Australian Prudential Supervision – time to recalibrate?
Recent reports that the Chairman of the US Federal Deposit Insurance Corporation is going to take a look at the CAMELS rating system, to focus on efforts to reduce the community banks’ compliance burden was not unsurprising for the US audience - especially given the Trump Administration publicly avowed aim to roll back banking regulation - but certainly would appeal and resonate with the Australian customer owned banking constituency.
BTW the acronym CAMELS stand for the factors that US bank regulators/examiners use to rate bank institutions, namely: Capital adequacy, Asset quality, Management capability, Earnings, Liquidity and Sensitivity to market conditions.
The Australian Customer Owned Banking Association has been strident in its calls to regulators and policy-makers to recognise the disproportionate impact and anti-competitive effect of regulation and new legislative requirements on smaller institutions.
So, the proposed regulatory self-assessment underway in the US could be a catalyst (or at least provide some impetus) for such an evaluation here namely, whether the Australian prudential regulatory ‘one size fits all’ approach is still valid, ‘fit for purpose’ and is promoting diversity and competition.
But first, it’s worth unpacking some aspects of the complexity and dynamic tension of prudential regulation. By its nature, it is intrusive and costly – an expense which is only going to increase post the Hayne banking royal commission!
Allowed to fail
However, the scope and intensity of prudential regulation must be the minimum necessary for its purpose, essentially to ensure regulated financial institutions keep their financial promises, e.g. remain financially sound and able to meet their obligations to depositors, fund members, policy holders, etc.
In an efficient financial system, it is important that poorly managed institutions be allowed to fail. Such failure, especially in the Australian context, is more likely to be seen as incompetence on the part of a regulator(s) – think HIH - and so run the risk that such a regulator(s) would potentially see its role too narrowly and act accordingly. Again, think of the regulators’ response and future, ‘more spirited’ approach following the release of the banking royal commission interim and final reports.
This segues into the principle of competitive neutrality, whereby like products and markets should be subject to equivalent regulatory treatment. But how to do this whilst promoting the advantages of diversity, including the need to maintain markets which are as openly contestable as possible?
An effective regulatory framework needs to be sufficiently flexible and able to meet market changes, including new products and services. APRA’s welcomed Restricted ADI licensing framework is a good example of this.
Of course, complicating matters we have the 400-pound gorilla in the room, that prudential regulation carries the moral hazard for government in that there is an expectation of compensation for failure. So logically from regulator’s perspective, why adopt a ‘lite’ touch to supervision when there is no upside and serious downside, especially from your political masters
So no easy answers?
Due to Australia's highly concentrated banking market and market dominance of the 'big four' banks, competition and ethics in the banking market is a high-priority public policy issue. The Hayne banking royal commission has clearly demonstrated the conflicts of interest in vertical integration models within and across the ‘listed model’, major banks.
Following stated US regulatory intentions and notwithstanding the comments above, it seems reasonable to seriously consider calls for a prudential regulatory framework that gives appropriate weight to promoting competition and diversity, accommodating both the customer-owned banking model as well as the listed model.