APRA - Its Objectives and Powers - ARCHIVED CONTENT

 

I am assuming that this audience is reasonably well aware of what APRA does, and why the Wallis Committee recommended its establishment. Rather than go over this ground, I would like to describe in some detail APRA’s constitution and its powers in relation to the banking system. Some features of the new arrangements – including changes to depositor protection – are both interesting and significant, but they have not attracted much attention. Focusing on our banking powers is not to suggest that APRA’s responsibilities for other financial institutions are somehow less significant. It simply recognises that there has been more change in the banking powers than others.

 

The measures implemented by the Government in response to the recommendations of the Financial System Inquiry are embodied in one of the largest packages of legislation affecting financial institutions in the past forty years. It extends to some 402 pages.

 

This includes four completely new Acts -
1.    APRA Act 1998,
2.    Payments System and Netting Act,
3.    Payment Systems (Regulation) Act 1998; and
4.    Financial Sector (Shareholdings) Act.

There are, as well, two omnibus Acts -
Financial Sector Reform (Amendments and Transitional Provisions) Act; and
Financial Sector Reform (Consequential Amendments) Act - which between them amended and repealed more than 70 existing Acts. Of the amended Acts, the Banking Act 1959 is the one most substantively altered.

 

While this volume of legislation is substantial, it is not yet complete. The proposal to bring State-regulated financial entities, such as building societies and credit unions, under APRA requires further legislation at both Federal and State levels. Consistent with the philosophy behind establishing APRA as a single regulator, further legislative changes are also likely in time, to harmonise powers and processes across the various pieces of legislation for which APRA is responsible.

 

The APRA Act is concerned primarily with establishing the structure and administration of APRA in line with these principles. Various other Acts specify our regulatory functions.

 

The APRA Act establishes us as an independent authority subject to the Commonwealth Authorities and Companies Act . We are not a government department or otherwise part of the Australian Public Service. We are not subject, in the normal course, to ministerial direction.

 

Ultimately, of course, APRA is accountable to the government of the day. To this end, there is a requirement for the Board of APRA to inform the Government of APRA’s polices. Should the Government disagree with those policies, the Treasurer may recommend that the Governor-General, acting with the advice of the Federal Executive Council, issue an order determining the policy to be adopted by APRA. In this event, the Treasurer is required to inform the Board of APRA that the Government takes full responsibility for the adoption this policy. The Treasurer must also table the relevant documents in Parliament.

 

These arrangements provide for transparency and full accountability in any directions given by the Treasurer, and are similar to those which apply to the conduct of monetary policy by the Reserve Bank of Australia.

 

APRA will, of course, produce an annual report on its activities. It is likely that we will also appear before Parliamentary Committees.

 

As I’ve already indicated, APRA’s Act provides for it to be governed by a Board, again similar to the Reserve Bank. This consists of an independent chairperson, the Chief Executive Officer, two representatives of the Reserve Bank, a representative from ASIC and four others. Members of the Board cannot be directors, officers or employees of any entity regulated by APRA. Such a Board both promotes co-ordination among the various regulatory agencies and, importantly, provides for "non-official" oversight of the establishment and conduct of prudential regulation policy.

 

Section 8 of the APRA Act 1998 sets out our charter in carrying out the functions under the various Acts for which we are responsible. It says that APRA is established "for the purpose of regulating bodies in the financial sector in accordance with other laws of the Commonwealth that provide for prudential regulation or for retirement income standards, and for developing policy to be applied in performing that regulatory role". Importantly, it goes on to say that, in undertaking such functions APRA is required "to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality".

 

APRA’s remit, therefore, is not one simply of financial safety but involves a more complex balancing of objectives. The need for such balance is, of course, hardly unique to APRA’s work.

 

In undertaking the protection of depositors, the Banking Act previously provided that where a bank informed the Reserve Bank it considered it was likely to become unable to meet its obligations, or a bank became unable to meet its obligations, or the Reserve Bank was of the opinion that a bank was likely to become unable to meet its obligations, the Reserve Bank could appoint a person to investigate the affairs of that bank and could assume control of and carry on the business of that bank. Where the Reserve Bank did this it was required to carry on the business of the bank until such time as the deposits had been repaid or the Reserve Bank was satisfied that suitable provision had been made for their repayment.

