APRA outlines pilot reviews of risk culture

APRA has warned it can’t regulate risk culture into existence, as it outlines pilot reviews on the issue.

APRA said it had no intention of imposing a common risk culture on institutions. Photographer Adam Yip/News Corp Australia.

The prudential regulator has started pilot reviews of risk culture in an effort to minimise industry losses and threats to financial stability, leading to much closer scrutiny of organisations with shortcomings in their risk management practices.

In a highly anticipated information paper on risk culture, released on Tuesday, the Australian Prudential Regulation Authority said it had no intention of imposing a common risk culture on institutions, or even listing the characteristics of a “good” culture.

However, it recognised that a poor risk culture led to higher levels of risk-taking, significant losses and even institutional failures in the financial crisis, although Australia was largely spared.

APRA chair Wayne Byres said it was incumbent on boards and chief executives to develop a sound culture that enabled companies to operate within their risk frameworks.

“This is not an easy task, but nonetheless it is critically important for an institution’s long-run health,” Mr Byres said.

“APRA cannot regulate risk culture into existence.

“However, APRA will apply greater supervisory intensity to institutions that are either unwilling or unable to address behaviours that are inconsistent with prudent risk management practices.”

The regulator’s recent work on culture is underpinned by a new prudential risk standard introduced in January last year that requires the boards of banks and insurers to form a view of their institutions’ risk culture.

According to APRA, this had led to a much stronger focus by boards on the issue, even though most institutions were still grappling with how best to articulate the type of risk culture they wanted, and the identification of specific weaknesses and how to deal with them.

While Australia was spared the worst of the financial crisis, there were examples of poor risk culture such as the failure of the insurer HIH in 2001 and National Australia Bank’s foreign currency options crisis in 2004.

More recent cases included higher levels of risk-taking in the underwriting and pricing of life insurance, and lower credit standards in home lending amid a scramble for market share.

APRA said closer scrutiny showed that risk considerations “were not always front of mind” in a highly competitive environment.

This was one of the factors behind the establishment last year of a small APRA team dedicated to governance, culture and remuneration risk.

The team will work with supervisors to develop the regulator’s thinking, supervisory practices and industry engagement.

It is understood that APRA started its pilot risk culture reviews in the last month or so.

The agency consults regularly with the market conduct regulator, the Australian Securities & Investments Commission, which is conducting its own so-called cultural audits.

The APRA information paper said its more intensive review process would enable it to better anticipate potential risk issues and strengthen its forward-looking supervisory approach.

“For example, where a regulated institution is found to have indicators of a poor risk culture, supervisory attention will corresponding increase,” it said.

“As with APRA’s more general approach to supervision, which focuses on the prevention of problems before they materialise, the goal of these risk culture reviews will be to promote prompt corrective action to any shortcomings identified, or establish mitigating actions.

“In doing so, the potential for loss from unbalanced and ill-considered risk decisions is reduced, potentially adverse outcomes for depositors, policyholders and superannuation fund members can be avoided, and (in the extreme case) threats to financial stability are eliminated.”

APRA said it would also undertake a stocktake of current remuneration practices to gauge how well existing requirements were being implemented, and how they were interacting with risk cultures.

Comparisons will be made with recent international regulatory developments.

The work will start this year and continue into 2017.