The Australian Prudential Regulation Authority (APRA) yesterday released its Information Paper on Risk Culture (the Paper).
The Paper has been launched against a backdrop of intense international focus on the culture of financial institutions and marks the beginning of a new formal work program for Australian institutions.
It is evident that promoting sound risk culture is seen by APRA as essential to its supervisory goal of ensuring stability and that uplifting risk culture helps protect against future recessions.
While recognising that industry has made a commitment to good culture, and that work has commenced across institutions, APRA notes that all such work (including their own) is at a very early stage of maturity.
The Paper reports that Australian institutions currently see their own risk cultures as broadly “good” or “strong”. However APRA is questioning of this self-assessment given that institutions have also said they are struggling to measure and evaluate their own culture, they have acknowledged that risk culture is an issue for industry and also in light of the recent examples cited in the Paper. For APRA, this suggests “a need for a deeper analysis and understanding of risk culture across the entire financial sector”.
It is clear that the regulator is of the view that much more needs to be done in terms of understanding, assessing, and driving good cultural outcomes.
What does the Paper mean for industry?
The Paper warns industry against complacency on culture and suggests that Australian institutions need to challenge current thinking that they “have a good, if not strong, risk culture”.
There is certainly no complacency on APRA’s part. The Paper represents a high level starting point from which the regulator will commence a concerted, consistent and sustained effort on strengthening risk culture within Australia’s financial intuitions; an effort which will see more granularity and detail over time.
APRA does not intend to prescribe the specific characteristics of a “good” risk culture, but will be hoping for cooperative and iterative engagement with industry so that the different approaches can be felt out, tested and, if necessary, re-considered. Practices identified as poor will, however, likely increase supervisory intensity for the relevant institutions.
What is the background?
The Paper notes that the GFC exposed shortcomings in attitudes to risk and made clear that poor risk culture can substantially impact financial stability. The significant evolution of regulatory responses on risk culture that has been unfolding abroad is canvassed in some detail.
Whilst APRA acknowledges that Australian financial intuitions did not suffer to the extent seen elsewhere during the GFC, APRA also highlights two recent examples from the Australian life insurance and residential mortgage industry (where sound risk practices may have been sacrificed to considerations of growth or market share) as indicative of a cause for concern about risk culture and unconscious risk-taking.
What is the current state within Australia’s financial institutions?
APRA observes that there are varying degrees of understanding, sophistication and effectiveness in industry risk culture programs, however the regulator’s overall verdict is that industry is in the early stages of maturity with “the focus to date being on the initial task of understanding and assessing the current state.”
The Paper provides a detailed outline of current industry practices for managing culture, including anonymised real life examples of the different tools and approaches being deployed by institutions and the specific issues that they struggling with (such as being able to measure and assess culture).
APRA commends the stronger Board involvement in culture that has emerged since CPS 220 was released, but the Paper suggests industry could improve CEO and Senior Executive responsibility.
What will APRA do next?
APRA initiatives to commence over the coming year will include:
- Pilot reviews of industry, with a view to testing approaches that may be appropriate for APRA to employ and informing perspectives on good and poor practices.
- A stock take of industry remuneration practices that will involve the analysis of employment contracts and remuneration outcomes.
- Benchmarking Australian remuneration requirements against international standards.
- Harmonisation of standards across industry.
How should institutions respond?
Changing culture can feel daunting and somewhat intangible. In our experience, developing an effective risk culture program starts with the Board and Senior Executives, including self-awareness of their effectiveness and the extent to which they currently influence culture. Robust frameworks commensurate with business complexity need to be set up that engage the entire organisation and there are an array of techniques that institutions can employ to undertake ongoing and reliable assessments of culture.
For more information feel free to contact the authors.