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ECONOMICS LEGISLATION COMMITTEE
20/10/2010
TREASURY PORTFOLIO
Australian Prudential Regulation Authority

CHAIR —Dr Laker, would you like to make an opening statement?

Dr Laker —Thank you, Madam Chair. Firstly, can I introduce APRA’s new member, Ian Laughlin, on my right—your left. Ian joined us on 1 July this year after a long career in the life insurance industry in Australia and abroad, and he will bring considerable experience and skills to our work. Secondly, I would like to provide a brief update on developments.

We last appeared before this committee in early June at a time of renewed turbulence in global financial markets. The spotlight on European sovereign debt problems and on the serious challenges facing banking systems and the public finances of a number of advanced countries led to a sharp decline in equity prices around the globe and it yet again heightened uncertainties about the openness of global funding markets. We advised the committee that we were closely monitoring the various impacts of this turbulence on our regulated institutions and that those impacts were being well managed. Since then, global financial conditions have become a little more settled and Australian banks, which had held back for a time from tapping long-term offshore funding markets, have returned to those markets. The episode is a reminder nonetheless that there is an underlying fragility in global market sentiment that may produce further twists and turns until the outlook for global economic recovery is more assured. Pressures on banking systems and public finances abroad are contained and reforms to strengthen the resilience of the global financial system are in place.

This uncertain global setting is a counterweight to the positive outlook for the Australian economy, where a strong terms-of-trade boost is at work, and it argues for continued caution on the part of our regulated institutions and of APRA itself. The operating environment for our institutions is certainly more favourable than it has been since the global financial crisis first erupted, but this is no time for boards and management to succumb to an adrenaline rush or to gloss over the lessons from the crisis.

One action that helped to calm market sentiment in Europe, in addition to support packages to troubled European sovereigns, was an EU banking sector stress test exercise completed in July which tested the capital resilience of 91 EU banks to an adverse economic and financial scenario. Just after our last appearance, APRA published the results of a macroeconomic stress test it had conducted for the largest authorised deposit taking institutions—ADIs—in Australia. The goal in our case was not to assuage market nerves—the strong capital position of our banking system has been well recognised—but to ensure that we in APRA understood what near death could imply for ADIs and whether existing capital buffers would be sufficient to cope.

The macroeconomic stress test, developed in conjunction with the reserve banks of Australia and New Zealand, generated an economic downturn in Australia significantly worse than that experienced in the early 1990s recession and more severe than that built into other recent macroeconomic stress tests in some other countries. The results, published in a different format to those of the EU banks, confirmed that the ADI industry has the capital resources to weather much greater adversity than it has confronted to date.

During the crisis APRA also undertook stress testing in the other industries it regulates. In particular, we stress tested the impact of declining equity and asset prices, widening credit spreads and increased market volatility on the capital positions of the life and general insurance industries. Stress testing now forms an important part of APRA’s supervisory armoury.

Since our last appearance, reforms to strengthen global capital and liquidity regulations have taken firmer shape. Over the first half of 2010, the Basel Committee on Banking Supervision, which is driving these particular reforms, carried out a quantitative impact study of its December 2009 proposals, as well as assessments of their economic impact over the transition period and of their long-run economic benefits and costs. After reviewing the various impacts, the Basel committee announced in July 2010 that it has reached broad agreement on the overall design of its capital reforms. Broad agreement on the calibration and transition arrangements for those reforms was announced in September 2010.

In brief summary, the agreed capital reform package gives much greater weight to common equity in the capital base, raises the minimum requirements for common equity substantially and introduces stricter eligibility criteria for other forms of capital and for regulatory capital adjustments. It also introduces two new capital buffers in the form of a conservation buffer and, if needed, a countercyclical capital buffer.

APRA does not expect that this tougher global capital regime will have significant implications for ADIs in Australia, which have remained, as I said before, well capitalised throughout the crisis. Implementation of the reforms does not begin until 1 January 2013, giving us ample time to consult extensively with industry and other interested parties on the reforms.

The Basel committee’s liquidity reforms seek to promote stronger liquidity buffers and more stable sources of funding to ensure that banking systems are more resilient to the sort of liquidity stresses that emerged, often very sharply, during the global financial crisis. The reforms involve two new global liquidity standards, a 30-day liquidity coverage ratio to address an acute stress scenario and a longer term structural liquidity ratio. Details on these measures were agreed at a Basel committee meeting I attended yesterday in Seoul, South Korea.

In contrast to the capital reforms, the proposed liquidity coverage ratio does pose problems for Australia since the volume of high quality liquid assets, particularly government securities, needed to meet the requirement is simply not available. Acknowledging this reality, the Basel committee is considering refining the standard to accommodate countries in this position. Alternative arrangements are under discussion and we will outline how the standard will be implemented in Australia once the Basel committee announces full details of its liquidity reforms in December this year. The liquidity coverage ratio will come into effect on 1 January 2015 and the longer term structural liquidity ratio by 1 January 2018.

Finally, can I note that the United Nations has designated today, 20 October, as World Statistics Day.

CHAIR —Yes!

Dr Laker —It is true. APRA is proud—I want to get in an advertisement here—

Senator Sherry —It is appropriate that it is at estimates that we hear about World Statistics Day!

CHAIR —A good way to celebrate it.

