commented on but are not reflected in the grading. The assessment of compliance with each principle is made on a qualitative basis. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This is explained below in the detailed assessment section.

6. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with officials of APRA, the RBA, the Treasury and banking sector participants. The team met the industry association representing banks in addition to a number of domestic and non-domestic institutions, as well as detailed responses to additional questionnaires and facilitied access to supervisory documents and files.

7. The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided excellent cooperation, including extensive provision of documentation, at a time when many other initiatives related to domestic and global regulatory initiatives are in progress.

8. The standards were evaluated in the context of the Australian financial system’s sophistication and complexity. It is important to note that Australia has been assessed against the BCP as revised in 2006. This is significant for two reasons: (i) the revised BCP have a heightened focus on risk management and its practice by supervised institutions and its assessment by the supervisory authority; and (ii) the standards are evaluated in the context of a financial system’s sophistication and complexity.

9. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team.1 Banking systems differ from one country to another, as do their domestic circumstances. Furthermore, banking activities are undergoing rapid change after the crisis, prompting the evolution of thinking on and practices for supervision. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Australian authorities with an internationally consistent measure of the quality of its banking supervision in relation to the revised Core Principles, which are internationally acknowledged as minimum standards.

10. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and non-applicable. An assessment of “compliant” is given when all essential criteria are met without any significant deficiencies, including instances where the principle has been achieved by other means. A “largely compliant” assessment is given when there are only minor shortcomings, which do not raise serious concerns about the authority’s ability to achieve the objective of the principle and there is clear intent to achieve full compliance with the principle within a prescribed period of time. A principle is considered to be “materially noncompliant” in case of severe shortcomings, despite the existence of formal rules and procedures and there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle is assessed “noncompliant” if it is not substantially implemented, several essential criteria are not complied with, or supervision is manifestly ineffective. Finally, a category of “non applicable” is reserved (though not used) for those cases that the criteria would not relate to the Australian authorities.

11. For completeness’ sake, it should be noted that the ratings assigned during this assessment are not directly comparable to the ones assigned in terms of an FSAP performed using the pre-2006 BCP Methodology. Differences may stem from the fact that the bar to measure the effectiveness of a supervisory framework was raised by the 2006 update of the BCP Methodology, as well as by lessons drawn from the financial crisis that may have a bearing on supervisory practices.

C. Institutional and Macroeconomic Setting and Market Structure—Overview2

12. Australia’s financial sector is large and mature with assets totaling 330 percent of GDP. The financial sector has grown rapidly over much of the last two decades, and two types of assets have contributed significantly to its growth, i.e., home mortgages and superannuation funds (a retirement scheme comprising mandatory contributions by employers and voluntary and tax-concessional contributions by employees). ADIs, mostly banks, are the dominant group of financial institutions with 60 percent of financial sector assets, followed by superannuation funds (including investment-linked superannuation written by life insurance companies) with 25 percent. The non-life insurance sector is relatively small with 3 percent of financial sector assets, and non-superannuation managed funds have another 6 percent. The stock market had a capitalization of 80 percent of GDP at end-2011, although this was below the peak of 150 percent in mid-2007.

13. Australia’s financial sector faces a unique set of risks. Its concentrated banking sector dominated by four large banks with broadly similar business models and reliance on offshore funding, reflects long standing structural issues that will remain key sources of risk over the medium-term. Against a pessimistic global environment, these risks will need to be closely managed, particularly if the domestic economy slows sharply.

14. Profitability of the Australian banking system remains strong and the banking system is well-capitalized. The four major Australian banks reported aggregated after tax profits of $11 billion in the year ended June 2012, up 1 percent from the previous year. The return on equity for the major banks has remained steady over the past two years at 15 percent. Australian ADIs have been increasing regulatory capital in advance of the implementation of Basel III from 2013. APRA has taken a more conservative stance in certain areas than is required by the BCBS standards, including requiring banks to maintain higher quality capital (in terms of deductions) and to meet an accelerated timetable for meeting minimum requirements for Tier 1 capital). As of June 2012, the aggregate Tier 1 capital ratio for Australian banks was 10.5 percent of risk-weighted assets, up from 8.5 percent in 2009. The total capital ratio was 11.8 percent as of June 2012.

