APRA Chair John Lonsdale’s speech to AFR Banking Summit

Good morning and thank you for the invitation to speak here again.

Ten days ago, around four million Australians in south-eastern Queensland and northern New South Wales began to batten down the hatches in preparation for an expected cyclone. Schools, shops and public transport were closed. Households stocked up on supplies such as food and batteries. Then they waited. And waited – anxiety turning into boredom and mild frustration – as each new update from the weather bureau saw Alfred’s estimated landfall pushed back further and further. Finally crossing the coast as a tropical low two days later than originally forecast, the weather system still caused significant wind and flooding damage.

Waiting for a storm is an apt analogy for what’s occurring as Australian business and political leaders monitor a geopolitical maelstrom brewing overseas for which the trajectory is uncertain. The possibility of a global trade war is only one of the developments fuelling uncertainty across the economy. Other factors are military conflicts in eastern Europe and the Middle East, territorial disputes in the Asia-Pacific and a fraying of the international consensus on financial regulation that’s existed since the global financial crisis (GFC). Adding further complexity into the mix, traditional financial service providers such as banks face growing competition from new entrants and technologies that are challenging their business models. 

An environment high on speculation and short on certainty increases the degree of difficulty financial leaders face making decisions that will affect not only their institution’s future but the wellbeing of households and businesses. It adds to long-term trends that have raised the demands on board directors’ time and expertise as issues once considered boutique – such as cyber-security, climate change and social licence – become more central to strategic decision-making. 

One need only think back to the financial services Royal Commission to be reminded of the relationship between bad governance and poor outcomes for both entities and their customers. Although overall standards of governance among APRA-regulated entities have risen since then, the link endures with almost 80 per cent of entities subject to intensified APRA supervision having governance problems.

With these issues in mind, APRA this month embarked on the first step in updating our cross-industry prudential standards on governance. In a discussion paper, we’ve outlined eight proposals that we believe will bring Australian standards in line with international and domestic best practice, as well as higher community expectations. The end goal is to ensure the entities we regulate are managed prudently by people with the right skills, experience and character for the challenges of a highly interconnected global financial system and a rapidly evolving operating environment.

Staying the course

Before going further on governance, I’d like to talk about the current focus on deregulation and fragmentation in the international financial system. 

Calls to rethink the impact of regulation on competition and efficiency have been growing globally for several years; indeed it was the subject of a speech I delivered last June. There’s no doubt, however, that the campaign has been boosted by a new US administration with an agenda that includes cutting red tape, increasing trade barriers and reviewing multi-national frameworks. 

In my recent discussions with boards and CEOs, this international upheaval is the number one topic I’m asked about. The Council of Financial Regulators has also been considering the issue as we assess the possible implications for the Australian financial system. The short answer is that it’s too soon to tell, but I can make a few broad points on how we’re thinking about this issue.

My first point and most obvious point is that what happens in the world’s biggest economy has implications for the world, and therefore for Australia – a mid-sized, relatively open economy that relies on trade for our national prosperity. What those implications are depends both on what the US does as well as how other countries respond. 

Amid speculation the US will halt or rollback its Basel III implementation, the UK has already pushed back its timeline¹ for further implementation of the Basel III framework, and the European Commission is considering its options.² However, based on my conversations with overseas peers, I don’t detect a significant appetite for a wholesale rollback of the regulatory settings that have helped to protect global financial stability since the GFC. 

That brings me to my second point: APRA strongly supports the work done internationally since 2008 to strengthen the resilience of the banking system and curb some of the high-risk behaviours that led to the GFC. We see value in cooperation through international institutions because we recognise that financial instability can rapidly cross borders and we should learn lessons from overseas experience.

Our adherence to Basel principles and “unquestionably strong” capital means international investors can have confidence that they are investing in resilient entities within a market that is stable and well-regulated. That’s essential for a country whose banking sector depends on continued access to offshore international markets for funding and investment.

