APRA expected to ‘walk the talk’ on risk management failings in banks

The Australian Prudential Regulation Authority (APRA) is expected to follow through its critical assessment of risk management practices and culture within the nation’s banking sector with real action and not just words, according to a leading law firm. The APRA published its Final Report of the Prudential Inquiry into the Commonwealth Bank of Australia (CBA) following a series of significant operational and governance shortcomings that damaged the bank’s reputation last May. The final report’s major finding was that the CBA’s financial success had “dulled the institution’s senses”, especially in the management of non- financial risks. The APRA called on all regulated institutions to “reflect on the findings” and consider whether similar issues might exist within their own organisations. The authority wrote to the boards of 36 authorised deposit-taking institutions (ADIs), insurers and superannuation licensees, asking them to conduct a self- assessment against the findings and provide that assessment to the APRA. The APRA has now examined these self-assessments to “assess their quality, identify common themes and, where necessary, challenge institutions’ findings”. The APRA released an information paper based on this analysis in May this year, to help institutions understand and address the challenges of embedding effective risk governance frameworks and practices, it states in the executive summary of the paper. Risk and insurance managers at Australian financial firms will not have enjoyed reading the paper. The APRA states that it is clear that the weaknesses identified in the final report are not unique to the CBA. A number of common themes have emerged from the self- assessments, including: Non-financial risk management requires improvement Accountabilities are not always clear, cascaded and effectively enforced Acknowledged weaknesses are well known and some have been longstanding Risk culture is not well understood and therefore may not be reinforcing the “desired behaviours”. “Most institutions critically examined their organisation and have committed to a considerable list of actions. They have, however, generally rejected the notion that the cultural traits of complacency, insularity and collegiality underpinning the Prudential Inquiry findings are prevalent,” states the APRA. “Significant uplift is required across industries to bring governance and the management of non-financial risks to an appropriate standard. This includes embedding robust frameworks that incentivise delivery of sound outcomes, proactive management of issues and consistent application of rewards and consequences,” it adds. “Boards and management are ultimately responsible for addressing weaknesses in their institution, and [the] APRA will be holding them to account. Over the next 12 months, [the] APRA will strengthen prudential expectations and increase supervisory intensity for governance, accountability and culture for all regulated institutions,” continues the paper. The APRA explained that it is now meeting with participating institutions and, as a next step, will write to the boards of each of the 36 institutions to provide feedback on their self-assessments, and outline the APRA’s intended targeted supervisory engagement. The supervisor said that, for some institutions, the problems identified in the self-assessment are “material” and the changes required to address them are “significant”. The APRA is therefore considering applying an additional operational risk capital requirement to reflect the higher risk profile of these institutions. In a note issued last week, Philip Charlton and Danielle Avery of law firm Norton Rose Fullbright suggest that APRA-regulated banks, insurers and other financial institutions need to take the conclusions of the report carried out by Royal Commissioner Kenneth Hayne very seriously. “In a clear signal to the sector, APRA foreshadowed increased supervisory intensity for governance, accountability and culture for all regulated institutions. Given Hayne's robust commentary on the performance of regulators, we can expect [the] APRA to walk the talk on this,” they state. The lawyers suggest that institutions now need to ask themselves: What remedial work have you mobilised to address culture, and the issues uncovered in the self-assessment? Has the board and senior management been sufficiently rigorous and self-critical, given the wide range of weaknesses exposed? Are you prepared for an APRA-imposed operational risk capital requirement where issues are significant? Are you unwittingly cultivating complexity – or failing to drive appropriate simplicity – in your systems, processes and policies? Are you adequately considering the underlying drivers for internal failures through root-cause analysis? Are you failing to prioritise the resolution of weaknesses, only responding reactively when there is regulatory scrutiny or adverse public commentary? The lawyers conclude: “There is no doubt that regulatory focus on whether institutions are proactively improving the management of non-financial risk and prioritising risk culture, governance and remuneration will continue to sharpen. There is also no question that, in this regard, all organisations – and particularly financial institutions – must be able to demonstrate, both to regulators and, increasingly, the public, an effective and continuing response to these challenges.”

APRA expected to ‘walk the talk’ on risk management failings in banks

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