II. Preconditions for Effective Banking Supervision

A. Sound and Sustainable Macroeconomic Policies

15. Five years after the U.S. sub-prime debacle triggered the global financial crisis (GFC), the Australian economy continues to thrive and the outlook remains favorable. Australia is one of the few advanced economies to avoid a recession, in part because of strong fundamentals at the onset of the crisis. Growth dipped only briefly below trend during the crisis and rebounded quickly, supported by robust demand for commodities from China, which fueled a mining boom and pushed the terms of trade to 60-year highs. As a result, the current account deficit fell to about 2½ percent of GDP in the first half of 2011 from an average of 4½ percent for the previous 15 years. The economy and the financial sector continue to outperform most of the country’s peers with the economy expected to grow close to trend at 3-3.5 percent annually in 2012 and 2013. Inflation, meanwhile, is expected to remain subdued and well within the authorities’ target band of 2-3 percent over the medium term and the government has made returning to surplus by 2012/13 a major policy priority. In addition, unlike many other advanced economies, Australia’s monetary policy space is still sizable an doutput is close to potential.

B. A Well-Developed Public Infrastructure

16. Policy coordination and cooperation between Australia’s four main financial sector agencies is supported mainly through the Council of Financial Regulators (CFR). The CFR is the primary coordinating body for Australia’s main financial sector agencies: the RBA (Chair), APRA, ASIC, and Treasury. The CFR’s objectives are specified in its Charter and require it to promote the stability of the Australian financial system and to contribute to the efficiency and effectiveness of financial regulation. The CFR does not have a legal personality, nor does it have powers separate from its member agencies. Its members share information and views and advise the Government on Australia’s financial system architecture. APRA and the RBA both have mandates for financial stability and have legal gateways to share institution-level data that is needed for them to carry out their respective duties.

17. A significant area of regulatory cooperation is the Trans-Tasman Council on Banking Supervision (TTBC). The TTBC comprises representatives of the Australian and New Zealand Treasuries, the RBA, the Reserve Bank of New Zealand, and APRA. Trans-Tasman cooperation has been enhanced by legislation passed in 2005 by Australian and New Zealand parliaments. These laws implement reciprocal obligations that require APRA and the Reserve Bank of New Zealand to support the other agency in meeting its statutory responsibilities for prudential regulation and financial stability. These laws also oblige the regulators to seek to avoid actions, where reasonably practicable, that are likely to be detrimental to the other country’s financial stability. In 2010, the TTBC agencies, along with ASIC, signed a Memorandum of Cooperation on the management of trans-Tasman bank distress and in 2011, the TTBC started developing guidance on the joint resolution of distress in a trans-Tasman bank.

18. The common law system, as developed in the United Kingdom, forms the basis of Australian jurisprudence. The Australian Constitution of 1901 established a federal system of government, under which powers are distributed between the Commonwealth and the six States. It defined exclusive powers (investing the federal government with the exclusive power to make laws on matters such as trade and commerce and taxation). The states and territories have independent legislative power in all matters not specifically assigned to the federal government. Where there is any inconsistency between federal and state or territory laws, federal laws prevail. Federal laws apply to the whole of Australia. In effect, Australia has seven legal systems—the six state and territory systems and one federal system. Each of the federal and state systems incorporates three separate branches of government—legislative, executive and judicial. The Constitution grants the legislative power to Parliament. Proposed legislation must be passed by both Houses of Parliament—the Senate and House of Representatives. Only Parliament can pass Acts to create statute law, but these Acts often confer on the Executive the power to make regulations, rules and by-laws pursuant to the particular Acts. The executive government administers the laws which the judiciary independently interprets and applies.