Dr Laker —APRA, as I was about to say, is proud of its statistics unit, which was formed from seven statistical groups in our predecessor bodies. APRA’s statistics not only inform our prudential supervision and research but also support other agencies, particularly the Reserve Bank of Australia and the Australian Bureau of Statistics, in their missions. APRA’s statistics have also proven very useful in better informing industry and the public on the economic dynamics of the industries we supervise, particularly during the global financial crisis. We are now happy to take the committee’s questions.

CHAIR —Thank you, Dr Laker. Can I just clarify: when you were talking about capital requirements that were going to change in 2013, I think, you talked about a counter cyclical buffer. Could you explain what that is? Is it related to the structural liquidity issue?

Dr Laker —No, Madam Chair, they are entirely different measures. The countercyclical capital buffer is a buffer that would be added on top of the minimum requirement and the conservation buffer, and would come into effect if, in a country, there was a major concern that excessive credit growth was leading to a build-up of risks in the financial system, and in the banking system in particular. So it would be added to the 4½ plus the 2½—that is, in the minimum requirement plus the capital conservation buffer, and it would range between zero and 2.5 per cent. That is about the capital that is available to support risks that are building up if an economy is experiencing much faster credit growth than the normal trend.

CHAIR —So would the value of that, the percentage, vary according to how the risk was judged, or would it be a fixed percentage?

Dr Laker —It is a macro prudential measure, so it is one that, if it were to be implemented in a period of very strong credit growth in Australia, we would consult with the Reserve Bank of Australia in doing so. But it would essentially raise the floor that banks have to meet and if they were to go into that buffer—the buffer is to be used; it is not a floor in itself—if the buffer were to be used, the restrictions on the capital distribution policies of banks would come in at an earlier point.

CHAIR —I see; thank you. Are there further questions?

Senator BUSHBY —I thank the officers from APRA who are assisting us tonight. I have a couple of questions about questions on notice. We have had a lot of problems with questions on notice from a lot of agencies and, unfortunately, APRA is one of the ones that has been a bit slow. I am wondering: why did APRA fail to submit the answers to the questions on notice before the due date, even though the date was actually pushed back from 30 July to 20 August?

Dr Laker —I am not aware that we missed the due date in providing them to the Treasury, but I am not sure what happens after that.

Senator BUSHBY —That was my next question.

Dr Laker —I do not see those after they leave APRA.

Senator BUSHBY —So you are saying that, to the best of your knowledge—and I would appreciate you letting me know if it is any different—you would have prepared and supplied answers to all questions that were taken on notice to the Treasury by the due date?

Dr Laker —In the absence of specific knowledge about particular questions, I can only tell you that answers to questions on notice come to me for a final sign-off, and our secretary is quite diligent in making sure they go off by the due date.

Senator BUSHBY —You send them to Treasury, you do not send them to—

Dr Laker —I do not know what happens once I sign them off as far as how quickly they then become entered into Hansard.

Senator BUSHBY —Are you aware of where they go from you? Do they go to the Treasury?

Dr Laker —They would normally go to the Treasury.

Senator BUSHBY —Okay.

Dr Laker —Many of the questions on notice are part of broader questions for Treasury agencies and sometimes for the whole-of-government agencies, and we feed information into that. But if there were specific questions that got to you late, I would be happy to respond to that.

Senator BUSHBY —I admit that I am not asking you only. I am asking a number of agencies, as many as I can, because the record from the June estimates across the board was not very good. In fact, we have still been receiving a lot of them in the last seven days. I do not actually have it in front of me but I think, from memory, some of yours came in late September. If what you say is the case, it is probably because they have been held up elsewhere, and I would like to understand where they have been held up.

Dr Laker —I cannot confirm or deny that because I am not sure what the track record is. All I can say is that our secretary would be mortified to think that she had not met the timelines, because she is very strict on those.

Senator Sherry —Senator, As Dr Laker has indicated it, and I know APRA have a good record of providing answers, perhaps I should take on notice the date in which they were received in the minister’s office. That would indicate where any hold-up occurred. Secondly, as I have said in a previous estimates, I do not believe it is satisfactory that answers to questions on notice have been late. However, I would point out there was an election and some weeks before there was government formed, so that—

Senator BUSHBY —I understand that. There was advice from the Clerk of the Senate, though, that an election intervening should not impact on the obligation of departments to comply. The date it was extended to was 20 August, which was before the election. Originally it was 30 July.

Senator Sherry —Well it should not impact, but I would certainly contend that, given there was an election and an unusually lengthy period before there was a government formed, that would have been a factor. Beyond that, as I said at the previous estimates, I do not believe it is satisfactory but I will take on notice to check the date in which they arrived in the appropriate Treasury minister’s office. I am assuming APRA and Dr Laker, as in the past, passed them on by the due time. You can then identify where the hold-up occurred.

Senator BUSHBY —I am just glancing through them here. A lot of them were on time from APRA. Without having a good look—there are four hundred and something of them—I cannot pick the ones that were not. Certainly some of them were and some of them were not.

Dr Laker —All I can say Senator, is that we take those timetables very seriously.