 

In addition, the Banking Act provided for depositor priority – that is, in the event that a bank was unable to meet its obligations, the assets of the bank in Australia were to be available to meet its deposit liabilities in Australia in priority to all other liabilities.

 

In the amended Banking Act, responsibility for the conduct of prudential supervision and depositor protection moves from the Reserve Bank to APRA. And all the references to "banks" have been changed to "authorised deposit-taking institutions (ADIs)". This follows from the Wallis Committee’s recommendation that APRA should regulate - as a single class of financial institutions - banks, building societies and credit unions and other entities which undertake the business of banking. This is intended to provide for a more consistent, competitively neutral and efficient approach to the regulation of such institutions, while enhancing overall depositor protection and financial system stability.

 

Banking business

One interesting fact which I am sure many lawyers have come across in the past was that the old Banking Act contained no definition of "banking business". (In one quite real sense, a bank was simply an entity granted the right to hold a banking authority.) The amended Act remedies this situation and provides more clearly a feel for the activities captured by the concept of banking business. The business of banking is now defined to encompass explicitly, besides the notion of banking business under the Constitution, the taking of money on deposit and the making of advances. The concepts of the general and specific business of banking in the old Banking Act have been discontinued. Any entity which engages in any taking of deposits and making of advances, unless granted an exemption by APRA under the Act, now requires an authorisation to continue with such activities.

 

The Act also now provides for regulations to be made to capture other types of activity as part of the definition of banking business. This power is intended to prevent any definition of banking business becoming dated and provides the authorities with some flexibility as to the scope of activities to be regulated under the Banking Act.

 

A "bank" now is simply an ADI which has been granted approval to use the word "bank" in its title. APRA may place conditions on the granting of such approvals – for instance, a minimum level of capital. Use of the terms "credit union" and "building society" is similarly restricted. We have not yet determined a formal policy on this, but we will need to do so. I think it is likely we will also see financial institutions with authorities under the Banking Act who are content simply to carry the nomenclature of "Authorised Deposit-taking Institution".

 

With the removal of references to banks, an authority granted under the Banking Act is no longer a "banking authority" but rather a "section 9 authority" – an authority to carry on banking business.

 

The granting and revocation of authorities is now the responsibility of APRA, rather than the Governor-General. And APRA can withdraw an authority in the event that an ADI has not complied with provisions of the Act or has breached any conditions placed on its authority. These changes are consistent with practice in many other countries governing the licensing of financial institutions and strengthen APRA’s ability to control the entry and exit of regulated institutions.

The regulation powers continue in the amended Act, but have been supplemented by a formal power for APRA to establish prudential standards. (Standard-making powers currently exist in the provisions of the Financial Institutions Code governing the State-based regulation of building societies and credit unions.) Such powers will allow us to give legal effect to the types of prudential guidelines on which bank supervision has been based, without the need to resort to regulations. A breach of a standard will not of itself carry a penalty, but it will constitute grounds for the issuance of directions by APRA.

 

The Banking Act now gives APRA an important new set of powers to issue directions to authorised institutions. This greatly enhances the package of powers available to prevent a crisis developing in the ADI sector. Importantly, directions powers can be targeted to individual institutions and to particular aspects of their operations. The power to give directions can also be used in conjunction with our depositor protection powers to more effectively resolve a crisis if one does occur. From a supervisor’s perspective, however, prevention is much better than attempting to deal with a crisis once it emerges.

 

APRA may issue a direction in the event that an authorised institution fails to comply with a prudential standard or regulation but, more importantly, we may issue a direction if we believe it necessary in the interests of depositors. This allows us greater flexibility to deal pro-actively with emerging problems in a bank or other ADI. Directions may be given on a confidential basis so that corrective action can be implemented by an institution without the potential for loss of confidence which might be created by a public order. ADIs are highly vulnerable to runs generated by loss of confidence and, in some circumstances, publishing a direction order could undo the objective of serving the order. 

A direction can include:

Failure to comply with a direction constitutes grounds for revocation of an authority and, for individuals concerned, failure to ensure compliance with a direction can attract criminal proceedings.