19. There is a strict separation between the Judiciary and the Parliament and Executive. Only courts can exercise the judicial power of the Commonwealth to decide whether a person has contravened a law of the Commonwealth Parliament. Dispute in Australia can be settled through the judicial system. The High Court decides disputes concerning the meaning of the Constitution and is also the final court of appeal. The Australian legal system provides for enforcement of the judgments of Australia courts, including by courts in a different state form which a judgment was made. A foreign judgment has no inherent legal force in Australia. Therefore, to enforce a foreign judgment an applicant must seek recognition and enforcement under either the common law or a statutory regime. The Foreign Judgments Act 1991 provides a statutory regime for the recognition and enforcement of certain foreign judgments. Where the Act does not apply, the common law governs the recognition and enforcement of foreign judgments. Australia has a number of options available for alternative dispute resolution. These include mediation, conciliation, conferencing, neutral evaluation and arbitration. In Australia there is generally no requirement to undertake alternative dispute resolution before seeking court resolution.

20. Australia has implemented International Financial Reporting Standards (IFRS). Accounting standards in Australia are made by the Australian Accounting Standards Board (AASB). The AASB’s role changed following adoption of the International Financial Reporting Standards (IFRS) in Australia as it is now involved in the International Accounting Standards Board’s IFRS standard-setting process. The AASB reviews IFRS text to ensure they are appropriate for Australia and issues Australian equivalent A-IFRS which apply to Australian companies with the force of law. The Financial Reporting Council, which is the body for responsible for overseeing the effectiveness of the financial reporting framework in Australia, provides oversight of the AASB’s activities. There is a full range of high-quality accountancy, audit, legal, and ancillary financial services available in the jurisdiction.

C. Effective Market Discipline.

Australia’s corporate financial reporting requirements are contained in the Corporations Act. Australian auditing standards are made by the Auditing and Assurance Standards Board (AUASB) and are based on the International Auditing and Assurance Standards Board.

21. Australia has a well-developed capital market. Its stock exchange, ASX, functions primarily as a trading operator, clearing house and settlements system facilitator. It oversees compliance with its listing rules, promotes standards of corporate governance among listed companies and seeks to educate retail customers. It places particular emphasis on transparency and disclosure. Overall, capital markets corporate governance systems comply with the OECD Principles of Corporate Governance. The listed equity market is quite active with over 2,200 companies listed on the exchange. Its debts market is relatively underdeveloped and its over-the-counter market, though active, is small by international standards.

D. Financial Sector Safety Net

22. The Reserve Bank of Australia plays a key role in managing and providing liquidity to the financial system. It is the ultimate provider of liquidity to the financial markets. As well as fostering lower inflation and sustainable growth, it also seeks to ensure that the payment system is safe and robust. It also plays a key role in developing a framework for dealing with financial institutions in distress. It chairs the CFR. The objectives of the Council include the promotion of the stability of the Australian financial system and to contribute to the efficiency and effectiveness of financial regulation.

23. A Financial Claim Scheme was established in October 2008 for authorized deposit-taking institutions (ADIs) and general insurers. The FCS is a deposit protection scheme which provides for prompt access to deposits if they fail. The FSC is activated for an ADI when APRA has determined that the ADI is insolvent and has applied to the Court to be wound up. The maximum payout to a depositor is $250,000 (it had been $1 million between 2008 and 1 February 2012 to foster confidence in the banking system). The FCS is ex-post funded, so, , payouts will initially come from the Government but any eventual shortfall will be met by a levy on the industry.