Senator BUSHBY —Not a problem. We will move on anyway. The Cooper review, which was handed to the government on 30 June this year proposes that APRA takes a more active and direct supervisory role in the superannuation industry, and I think we discussed to some extent at the last estimates what might come out of the Cooper review. For example, chapter 6 of the review proposes that APRA should have the power to determine the minimum level of capital funds and chapter 4 gives APRA a huge role in developing outcomes, reporting standards for funds and collecting standardised data from them. Do you have any general comment on any of the recommendations of the Cooper review, given that you have stated in past estimates that a lot of what you were saying was that you were waiting for the outcome of the review and that would then inform you as to what you would be doing?

Dr Laker —Could I ask the deputy chairman to respond? He has been closely involved in the development of these issues.

Mr Jones —We have had active input into the Cooper processes.

Senator BUSHBY —I have asked about that before.

Mr Jones —Certainly, our views on any of these matters are well known. But it is really up to the government to determine the way in which they are going to address the various recommendations, I think, at this stage.

Senator Sherry —In fact—and I suspect you are probably aware of this, Senator Bushby—the previous minister, Mr Bowen, announced some policy during the election campaign. If you want me to go through that, I can. I think I have those announcements there. Beyond that—and obviously the markets group are appearing after APRA—I am aware there is a consultation taking place at the present time. But beyond the government’s policy announcements that took place in the election there is no finalisation of policy at this stage.

Senator BUSHBY —One of the reasons why I was asking the question in that particular way was because answers to previous questions that I have asked here on particular activities that you undertake have been responded to. I asked:

Does APRA intend to publish data of the investment option level or are you still holding off until after the Cooper review comes out?

You said that the answer was ‘yes’:

Yes, we do intend to publish it but we are not going to start the process of designing the collection until after Cooper has reported.

So it was suggested to me that you were going to take your lead to a significant degree by what Cooper said and to the extent that you have discretion within your own agency to actually make decisions. Quite clearly, if the government makes decisions in a policy sense and instructs you to do things then that is different. But it appeared to me that you were going to be taking, to some degree, your lead as to what you do within your own decision making processes from Cooper.

Mr Jones —With regard to the statistics, we had in fact developed a statistical process that would have an enhanced statistical methodology. We began this before the Cooper inquiry and, as we mentioned in the previous estimates, we stopped this for 12 months. The recommendations that came from Cooper are consistent with the approach that we were going to take, and so we still wait government’s response—

Senator BUSHBY —You are saying that they are consistent?

Mr Jones —They are entirely consistent. The critical issue on the statistics will be the extent to which the government picks up the recommendations on Cooper with regard to statistics which go beyond what our initial consultation process had with regard to the stats.

Senator BUSHBY —I was only using it as an example when I raised it. I was going to ask questions later about it but I will ask them now. The Cooper review, as I understand it, proposes that APRA develop superperformance data at an investment option level for MySuper products but it does not go beyond that.

Mr Jones —Correct.

Senator BUSHBY —Whereas you were saying prior to the Cooper review that performance data should be published at an investment option level in all regulated funds.

Mr Jones —Yes. Our view is that these views are not necessarily conflicting in the sense that we will still be looking at a process whereby we will publish statistics on investment options. In fact, as we flagged to the industry prior to Cooper, we probably see merit in publishing around the top 15 investment options or something like that. That will cover the vast majority.

Senator BUSHBY —In that sense, you are saying you have not found that finding inconsistent and you are going to proceed along the path which you were already heading on, which at the last estimates you indicated that you had put on hold pending the outcome.

Mr Jones —Correct. The reason why we put the thing on hold was that, should government decide that they would like a substantially enhanced statistical package, it may be necessary for us to go into further consultation with industry about the way in which that process will be done.

Senator BUSHBY —So is it still on hold pending the government’s response to the Cooper review?

Mr Jones —Yes, it is.

Senator BUSHBY —Okay.

Mr Jones —I think the outcome will nevertheless be that we will still publish. Should the government say, ‘We would like you to publish an even wider selection,’ we can. Should the government say, ‘We are quite content with what you had already proposed,’ we have a process already in place to do that.

Senator BUSHBY —What could a wider selection entail? What could you do if you were asked to?

Mr Jones —We could do all sorts of things in terms of information regarding, for example, more enhanced statistics on costs. Most of our emphasis has been on performance rather than costs, and so we could look at more information on costs. But in all of these processes the requirement under the legislation is that we consult with industry and, further, we give industry sufficient time to get their processes in place to meet the new statistical needs.

Senator BUSHBY —Mr Chapman said at the previous estimates:

There are probably areas in their final recommendations—

talking about Cooper—

that we will be strongly in agreement with. There will be some areas that we possibly disagree with.

Now that the review has been published, can you put any of the recommendations in the latter bracket? Is there anything that you strongly disagree with?

Mr Jones —It comes as a package. There were 177 recommendations. Some of the recommendations probably go beyond things that we contemplated and some of the recommendations have no particular relevance to APRA. Some of them relate to the tax office.

Senator BUSHBY —I understand that. I do not want to put words in Mr Chapman’s mouth but, as I recall, the statement was made in the context of recommendations that would actually impact on APRA or have some relevance to what you do. The indication was that you would consider that there were some that you would agree with and some that you would not. Maybe tonight you are not prepared in this forum to indicate which ones you might not be as pleased with in terms of how they might impact on what you do. In terms of the government preparing its report, have you been asked for input on any of the recommendations that might impact on you?

Mr Jones —Most definitely.

Senator BUSHBY —You provided input?