Our policy is therefore to be compliant with relevant international standards, but only where it makes sense for Australia. So, we are super-compliant with Basel III capital standards but have yet, for example, to implement Basel standards on cryptocurrency or the Fundamental Review of the Trading Book because they have less immediate relevance to the Australian banking system.

My third point is that we are reluctant to lower the regulatory standards that keep Australia’s financial system resilient and our economy strong, particularly when we see geopolitical risks increasing. But that doesn’t mean we’re closed off to making our prudential framework simpler, less burdensome or more proportionate. Unlike deregulation, which can mean lowering standards, this simplification means making regulation easier to understand and implement and less costly and burdensome to comply with. 

APRA’s prudential framework has a significant level of proportionality, with simpler requirements in some areas for smaller, less complex and less systemically important institutions where it’s safe to do so. However, we are always looking to balance regulation benefits and costs, as well as transparency. Mindful of community concerns about the level of competition in banking and insurance, we are actively exploring how we can make our framework even more proportionate without harming financial safety. For example, we are reviewing the thresholds we use to distinguish between significant financial institutions and non-significant financial institutions that benefit from simpler and lower requirements in a range of areas including capital and liquidity.

Under new management

Proportionality and regulatory burden were both front of mind for APRA as we embarked earlier this month on a review of our requirements for governance. Of the eight proposals we announced, some would lift requirements, but others are intended to ease the workload for directors by stripping away unnecessary or duplicative rules; and allowing boards to delegate more day-to-day operational issues to committees or senior management. Several proposals also incorporate simpler, less costly requirements for smaller, less complex institutions. 

For many entities, these proposals wouldn’t represent a big change because they already have in place mature governance practices that often go further than our current prudential requirements. For some with weaker arrangements, they will need to catch-up to modern good governance practice.

Governance is integral to the safety and stability of the entities we regulate and the outcomes they deliver for the community. When financial institutions are well-led and make good decisions, they are more financially successful and better able to withstand a crisis. Poor governance creates weaknesses, which can crystallise in misconduct, losses and failures. Think of any of the major financial collapses from recent decades – Silicon Valley Bank and Credit Suisse, Lehmann Brothers and Royal Bank of Scotland, HIH Insurance and Pyramid Building Society in Australia – and poor governance was integral in every case. 

Although we are only two weeks into a three-month consultation period, we have spoken to Chairs and CEOs of many APRA-regulated entities, as well as industry associations, to gauge their initial reactions.  

Given the change some of the measures represent for some entities, particularly around tenure and board appointments, we expected some lively debate. At this early stage, however, the response has mostly been positive. Industry has generally accepted the evidence we outlined in the discussion paper of areas of current governance weaknesses and the need to make improvements. Our proposals to reduce the burden on directors have been particularly welcomed by industry.

While we will continue to engage directly with industry on the package and will respond formally in due course, I did want to take the opportunity today to counter the suggestion that APRA is taking decision-making responsibilities away from boards.

Let me start with proposal one: skills and experience. 

Today’s boards must be across a rapidly changing operational and risk environment. This has increased the demands on directors’ time and expertise. In light of the enormous responsibility that banks, insurers and superannuation trustees have for protecting Australians’ financial interests, we want to be sure their leaders are properly qualified to navigate these challenges.

Yet for some boards, we see gaps in directors' skills and capabilities. This often reflects failure to think seriously about the mix of skills the board requires or how to remedy skill gaps when they are identified. We are not proposing that APRA’s role will be to tell boards what skills and experiences they need to govern their entity. What we want is assurance that they have properly considered what skills and experience the board needs. Where gaps are identified, we want to see evidence that active steps are being taken to fill them. 

The same thinking is behind our proposed changes around fitness and propriety. Over a period of time, APRA has observed that some fit and proper assessments are waved through with little real scrutiny. We’ve also seen instances where boards are reluctant to reconsider whether an individual remained fit and proper despite that person causing material reputational or financial damage to the institution. 