E. Main Findings

Objectives, independence, powers, transparency, and cooperation (CP1)

24. APRA has clear responsibility for the supervision of banks in Australia. While Australia classifies APRA as an independent statutory authority, there are two areas where there is the potential for APRA’s independence to be compromised. One relates to the fact that the Minister may give APRA a written direction about policies it should pursue, or priorities it should follow, in performing or exercising any of its functions or powers. Such a direction may only be given once the Minister has given APRA notice in writing of the proposed direction, and given the Chair of APRA an adequate opportunity to discuss with the Minister the proposed direction. Further, where a direction is given, that direction must be laid before each House of Parliament within 15 sitting days. The second relates to the fact that prudential regulations made by APRA must be tabled in each House of Parliament. After the prudential standards have been laid before each House, a notice of motion to disallow the prudential standards may be given within 15 sitting days. If the notice of motion to disallow is then passed within 15 sitting days after the giving of the notice, the regulations will cease to have effect, APRA has said that neither of these provisions has ever been invoked and that they are not likely to be. Nonetheless, they have the potential to compromise the independence of APRA.

25. There is no provision mandating the public disclosure of the specific reasons for the termination of the appointment of APRA Members (i.e., its governing body).

26. The membership of APRA’s Risk Management Committee and Audit Committee membership comprises both internal and external members. It is recommended that a separate audit committee be established whose membership would comprise external members only.

Licensing and structure (CPs 2–5)

27. The Australian regulatory approach regarding licensing and control are broadly appropriate and clearly articulated. There remain, however, some areas where adjustments are needed. Australian law permits the existence of non-authorized, non-supervised financial companies who are carrying out deposit like activities. While the number of such institutions is small and the scale of their activities is mostly de minimis, there are major global institutions benefitting from this exemption and deposit like facilities are being offered to the public. At present, APRA is subject to an unnecessary reputational risk arising from this source.

28. There is some degree of legal restriction on APRA’s powers concerning the right to object to or prevent a change of control of an ADI. The Treasurer, rather than APRA, has the power of approval for change of control for ADIs whose asset-size exceeds one billion. The Treasurer is legally responsible for approving the holding of a stake in any ADI in excess of 15 percent. The Treasurer has delegated approval authority to APRA in cases where the ADI’s assets are less than $1 billion, and the Treasurer takes advice from APRA in relation to ADI’s with assets are greater than $1 billion. Although there is no indication that the Treasurer would fail to abide by advice from APRA where the supervisor had concerns, it would support the clarity of APRA’s responsibilities for it to be given a binding right of veto on prudential grounds concerning change of control of ADIs irrespective of the scale of the entity.

Prudential regulation and requirements (CPs 6–18)

29. Australia has historically adopted a very conservative definition of capital. This stance is being maintained with the advent of the revised Basel III capital framework as APRA intends to remain super-equivalent to the Basel standard. This means that the capital levels in Australian banks can appear low relative to their peers, so it is important for the supervisor and the industry to press for strong and comparable disclosure standards so that the capital strength of the Australian banking sector can be accurately assessed and compared with the global community.

30. APRA undertakes a well-structured Pillar 2 assessment. However, while APRA reviews the firms’ Pillar 2 assessments (ICAAPs) it does not use this input as the sole or main determinant of the minimum level of capital that banks must hold. Instead APRA places greater weight upon its PAIRS rating methodology as an input. This choice reflects a number of factors including the supervisor’s view that the ICAAP process in banks is not sufficiently mature or robust to act as the sole determinant of the capital level. APRA continues to focus effort on the improvement of the banks’ ICAAP assessments. Banks are required to hold capital above the minimum level prescribed by APRA, but the size of the buffer is at the firm’s individual discretion.

31. APRA’s supervisory approach is based squarely on the premise that risk management stems from the Board’s responsibilities for management and oversight. The processes and procedures embedding good risk management within the banks are still undergoing seasoning, however, and not all firms have achieved the same level of art. Broadly, while progress is being made throughout the industry, firms need to strengthen their work on relating risk to capital. Stress testing practices need further development.