Mr Jones —Yes, we have.

Senator BUSHBY —Which recommendations, even broadly speaking, if they were enacted would entail the biggest regulatory impost on APRA?

Mr Jones —The biggest regulatory impost—in terms of the biggest?

Senator BUSHBY —What would have the biggest impact in terms of changing the way you operate and also, but separately, requiring you to use more resources?

Mr Jones —The recommendations which would probably have the largest impact would be, I would suggest, the recommendations that APRA be given standards making powers the same as—

Senator BUSHBY —The what-making powers?

Mr Jones —Standards making powers—the same as APRA has in the other industries. We currently have standards making powers in the other regulated sectors, but an area in which we did not have the powers with regard to superannuation to make standards. That was a recommendation of Cooper. When we spoke to the Cooper committee, we argued strongly in favour of it, as we have in previous inquiries over a number of years. We believe that this is something that would be very useful for APRA in improving the governance of superannuation funds. In terms of those that have greatest impact on our resources, large statistical collections involve additional resources in terms of analysis but—

Senator BUSHBY —In the context of providing advice to help inform the government with its response or otherwise, have you undertaken any analysis of what the impact any of those recommendation would have on your budget?

Mr Jones —Yes, we have.

Senator BUSHBY —I recall at the last estimates that you indicated your budget was fairly tight and that, if you were asked to take on additional responsibilities, you would have great difficulty doing that without additional resources. Is that still the case?

Mr Jones —I think it would probably depend upon the extent to which the various recommendations were taken. There may be some recommendations that could possibly be done with existing resources. But if there were a substantial number of new areas where—

Senator BUSHBY —And some of these recommendations would involve that.

Mr Jones —Some of these recommendations could involve that.

Senator BUSHBY —You would need to increase your staffing levels and other resources to be able to do it.

Mr Jones —That is entirely possible.

Senator Sherry —I should indicate, Senator, that as part of our policy announcement—I think it was part of our policy announcement during the election campaign; I would have to double-check whether this was made at the same time—an additional $21.1 million will be provided to APRA and ASIC to implement and monitor the new arrangements. I do not have the breakdown of those figures.

Senator BUSHBY —The obvious question is: how is that broken down?

Senator Sherry —I do not have that. I do not know whether APRA has it.

Senator BUSHBY —Are you aware of whether that $21 million is based on any actual information advice or is it—

Senator Sherry —I am not aware of that. Markets group may be able to inform you because they may have some basis for that calculation.

Senator BUSHBY —It might have come from the same direction as we were discussing earlier where someone in Labor Party headquarters decided $21 million was a good figure.

Senator Sherry —I am sure that the basis for the allocation—

Senator CAMERON —There hasn’t been such a good figure from you lot.

Senator BUSHBY —We will get into that one later. You missed the context of that, Senator.

Senator Sherry —Markets groups may be able to shed some light on that, Senator, but I do not know.

Senator BUSHBY —Was APRA surprised that Cooper’s recommendations did not encourage the adoption of a wider use of unit pricing or a more regular pricing method in the superannuation industry?

Mr Jones —No, not particularly. I know that there are a lot of submissions in various ways to it, but also APRA has never had a view that we favour unit pricing over crediting rates. Our approach has simply been to ensure that whichever methodology was adopted by the trustees it was done appropriately to try to avoid any sorts of errors that could come by either methodology.

Senator BUSHBY —At the previous estimates—although it might have been the one before—we were having discussions with Mr Venkatramani, and he noted that during the GFC the inequities that arise from the highly volatile market when some people are on the unit pricing and others are not leads to some problems and that APRA was actually working with funds to try and encourage a more regular pricing of their funds to ensure that in volatile times those inequities were minimised.

Mr Jones —Correct. But you can get inconsistencies with either methodology in those circumstances. For example, where you have funds that are heavily invested in alternative assets for which there are no market prices then you may have difficulty in getting appropriate pricing whether you do unit pricing on a daily basis or whether you do crediting rates and so on.

Senator BUSHBY —I understand that, but the clear indication from the evidence that APRA gave last time or the time before—I cannot recall which—was that there were advantages in pricing more regularly. My question to you was: are you surprised that the Cooper review did not recommend approaches, either unit pricing or more regular pricing?

Mr Jones —No, I do not think we were particularly surprised because I do not think there is industry consensus. I think that is part of the dilemma—the different sides of the industry that would be providing input into Cooper, I would imagine, would each have their own views.

Senator BUSHBY —Basel III—how is it pronounced?

CHAIR —Good question!

Senator Sherry —I can actually explain that, but the witnesses—

Mr Laker —Would you like to go ahead first, Senator?

Senator Sherry —My grandmother was Swiss-Deutsch, and she lived for much of her life in Basel. It is pronounced ‘basil’ or ‘barl’—It depends whether you are German or French. That is the explanation. Either is correct, depending on whether you are German or French.

Mr Laker —To add to that, at one stage, when I first started going to that particular city, it was spelt in the French way, ‘Bale’, and there was a conscious commitment to return that word to the Swiss-German version and change the spelling. So we now spell it ‘Basel’ and pronounce it ‘basil’. It was a deliberate decision.

Senator Sherry —I was not up to date with that.

Mr Laker —Thank you; you were right to start with.