 

I must emphasise that it is not our intention to become involved in the detailed day-to-day management of ADIs. Direction powers will give APRA the legal authority to ensure an ADI takes actions to address significant problems in the event that an institution does not respond to a request. I expect that direction powers will be used rarely, and as a last resort.

 

Auditors

APRA’s ability to ascertain information about authorised institutions, and thereby to address problems before they might endanger depositors, has been strengthened. Behind the management of an institution, its auditors could be expected not unreasonably to have the next best understanding of its accounts and management systems. APRA may now require auditors of authorised institutions to provide information about them.

 

Importantly, this new provision of the law also places an obligation on auditors to inform APRA should they have reasonable grounds to believe that an authorised institution is insolvent, or that there is a significant risk of it becoming insolvent, or that an authorised institution has failed to comply with requirements in the Banking Act (such as standards or directions), or that an existing or proposed state of affairs of an institution may materially prejudice the interests of depositors of the ADI. This is, if you like, a provision requiring statutory whistle-blowing by auditors.

 

An auditor is not excused from providing information on the grounds of self-incrimination (however, individuals are indemnified against direct use of such incriminating information for prosecution purposes). Failure of an auditor to inform APRA as required attracts the risk of criminal prosecution, with the penalty a term of imprisonment. At the same time, the amended Act offers auditors who provide information with the protection of the strong indemnity granted to APRA under section 70A of the Banking Act.

 

Depositor protection

While most of the provisions of the Banking Act dealing with depositor protection have been replaced by new sections, the content of the repealed sections has been largely preserved. Most notably, the parts covering depositor priority continue as before. Protection of depositors is one of APRA’s prime functions – as it was previously for the Reserve Bank.

 

Reflecting the age of the old Banking Act, dating as it does from 1945, many of the powers provided to protect depositors were undefined and ambiguous. For example, it was unclear exactly what powers could be exercised should the Reserve Bank take over the management of a troubled bank. While this gave scope for a broad interpretation of powers, it left open a risk that the courts might not accept the use of powers which the Reserve Bank felt it needed to exercise to protect depositors’ interests.

 

The amended Act clarifies APRA’s powers to deal with a troubled ADI - with the dual aims of creating greater certainty for both regulator and depositors and improving the ability of APRA to protect depositors. This includes a provision for APRA to appoint an administrator to act as a statutory manager and to take control of a troubled ADI rather than APRA having to act as a statutory manager itself. (We have the right to act as statutory manager should we wish.) The Act also includes provisions covering the conduct of an administrator, including the obligation for an administrator to report to APRA and to comply with any directions. These new provisions give us greater flexibility in determining how best to conduct a statutory management.

 

The Act now also makes clear that appointment of a statutory manager will result in the directors of the ADI ceasing to hold office, and that all the powers of its Board transfer to the statutory manager. This removes some of the previous ambiguity over the position of directors of an institution placed under statutory management.

 

I should note that the appointment of a statutory manager is not automatically a step towards the wind-up of a troubled ADI. The interests of depositors (and the financial system) may be best served by continuing the operations of an ADI pending the implementation of other remedial measures, rather than simply winding it up. These could include finding additional capital support, arranging a merger or the sale or closure of some parts of the business. An ADI placed under statutory management might not be insolvent but could be facing other difficulties (eg liquidity, operational problems) which necessitate APRA’s intervention to protect depositors.

 

Included in the statutory manager’s powers is the right to sell or otherwise dispose of the whole or part of the ADI’s business on terms and conditions that the statutory manager considers appropriate. This power will assist a statutory manager to reconstruct a troubled ADI if necessary. Such reconstructions are becoming more common in dealing with weakened financial institutions around the world.

 

While Part II, Division 2 of the Banking Act provides for depositor protection, I must emphasise that it (still) does not provide for a depositor guarantee. While the amendments which I have described greatly expand APRA’s powers to deal with ADIs to prevent or resolve problems this does not mean that an ADI cannot fail. The role of APRA is to reduce the risk of failure, not to eliminate such risk. The prime responsibility for the conduct of an ADI’s business, and ultimately for its safety and soundness, rests with the board and management of an ADI.