32. Credit risk management, including impaired assets and provisioning are well developed in Australia. APRA keeps track of emerging credit risk issues on an industry wide basis, through its risk register and this aids assessment of sectorial concentrations. There is well established policy on large exposures which is being reviewed. In the context of a highly concentrated banking system, there is a tension between cautious prudential limits for the interbank market and the practical options open to institutions which APRA must consider. Similarly appropriate limits with respect to sovereign risk must be assessed in the context of the forthcoming Basel III liquidity framework which will generate concentrations. With the exception of domestic exposure, sovereign risk is not a major feature of the banking system but, despite its low levels, APRA monitors country risk and has given direction to industry during the Global Financial Crisis.

33. A notable feature of the Australian banking system at the time of the assessment is a significant exposure to overseas wholesale funding. Consequently the natural focus of much of APRA’s analytical work and engagement with the industry has been upon funding issues. Nevertheless, APRA must guard against too narrow a focus on the funding dimension of liquidity risk. Work undertaken in recent years to review liquidity standards, including contributing the Basel III work, and intensifying off-site data analysis needs to continue.

34. A comprehensive regime for the oversight of money laundering and terrorism financing has only been relatively recently introduced. Some banks, therefore, have yet to introduce a sufficiently advanced technology system that would eliminate possible errors using less sophisticated means.

Methods of ongoing banking supervision (CPs 19–21)

35. APRA has a thorough understanding of the operation of individual banks and the banking system. APRA operates a risk based supervisory model which is informed by a peer review process and supported by an extensive and flexible information technology system. The rating methodology used in the risk assessment itself is supported by internal guidance and ratings criteria which are subject to regular review and update. The ratings criteria provide a mix of concrete and judgmental factors, the latter of which puts a premium on the skill set of staff to ensure the exercise of sound supervisory discretion. As in other jurisdictions, continued evolution of the risk methodology to enhance its forward looking dimension will be important. Much of APRA’s activity seeks to embed a common approach to banking and insurance sectors and this is notable in the issuance of joint prudential standards where possible (e.g., corporate governance). APRA is therefore well placed to analyze the relationship of risks between these sectors and should begin to focus more on this area. The development of the “Level 3” (conglomerate) approach should be used as a platform to stimulate such work.

36. While APRA conducts a well planned and well executed approach to on and off-site supervision the resource allocation to on-site reviews is modest. The frequency and intensity of direct on-site supervision with the institutions has been increased since the GFC and at a minimum this heightened level needs to be maintained. As a matter of importance, APRA should consider extending the duration of its on-site reviews to ensure that it is able to fully scrutinize the institution’s own understanding and risk management practices.

Accounting and disclosure (CP 22)

37. Accounting and Auditing Standards are set to a very high standard in Australia and are based on best international practice. They are also implemented to a high standard. On the Accounting front, IFRSs were introduced in 2005 and Australia has also adopted the audit standards promulgated by the International Auditing and Assurance Board.

Corrective and remedial powers of supervisors (CP 23)

38. APRA has a wide range of supervisory tools to deal with problems arising in banks. These range from seeking to resolve the problem through standard supervisory actions, to appointing a person to investigate and report on financial matters, issuing directions which embrace a wide set of powers (e.g., directing banks to cease or curtail business), removing directors, senior management or auditors, effecting a compulsory transfer of business, revoking a license.

Consolidated and cross border banking supervision (CPs 24–25)

39. APRA meets the requirements for effective consolidated supervision. APRA meets the standard in terms of overseeing group risk management structures, being informed of breaches of prudential standards on a group-wide basis, calculating the necessary ratios on a solo and consolidated basis, etc. APRA should consider extending the scope of its reviews to cover risks unique to non-banking activities carried on within the group, e.g valuation of assets/pricing of units in the case of fund management.

40. Table 1 below offers a principle-by-principle summary of the assessment results.

Table 1.