Senator BUSHBY —You have given us an update on where we are currently at, Mr Laker. Those announcements are commonly known as Basel III, and you have outlined some dates. Those dates are internationally agreed—is that correct?

Mr Laker —Yes.

Senator BUSHBY —Have we signed up to the Basel III process?

Mr Laker —There is a formal step to go. The G20 leaders are meeting in Korea on 10 and 11 November, and they will ultimately sign off a full package of reforms—measures that will be put to them by the Basel Committee and others that will be put to them by the Financial Stability Board. So that is the formal process. The G20 really wanted a comprehensive reform package across a wide range of issues beyond some that we deal with. That is the process that needs to be satisfied and endorsed by the leaders of the G20, and I cannot prejudge how that will go, but the Basel Committee has virtually finalised the measures it will put for endorsement at that meeting.

Senator BUSHBY —And at officer level we have agreed to that?

Mr Laker —As a member of the committee, yes, these are internationally agreed minimum standards.

Senator BUSHBY —You will recall that I have asked questions before about introducing a solution to solve a problem that did not exist in Australia and Australian business, and banks suffering as a consequence of that, despite the fact that we have done everything right here. You actually express some concern, you are aware of that and you will be working as part of the process of developing this to ensure that Australian prudential or ADIs essentially will not suffer with the yoke that was not really necessary in Australia. Are you satisfied that you have achieved that?

Mr Laker —Broadly speaking, yes. Those concerns, particularly those expressed by the banking associations and a number of individual banks, were really expressed at a time when there was a fear that some of the solutions coming out of the global reform process could be quite draconian. Draconian they are not. Substantial they are. And our institutions are well positioned to deal with them in any event because we ourselves have been conservative—more conservative than many of our counterparts—for a number of years. I spoke this morning to a FINSIA conference where I pointed out that there are some areas where our requirements are less onerous than the new Basel III capital requirements and that we will be tightening in those areas in consultation with industry. There are other areas where our regime is tighter than what is allowed under Basel III. Those are areas where either we or the Reserve Bank before us took decisions in principle—some going back into the early 1990s—to treat certain items certain ways. We have said—and I said it again this morning—that we will consult with industry, but we would need reasons to depart from principle. The Australian banks have adopted and worked within that principle, for a number of years. I think the overall package for a number of countries is a tough ask—

Senator BUSHBY —It is easier for us because we are already—

Mr Laker —We started in a good position and we started with a conservative framework on capital.

Senator BUSHBY —Yes, and that largely goes back to the changes made in the late nineties that set up APRA, the processes that followed and things like that.

Dr Laker —It has been a continuous process, but I would think it owes more to some changes we made in the mid-2000 period, in 2005-06. When we tightened the capital regime, we required that common equity take a much larger share of tier 1 capital. We tightened the treatment of some intangible assets that were being counted but were of dubious value. But, well before our time, the regulation of banks in Australia on capital has always been conservative. Capital is the fundamental shock absorber for any system.

Senator BUSHBY —We were learning about statutory reserve deposits when I was doing economics in high school!

Senator Sherry —So was I, Senator Bushby!

Senator BUSHBY —I realise you cannot be specific, but will the effect or the impost of any of the Basel III decisions vary widely across Australia’s major banks? Will some banks be better able to meet those changes than others, without naming anybody?

Dr Laker —I would rather say that we do not see a significant challenge for our institutions. Some are well placed already, but we do not see significant challenges. But there is work to do.

Senator BUSHBY —Some commentators have said that our banks already satisfy most of these proposals—we have sort of touched on that—and that they will have little effect locally. In your view, will these proposals have any real effect on the costs of banks and potentially therefore on decisions they may make about borrowing rates?

Dr Laker —There are generous transition arrangements allowed if an institution at this point does not meet the Basel requirements, and there is quite a long time until 1 January 2013, when not the whole package but parts of the package will be first implemented. In that time, we have got a strongly growing economy and strong earnings in the banking system. So the combination of that time and the strong earnings capability means that we expect most of our banks to be able to meet those requirements, essentially out of retained earnings. But we need to see the final details coming out of Basel. We then consult with industry, looking at the specifics in each case. We have done quite a lot of work up to this point, which is the reason why I can give you that assurance, but I would like to see the numbers firm up in the consultation process.

Senator BUSHBY —You have given us an update on the Basel III recommendations on liquidity and how they are going to apply. You also highlighted the fact that one of the problems Australia has is the scarcity or paucity of high-quality securities that they can actually invest in—

Dr Laker —It is not a problem, in the sense that—

Senator BUSHBY —No, no. It is a nice problem to have—

Dr Laker —It is a challenge for us to work within the global framework.

Senator BUSHBY —to quote Peter Costello from a few years ago.

Dr Laker —It is a problem most of my colleagues around the Basel framework would like to have!

Senator BUSHBY —Yes. But it does create some practical issues—

Dr Laker —Yes, it does.

Senator BUSHBY —for our ADIs in terms of sourcing appropriate ways to achieve those liquidity requirements. You mentioned that Basel is looking at alternatives; but, in the event that alternatives do not come out of Basel, are you looking at alternatives at an Australian level or negotiating with Basel in terms of what might be able to be held? One of the problems is that we do not have covered bonds, which has been raised in this context before. What test is APRA applying in determining which securities can be eligible level 2 prudential liquidity assets under the Basel enhancements? And what role is there for, say, even RMBS to be used, given that it is eligible collateral in the RBA’s operations?