 

In addition to the areas I have already touched on, the depositor protection provisions in the old Act were also somewhat ambiguous in what would happen should the Reserve Bank take on the management of a troubled bank and then discover that it was in fact insolvent. The wording of the Act could have been read to imply that such management had to continue until depositors were paid out even though funds might not be available to do so. In addition, it was questionable whether the Reserve Bank itself could move for the winding up of a bank.

 

The Act now provides explicitly that if APRA considers an ADI is insolvent and is unlikely to be returned to solvency within a reasonable time APRA can, if it wishes, apply to the courts for a wind-up. In these circumstances depositors would be preferred creditors in accessing the assets of the failed institution. Such a wind-up would take place in accordance with the provisions of the Corporations Law.

 

Another of the difficulties with the old Banking Act (which predated the Corporations Law) was the question as to how its various provisions, notably relating to dealing with a troubled institution, would accord with the operations of the Corporations Law. This matter has been addressed by providing that the relevant sections of the Banking Act have effect notwithstanding any provisions of the Corporations Law or of a State or internal territory.

 

It should be clear from this account that there has been no legislative weakening of bank supervision powers or of depositor protection. Indeed, both have been strengthened in various ways, including by giving APRA greater powers of early intervention to head off an incipient serious weakening of a bank or other ADI and clearer powers to deal expeditiously with an institution in serious difficulty.

 

What of official liquidity or solvency support in all this? There has been no change. The legislation does not provide for official support of that kind, and it has not in the past.

It is true that the RBA – the former bank supervisor – has financial resources which are not available to APRA. But there has never been any obligation on the RBA to provide financial support to a bank in difficulty. Such support to financial institutions has been, and remains, entirely discretionary for the RBA.

 

APRA and the RBA recently concluded a Memorandum of Understanding which describes our respective responsibilities and arrangements for information-sharing and co-operation. One paragraph of this says: "The RBA will be responsible for determining whether, and how, it might provide emergency liquidity support to the financial system. It does not see its balance sheet as available to support the solvency of an individual financial institution in difficulty".

 

This statement of policy would have applied equally well before the Wallis reforms.

 

Conglomerates

There are some other legislative changes which have strengthened APRA’s ability to protect ADI depositors compared with powers previously available to the Reserve Bank.

APRA may now appoint a person to investigate not only authorised institutions but also their subsidiaries. Similarly, we have power to require information to be provided by those subsidiaries. The requirements on auditors to report to APRA (to which I referred earlier) also cover subsidiaries. These changes recognise that most of the banks encountering severe difficulties in Australia in the past have done so, in large part, because of deficiencies in their offshoots.

 

It has been official policy in Australia that in financial conglomerates which included a bank, the bank had to be the holding company. This policy rested primarily on the view that the banking regulator could better protect bank depositors against damaging contagion from the associates of a bank if the regulator could exercise indirect oversight of those associates as the bank’s subsidiaries.

 

Experience called this view into question although, no doubt, the absence of explicit powers over subsidiaries compromised the approach. This lack has been remedied, to a certain extent, with the amendments I have just noted. However, it was also recognised that continuing the prescriptive approach to banking group structures could interfere with the efficient organisation of such conglomerates and is inconsistent with longstanding policy in the prudential regulation of insurance. It was further accepted, however, that if other structures were to be allowed additional measures would be necessary to help the regulator address the risks flowing to an ADI from its membership of a conglomerate group. Other changes in the Banking Act deal with these issues.

 

Specifically, APRA now has the power to authorise non-operating holding companies (NOHCs) which own ADIs. Such authorities may be issued subject to conditions and are separate from the authorities granted to any ADI subsidiary. The various Banking Act powers which I have summarised with respect to standards, regulations, directions, responsibilities of auditors, investigation and collection of information extend to NOHCs owning an ADI.

 

As a result of these new powers, it is now open to ADIs to be owned by NOHCs, a possibility which had been anticipated with approvals for a couple of groups in recent times. This increases the range of organisation structures available to aspiring participants in banking. It should reduce the cost of participation for some. It also makes it possible for APRA more readily to contemplate the inclusion of non-financial activities alongside banking than was possible in the past.