Summary Compliance with the Basel Core Principles—Detailed Assessments

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Aggregate: Compliant (C) – 20, Largely compliant (LC) – 9, Materially noncompliant (MNC) – 1, Noncompliant (NC) – None (note: CP 1 is divided into six component for this analysis.)

III. Recommended Action Plan and Authorities’ Response

Recommended action plan

41. Table 2 lists the suggested steps for improving compliance. Recommendations are proposed on a prioritized basis.

Table 2.

Recommended Action Plan to Improve Compliance with the Basel Core Principles3

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Authorities’ response to the assessment

42. The Australian authorities wish to express their appreciation to the IMF and its assessment teams for their assessment. Australia is strongly committed to the FSAP process and the insights that the FSAP provides into a country’s financial sector. Australia acknowledges that it is important to continually review and seek to improve the regulatory framework and supervision practices.

43. The Australian authorities share the view expressed in the report that Australia has a very high level of compliance against the Basel Core Principles. There are some ratings, however, with which the Australian authorities disagree.

44. Importantly, the Australian authorities consider that any assessment of a country’s supervisory framework should appropriately reflect the outcomes of that framework. The strength of Australia’s banking system—particularly in the face of the global financial crisis—demonstrates the robustness of Australia’s supervisory approach.

45. The Australian authorities consider that there are some principles for which the rating does not reflect the strengths and performance of Australia’s supervisory approach or where the issues raised are more theoretical than reflective of actual deficiencies in practice or outcomes. These include the following Core Principles:

  • CP 3 Licensing criteria. The IMF has recommended that APRA evaluate proposed directors and senior management as to expertise and integrity at point of authorisation, on a complete and systematic basis, independently of the information provided by the institution. APRA undertakes its role as gatekeeper very seriously. It subjects licence applications, including proposed directors and senior management, to a comprehensive and thorough evaluation process, which includes independent checks (including reference to the home supervisor) as required. Licensing involves an iterative evaluation process commonly taking up to 18 months. APRA would not authorise a bank where there are unresolved concerns in any area including the fitness and propriety of an applicant’s directors or senior management. The Australian authorities are not aware of the assessment finding any evidence of deficiencies in the outcomes of APRA’s robust licensing process.

  • CP 7 Risk management. The IMF has assessed Australia as ‘Largely Compliant’ on the basis that not all banks have achieved an appropriate standard of risk management, particularly in relating risk to capital. This is an assessment of the performance of Australian banks not of the supervisor or supervisory regime, an interpretation of CP 7 that, in the view of the Australian authorities, the IMF does not appear to have applied consistently. The Australian authorities have strong reservations about this interpretation and the resulting assessment. Achievement of strong practice in risk management is evolutionary; it goes to the heart of the role of a prudential supervisor to raise the risk management bar. APRA will continue to push banks to better practice, and where it is not satisfied with the adequacy of a bank’s risk management, it has taken and would take action.

  • CP 11 Exposure to related parties. The assessment finds a narrow gap in the current prudential framework in this area. However, the assessment finds no evidence of issues in practice and does not recognise that APRA’s supervisory framework and powers ensure that any issues that may arise in this area are identified and pursued.

  • CP 14 Liquidity. In Australia’s view, APRA’s comprehensive approach to supervision of liquidity risk meets the requirements of this Core Principle. The Australian authorities are concerned, in particular, that the IMF has taken a narrow definition of ‘on-site reviews’ and has discounted the breadth and frequency of APRA’s interactions with banks in relation to liquidity risk. These interactions ensure that APRA has a comprehensive understanding of all aspects of liquidity risk management. Further, the assessment does not recognise that banks are able to provide accurate liquidity data, on a daily basis if required. In the context of the new Basel III liquidity standards, the format of the prudential reporting requirements for liquidity—including daily reporting capacity—will be standardised.