Dr Laker —At this point, while the details are being finalised and are still under discussion, I do not really wish to go down to the detail. What I can say is that we think those discussions within the Basel committee have gone well. There is a very clear recognition—it is actually in the language of the Basel committee’s releases—that jurisdictions like ours face particular challenges in meeting a global standard. I am confident we will be able to work out a set of arrangements that make sense for Australia.

Senator BUSHBY —Without asking for details, is the direction they are heading in there to do with the actual liquidity requirements or how they may be held?

Dr Laker —If I were to answer that I would almost be giving away the direction in which we are discussing it.

Senator BUSHBY —Fair enough.

Dr Laker —I would rather just say to you that we are looking at what we think are quite sensible arrangements that would work for Australia. The difficulty we would face in nominating a particular class of assets is that the general principle that Basel is operating under is that the one type of liquid asset that proved not to be liquid in the crisis was bank paper. So the new Basel III liquidity framework does not count bank paper in high-quality liquid assets because it was proven that the liquidity disappeared overnight. That was the crisis of September and October.

Another area that the Basel committee generally has not wanted to contemplate is RMBS, for the same reason that that market globally is still moribund. As I said to Australian banks here who have raised that question with me, it is very hard to argue to include an asset in a definition of high-quality liquid assets when the market globally has been moribund for two or three years—coming back to life.

Senator BUSHBY —And there were not any actual problems with the RMBS? There were not any failures in Australia? Obviously the government—

Dr Laker —The quality of Australian RMBS has always been strong, but the market is a global one. A lot of the buyers of that Australian paper are overseas investors and they have retreated, in a sense, quite fully from that market globally until they get more confidence about other issues. The difficulty for a regulator like APRA is that there is a set of global principles that we are trying to work with.

Senator BUSHBY —Which comes back to the fact that Australia has its own circumstances, and rules that are being adopted nationally have the potential to impact in Australia in ways that are not really relevant or that are not needed. It is what we talked about before?

Dr Laker —Yes.

Senator BUSHBY —It sounds like there is potentially a solution there.

Dr Laker —I only see that issue really arising in the case of that particular global liquidity standard.

Senator COONAN —I would like to ask a few things on Basel, most of which have now been covered. Dr Laker, in the June estimates you alluded to the then proposed definitions of ‘liquid assets’ and that Australia would not be able to meet the narrow definition because of the sum total of government securities in Australia and nor the slightly broader definition because the assets included in that are not actively traded in Australia. At the Financial Services Institute of Australia conference a couple of weeks ago Mr Burns said that there is no free pass for Australian institutions under the rules and that there is no capacity for Australia to argue that we should have weaker rules than the rest of the world. You have talked about refining the standards in Australia for liquidity and I am wondering how all of that actually hangs together, because on the one hand we do have this great robust story to tell and on the other hand it is difficult to reconcile how we actually get to refinements and how that is actually characterised. Is it a side agreement? How are we characterised in this broad global description of financial institutions?

Dr Laker —The ink is not dry on the wording and the detail of the global liquidity standard. We spent quite some time on that issue yesterday in Korea, not just on what was called the Australian issue—because we are very unique around that table—but on a range of other elements of that global liquidity standard. And it is a package. But what we are seeking to reach agreement with the Basel committee on is a set of words within which we can operate, not a carve out for Australia. That is why we need to look carefully at how that language will operate. The Basel committee is quite naturally concerned that it does not open the door for others who are not in the same felicitous situation that we are in to somehow or other use our circumstances as a precedent for not biting the bullet on global standards. So, that language is very important and the ink is not dry on that yet. But I am confident that when we come back to the next estimates it will be clear how we have reached an arrangement that will work in Australia and that has the discipline on the Australian banks and other ADI that their counterparts in other markets will face.

Senator COONAN —I can appreciate the sensitivities of the parameters of this discussion, but are you able to give us some indication of the character of the refinements that you mentioned?

Dr Laker —Not at this point.

Senator COONAN —All right. I certainly respect that. Now, if our banks are required to hold more capital, won’t this cause even more of a squeeze on our credit markets? It seems to be a fairly broadly talked about possibility.

Dr Laker —That issue is not just an Australian issue; it is a global issue. A lot of work has gone on within the Basel context on what is the longer-term impact of tougher capital requirements and what are the transition impacts as you adjust your capital to the higher standards. The general assessment of all that work is that, around the globe, the transition will have a small impact on growth—not as much as some had argued. In the long term, you have got to balance the higher costs that inevitably follow from higher capital requirements with the higher safety and lower risk premiums that will come from having a much more well established banking system around the globe—a much more well capitalised banking system around the globe.

Senator COONAN —Has APRA done any work or been able to come to a view about what kind of increase in lending spreads this might cause, or is that premature?

Dr Laker —We have provided quite a degree of input into the work that has been done by the Basel committee—the quantitative impact study. We are looking at not just what it does to capital requirements and cost but what it might do to lending spreads. But we start from a position where we are either at or very close to these minimum standards in any event, so our circumstances are different. Other countries, as I have said before, have a bigger adjustment to accommodate them.

CHAIR —Senator Coonan, I am going to have to go to Senator Cameron now. We are running out of time.

Senator COONAN —Okay. Thank you.

