Bank salaries in APRA crosshairs

A fresh round of prudential reforms will target Australian bank executives’ remuneration and an adjusted capital framework.

Australian Prudential Regulation Authority chair Wayne Byres. Picture: Hollie Adams

Banks are bracing for a new round of reforms from the prudential regulator, with the hot-button issue of remuneration set for a massive overhaul after the release of a consultation paper in the coming weeks.

The Australian Prudential Regulation Authority will also finalise its loss-absorbing capital requirements to resuscitate failed banks, and an adjusted capital framework to help level the playing field between large banks and their smaller rivals.

Remuneration, however, is likely to provide the biggest bang, with one source saying yesterday that “it’s not going to be the status quo with a few tweaks”.

“It’s going to be a big issue when it emerges,” he said.

One of the Hayne royal commission’s recommendations was for APRA to develop a much stronger framework of regulation and supervision of pay structures, given the link with poor industry conduct and behaviour.

In March, APRA chairman Wayne Byres said the current system, where pay was largely based on the achievement of financial targets, would have to change, giving way to a new regime where ­financial and non-financial considerations held equal sway.

“We have to reach a view as to the right mix, but an obvious question for boards is to ask themselves why 50:50 wouldn’t be a good starting point,” Mr Byres said.

“And within whatever financial metrics are used, I’d argue there should be more than a single, share-price-based metric.

“That would mean total shareholder return would go from the primary, if not sole, determinant of long-term incentives to something less than 25 per cent.”

He flagged a move to greater board discretion, both in rewarding executives and deciding whether incentives should vest at all. The “totally formulaic approaches” with high leverage that some investors seemed to favour were “not going to cut it in the future”.

APRA, he said, was also examining clawback arrangements, as well as the case for longer deferrals to improve alignment between vesting and the emergence of risks.

The first body of work to be released will be APRA’s response to its proposal for revised capital requirements, including the next phase of consultation on the treatment of residential mortgages for all banks.

Smaller lenders using the standardised approach to the calculation of risk-weights have long argued that the sophisticated, internal ratings-based approach used by the major banks to calculate risk-weights have given them a huge advantage.

The aim was to improve the risk sensitivity of the capital framework, and improve transparency and the ability to make comparisons between banks.

APRA’s head of policy and advice Pat Brennan said in March that prudential standards could change but the amount of capital required would stay the same.

The objective with loss-absorbing capacity reforms was to protect taxpayers from the devastating impact of bank collapses.

The 2014 financial system inquiry recommended that recapitalisation capacity, particularly for large systemically important banks, should be sufficient to “facilitate the orderly resolution of Australian (banks) and minimise taxpayer support”.

Mr Byres said this was achieved by reducing the probability of failure, and by establishing enough recapitalisation capacity so that the overall cost was minimised if a failure or near-failure occurred.

Consultation had looked at building greater loss absorbing capacity into bank liability structures. Feedback was that its proposals needed changes.

Mr Byres said he didn’t want to jeopardise developing a framework that was easy to implement and didn’t affect access to funding that high credit ratings provided.