Under our proposed change, boards will require a serious and credible vetting process – not just box ticking – and actually remove directors where necessary. Unlike some peer regulators overseas, we don’t propose introducing a requirement for APRA to approve appointments, however we do intend to step up our oversight of succession planning and nominations. 

The other two proposals that have attracted most attention relate to tenure and groups. 

With regards to tenure, we are proposing a mandated limit of 10 years for non-executive directors at regulated entities for one main reason: while limits to ensure board renewal are seen as best practice internationally, there are too many cases of this discipline not being applied and so we feel the need to impose it as a requirement. Tenure limits allow vital board renewal to bring in fresh ideas and independent thinking. We have even had some directors tell us they want this reform because it’s currently so hard to renew their board.

Of course, many long-serving directors continue to make strong contributions to their entity years after they pass the decade mark in their role. We also know that securing appropriately skilled and experienced directors can sometimes be challenging for smaller entities, especially those based in regional areas. In recognition of these factors, we’ve proposed that APRA reserves the right, on a case-by-case basis, to grant a two-year tenure extension in limited and exceptional circumstances.

One of the questions I’ve been asked since our proposals became public is “Why 10 years?”. Why not, 12 years? Or nine years, which is sometimes considered as the longest a director can serve on a board and remain independent? Having consulted with industry, corporate governance experts and peer regulators, we formed a view that 10 years, with the option of a two-year extension, struck an appropriate balance between continuity and renewal.

But allow me to turn the question back on you – why not 10 years? We have a genuine consultation underway so if you think 10 years is not long enough, or too long, tell us why. 

On groups, we propose requiring that some directors don’t wear two hats – and are solely responsible for the interests of regulated entities within a group. This would be a change – we currently deem non-executive directors as independent even if they serve on multiple boards in the same group, despite the conflicts we often see in our supervision. 

Of course, we recognise this is a difficult issue – no two corporate groups are the same – and for this reason it’s hard to make a single rule to apply across divergent groups. Again, my message to those who may disagree with this proposal is to engage with us constructively and tell us how we can address intra-group conflicts in a way that can be supervised effectively. 

Finally, I’d like to address a claim that APRA is somehow singling out superannuation and seeking to run funds.  

We are clear in the paper that superannuation is being treated in the same way as other regulated sectors – banking and insurance. We know that some superannuation funds have different arrangements for nominating directors. We do not propose any changes in this area. What we are simply saying is that directors must be competent as well as fit and proper persons regardless of how they are nominated. This should not be a difficult proposition to accept. 

Some superannuation trustees run multi-billion-dollar funds with complex operational requirements. We expect them to have governance arrangement to match, as no doubt do their members.

Navigating uncertainty

These may be uncertain geopolitical and economic times, but they are not unique in history.

A little over 90 years ago, US President Franklin Delano Roosevelt rose in the Capitol Building to deliver his inaugural address, where he uttered those famous words: “There is nothing to fear but fear itself”. He was speaking at the height of the Great Depression, an economic disaster that spread from Wall Street to the rest of the world decades before international telephone calls existed, let alone today’s instant global interconnectivity. 

Among FDR’s New Deal policies which helped to lift his country out of the economic malaise were tighter financial regulations to restore confidence in the banking system and curb the excessive risk-taking that sparked the crisis. 

It’s a reminder of the importance of financial stability to employment and economic growth, and also that the goal of leadership is not to eradicate uncertainty – but to navigate it.

The boards of Australia’s banks, insurers and superannuation trustees don’t face anything like the “dark realities” FDR spoke of in that address. But with APRA-regulated entities now holding around $9 trillion in assets, they have enormous responsibilities when it comes to protecting the financial interests of Australian households and businesses. 

Recent Australian history shows the clear link between weak governance and poor outcomes for financial institutions and the customers that rely on them. As the global financial system becomes more complex and interconnected and new risks emerge, APRA’s governance review aims to ensure our banks, insurers and superannuation funds are overseen by leaders with the right mix of skills, experience and character to successfully meet those challenges.