Senator CAMERON —Dr Laker, can I just start by going back to the Cooper recommendations. Do APRA agree with any of the recommendations; and, if you do, how would they benefit the industry?

Mr Jones —Senator, APRA had a lot of input into the Cooper processes and so we were not particularly surprised by many of the recommendations and we see many of the recommendations coming from the Cooper inquiry as recommendations that are consistent with improving the integrity of the industry.

Senator CAMERON —Can you take me to some of the specific positives that you see in the report?

Mr Jones —I think it is probably not appropriate for APRA at this stage to talk about which recommendations we think are appropriate or not. In the most general sense, many of the recommendations coming from the inquiry are recommendations that we have advanced in the past in terms of improved governance behind funds and so on—same with some of statistics that we were discussing with Senator Bushby earlier.

Senator CAMERON —Okay. I want to go back to a question I asked on notice in relation to hedge funds—and thanks for the response that you gave. I also had responses from Treasury on this issue, which was the European inquiry into hedge funds and looking at more regulation of hedge funds. In your response, Dr Laker, you indicated that APRA looked at hedge funds as part of your ongoing supervision work and said:

… APRA supervisors look at exposure to hedge funds and similar non-traditional assets on a case-by-case basis to understand whether the trustee’s risk management is appropriate. Where this is not the case, our review findings would suggest/require remediation.

Have you found any cases where the risk management strategy was not appropriate?

Mr Jones —We have found circumstances where we have reservations about the nature of the risk management strategies, but they are not particularly related to hedge funds any more than they are related to many other types of investments, alternative assets or various other elements. But it is certainly something that we look at on a very regular basis.

Senator CAMERON —But you said in your response to my question that you look at exposure to hedge funds on a case-by-case basis. So you tell me it is on a case-by-case basis but you do not look at them specifically; is that what you are now telling me? That is different from what you told me.

Mr Jones —No, not at all. What we are saying is that each time we look at any particular institution we look at the nature of the investments. The investments come in a variety of ways and we would look at each particular circumstance.

Senator CAMERON —So you have found no need on hedge funds investment anywhere in Australia to say: there needs to be some remediation in that approach?

Mr Jones —We have found circumstances where we have said to funds, ‘We believe that you should look at the particular circumstances regarding the nature of your use of hedge funds,’ the same way as we have said to various institutions, ‘We believe you should look very carefully at your exposure to unlisted assets’—or anything else.

Senator CAMERON —I am not asking about listed assets. I am asking about hedge funds.

Mr Jones —And what I am saying is that we look at each one of these investments in the same way.

Senator CAMERON —That is fine, but what have you found out about hedge funds? That is what I am trying to understand.

Mr Jones —If you are asking whether we found anything particularly unusual that makes hedge funds unique, the answer is no.

Senator CAMERON —That is not what I am asking.

Mr Jones —What are you asking?

Senator CAMERON —I am asking, in relation to your response to me that you look at exposure to hedge funds ‘on a case-by-case basis’: how many hedge funds have you looked at?

Mr Jones —I cannot say how many we have looked at. We look at them within the context of each particular fund.

Senator CAMERON —Can you take that on notice?

Mr Jones —We can do that.

Senator CAMERON —I am sure you must be able to tell me if APRA has had a look at hedge funds—

Mr Jones —I am not sure, but we will take it on notice.

Senator CAMERON —You also, in this response, say:

If the level of exposure were to increase to levels that caused us concerns on an industry-wide basis, APRA would consider issuing further guidance.

What level would you believe would give rise to some concern?

Mr Jones —It is not a number that you need to work with. It is simply looking at the hedge fund exposure relative, for example, to the size of the fund. It may well also be the extent to which there have been appropriate levels of hedging within the fund.

Senator CAMERON —That is not what you have said to me here. In your written response you have said, ‘If the level of exposure were to increase to levels that caused us concerns on an industry wide basis’, and you are now telling me that you would look at it on an individual basis. I am confused.

Mr Jones —There is no point in looking at exposure on an industry wide basis if we are looking at each individual superannuation fund’s approach to hedge funds—if that is your question.

Senator CAMERON —No, I am now talking about your response, which is about the level of exposure, which is different, and you have answered it in your—

Mr Jones —By saying that, if the level of exposure were to increase on an industry wide basis we would issue further guidance—correct.

Senator CAMERON —Why?

Mr Jones —Why would we consider issuing further guidance? Because we may start to get very nervous about the extent of various exposures. But the concerns in many circumstances would be linked to the individual circumstances of a particular superannuation fund.

Senator CAMERON —Is APRA confident that superannuation fund trustees are capable of making properly informed and considered decisions about investment in hedge funds?

Mr Jones —We believe that in many circumstances trustees need to have a substantial amount of knowledge, and in many circumstances the trustees are forced to rely upon external advisers as a consequence of possibly inadequate knowledge on the part of the trustees themselves. But that is often no different to the nature of the information that they get from other advisers in regard to other types of investment products.

Senator CAMERON —I have just got a concern about hedge funds and what they have or have not delivered and what they have promised. I note that you included in your response to me an article by Mr Craig Roodt, the Senior Risk Specialist. I think, as a broad overview of what you should be doing in relation to hedge funds, it is pretty good. But there is no critical analysis about hedge funds per se. There is no advice about the pitfalls in hedge funds. There is a list of due diligence issues—

Mr Jones —Correct. We have actually provided a list of questions that trustees should look at with regard to any investment in hedge funds and we in fact ask trustees those questions. So the supervisors would in fact, on onsite visits, ask the trustees if they were aware of the types of issues that were particularly relevant. And you are quite correct: in not every circumstance do you get an answer that makes you 100 per cent happy.