  • CP 18 Abuse of financial services. The IMF has stated that the need for increased technology is the basis for the ‘largely compliant’ rating on this principle. It is suggested that increased technology is needed to prevent the banks from being used, intentionally or unintentionally for criminal activities. The Australian authorities observe that the banks are directing significant resources to system improvements for AML/CTF and other monitoring and control purposes, for example the US FATCA requirements. Within this context, the authorities are generally comfortable with the pace of technology upgrade by the banks. Although some of these improvements are still in train, the authorities do not believe that the ongoing nature of these upgrades is impeding the ability of banks to satisfy the essential criteria of this core principle.

  • CP 24 Consolidated supervision. The Australian authorities consider that the essential criteria are met through APRA’s supervisory practices. As a matter of course, APRA evaluates the risks that non-banking group activities may pose to the bank or banking group. Consistent with its risk-based approach to supervision, APRA can, and does on a routine basis, conduct on-site reviews of such activities where they are material to the bank or banking group. In many cases, non-banking activities are either immaterial or conducted in entities that have little capacity to impact on the overall soundness of the banking group. The Australian authorities do not consider that on-site reviews of these entities as a matter of course is necessary or required by CP 24.

46. The Australian authorities have serious concerns about the justification for the ‘Materially Non-Compliant’ rating on CP 4 Transfer of significant ownership. This rating is intended to apply ‘in the case of severe shortcomings, despite the existence of formal rules and procedures and where there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance’. The issues raised by the assessment do not appear to be consistent with this definition. Most importantly, the practical outcomes of the Australian approach in this area are acknowledged as not having led to material shortcomings. Key factors are longstanding Government policy ruling out takeovers or potential mergers among the four major banks, and the philosophy underpinning the Financial Sector (Shareholdings) Act 1998. The former reflects the structure of the Australian banking system and the prominence of the four largest banks. With respect to the latter, Australian Governments have long supported the general principle of a diversity of ownership to ensure the risks associated with a concentration of ownership are minimised. Taken together, the Australian authorities, including APRA, exercise effective control over the risks associated with the transfer of significant ownership of Australian banks. The recommendation that APRA be given the legal right to prevent a change of control of any bank on prudential grounds would amount to giving APRA a power of veto over the Government itself (rather than over another authority), which would run counter to a fundamental principle of Parliamentary sovereignty.

47. Finally, the Australian authorities have concerns about the assessment for CP 1 Objectives, autonomy, powers and resources. The IMF has made a number of recommendations in respect of CP 1.2 to, ‘ensure unambiguous independence within APRA.’ The Australian authorities agree with the need for an independent supervisor and are of the view that APRA is already unambiguously independent. APRA is established as a statutory authority, at arm’s length from Government and with substantial statutory and operational independence, including extensive powers to determine prudential standards. There is no evidence, past or present, of any Government or industry interference that compromises APRA’s operational independence.

48. The IMF, under CP 1.3 has also recommended that APRA be provided with sufficient delegated powers to issue prudential regulations without additional Parliamentary procedures. The Australian authorities disagree with this recommendation. APRA has extensive power to set legally enforceable standards. The requirement that APRA’s prudential standards be subject to the scrutiny of Parliament is an essential element of accountability in Australia’s Parliamentary framework. APRA exercises powers as a delegate of the Parliament; as such, oversight of how APRA uses Parliament’s delegation of power is a fundamental principle of Parliamentary sovereignty. The strength of Australia’s approach is that APRA’s prudential standards are legislative instruments under the Legislative Instruments Act 2003 and are legally binding on regulated entities. This makes them a flexible but powerful supervision and enforcement tool; a breach of a prudential standard is a breach of the law. No prudential standard has ever been disallowed by Parliament.

IV. Detailed Assessment

49. The Table 3 below offers the detailed Principle-by-Principle assessment. It provides a “description” of the system with regard to a particular Principle, a grading or “assessment,” and a “comments.”

Table 3.

Detailed Self-Assessment of Compliance with the Basel Core Principles

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