CHAIR —Senator Cameron, Senator Xenophon has a question.

Senator CAMERON —Okay. I might have some more questions on notice arising from this—

Mr Jones —Sure.

Senator CAMERON —but thanks for the response on notice and thanks for the response you have given me now.

Mr Jones —Thank you.

Senator XENOPHON —And now for something completely different, Dr Laker! The Bank of Queensland was spruiking a ‘save to win’ account whereby if depositors had at least $250 in an account they basically entered into a lottery through the Bank of Queensland to win up to $20,000 a month. Media reports initially indicated that APRA had approved this particular product. Could you confirm that that is not the case and tell me what your understanding is of those assertions made by the Bank of Queensland.

Dr Laker —I can confirm, and the Bank of Queensland has confirmed, that we have not been involved in the authorisation of that product. I can quote to you from the Bank of Queensland’s own release to the Australian Stock Exchange:

… media coverage stating that the Australian Prudential Regulation Authority (APRA) approved the account is incorrect. APRA has not been involved in the authorisation process of this account and, in the normal course, does not involve itself in the approval of any individual products.

I could not agree more. That is a fair statement.

Senator XENOPHON —Sure—although, as I understand it, there were media reports initially to that effect.

Dr Laker —I saw the media reports. They set the bells ringing, and we very quickly clarified, whatever happened and for whatever reason, that was a simple, incorrect statement.

Senator XENOPHON —Arguably. I will not go any further in relation to that. As one of the key regulators of the banking system do you have a concern about this type of account?

Dr Laker —Our focus on any sort of product is its prudential impact. As I say, we are not a product regulator as such, but an institution may come to us with an unusual product and we will go through with them any prudential issues that we see arising from that particular product. Those prudential issues could include matters like reputational risk if the product is not correctly launched. But we do not sit in judgment beyond the prudential issues. That is outside our remit. If there were concerns about the customer and how the customer was being treated, that is an issue for a fellow regulator.

Senator XENOPHON —Although Christopher Zinn from Choice said that the bank’s approach with this lottery style account went against the spirit of the banking system. Do you think there is merit in that?

Dr Laker —It is certainly the first time we have seen a product like this in the deposit sphere. But I would be very cautious in giving you a reply about whether it is within or without the spirit of it until I had a chance to think more about it. As I said, the first we heard about this product was when it was announced. We have not had a chance to think it through, really: are there issues about this kind of product which go beyond prudential issues or beyond issues to do with treating the customer fairly?

Senator XENOPHON —I guess two things arise out of that. Firstly, given the responsibility of banks to give considered financial advice, do you see any implications of such an account, particularly for young savers, which basically says you can take a punt on your savings rather than get the interest you can earn on your savings? Secondly, while you have acknowledged that APRA has not considered this but it may be within the purview of APRA in terms of what is being offered and its implications, is it something that APRA will take a considered view on and make a statement or take action on if it sees fit?

Dr Laker —On the first question, I think my deputy chairman has reminded me that if this has been approved by the lottery commissions—that was the statement that was made about this product—it would have a restriction on whether it was available to younger people. But we have not checked the facts on that.

Senator XENOPHON —Or 18- or 19-year-olds.

Dr Laker —But if your question was about younger children I think that is an issue that would be dealt with by the various state commissions that the bank has said this was approved by. I think, more generally, in response to your second question, we would certainly take a view about what certain products can do to the reputation and to the fair treatment of users of the product, but it takes us into an area which belongs to another regulator in the normal course of events. We do not sit and judge individual products; it is just not our role and we are not resourced to do it.

Senator XENOPHON —Is it ASIC’s role?

Dr Laker —It is a question you should put to ASIC about what they would be looking at in terms of what the product offer is to the customer and how well that is understood. We have sort of instinctive tests where we might feel uncomfortable about a certain product, but we also have to have a look at whether or not we have the authority to—

Senator XENOPHON —Finally, given that it is such an unusual product and given that it is in effect asking those who save to take a punt on the interest, will APRA consider whether it is in their purview at any time? Will there be formal consideration as to whether it ought to be subject to any action?

Dr Laker —What I can tell you is that we have talked to ASIC about this, and I think we would need to clarify where any responsibility for this kind of product lies. Until we have had a chance to have that dialogue more fully, I cannot really nominate it as falling in a or b. It is not immediately a prudential issue as such.

Senator XENOPHON —Will that dialogue take place in the next month or so?

Dr Laker —You may speed that up by talking to ASIC, if they have not already been before Senate estimates. We will talk about it but we need to be very clear on what basis we are making—

Senator XENOPHON —But you will talk to them about it in the next month.

Dr Laker —Yes.

Senator XENOPHON —Thank you.

Senator WILLIAMS —Considering the time, Chair, I will put my couple of questions on notice.

CHAIR —Thank you, Senator Williams; that will be helpful. Thank you, APRA. I hope you celebrate World Statistics Day in fine style after this. Thank you for coming in on such an auspicious occasion!

[8.19 pm]