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Economics Legislation Committee
Australian Prudential Regulation Authority

Australian Prudential Regulation Authority


CHAIR: Welcome. Do you have an opening statement, Mr Byres?

Mr Byres : I will just make a short statement about some recent initiatives and announcements that affect APRA and the institutions we supervise. In doing so, however, I would start by reiterating the underlying assessment I expressed when we appeared before this committee in February: that while there are certain risks in the economic and financial environment, at present Australia continues to benefit from a financial system that is fundamentally sound. That is not to be complacent—since the financial system will inevitably be adversely impacted by any external shocks or economic adversity that might emerge—but rather to acknowledge that there has also been a range of measures, past and ongoing, that have strengthened the underlying resilience of the financial system in recent years. That means we are better placed to deal with these risks than we might otherwise have been.

Probably the most high-profile issue we have focused on in the domestic environment in recent times has been the heightened risk in housing lending. That has reflected the environment of higher house prices and higher household debt, low interest rates and income growth, and strong competitive pressures. Our actions, including our most recent intervention to limit the extent of interest-only lending, have been designed to reinforce sound lending standards in authorised deposit-taking institutions—ADIs, as we call them. It is important to be clear that our goal has not been to seek to determine house prices. House prices are not within the control, nor the mandate, of the prudential regulator. Rather, our role in the current environment is to promote a higher than normal degree of prudence by lenders and ideally also by borrowers, in both credit decisions and balance sheet strength. This is an issue that we will continue to monitor closely, along with the other members of the Council of Financial Regulators.

As this committee knows, and as you have discussed, the Commonwealth budget earlier this month contained a number of announcements relevant to APRA in relation to the government's broader agenda to enhance competition and accountability in the Australian financial system. Although the government is yet to announce the legislative details that will underpin these new measures, I would like to make a few broad comments about how we view them.

Most importantly, we do not consider that the measures announced in the budget will fundamentally change APRA's supervisory philosophy. Although considerable attention has been given to new penalty provisions and enforcement powers, as a prudential supervisor APRA's primary objective will always be to identify potential weaknesses in its regulated institutions before they become major problems rather than rely heavily on after-the-event enforcement. That is not to suggest that we do not see the new powers as useful: indeed, their very presence will help us to encourage and promote prudent behaviour to begin with. But it is important to emphasise that prevention rather than rectification will remain our primary goal.

In addition, many of the measures involve a strengthening of APRA's existing powers rather than completely new additions to our armoury. APRA already has, for example, a 'fit and proper' regime covering senior executives, powers that allow for the disqualification of individuals, and a capacity to set and enforce standards for remuneration policies. The proposals announced in the budget will considerably strengthen these, particularly as they apply to ADIs, and better equip APRA to enforce change where clear shortcomings have been identified.

The two budget measures that are genuinely new are the proposed civil penalty regime and the proposed new power in the Banking Act to set some form of rules for non-ADI lenders where this is necessary to protect financial stability. We will be working with Treasury during the consultation on the proposed legislation to ensure there is clarity as to how these new measures are intended to work in practice.

Meanwhile, in the same way that institutions we regulate have had to adapt to changes in the operating environment, APRA itself has continued to evolve and innovate. We recently appointed new senior executives to our leadership team as part of a broader organisational restructure. That restructure includes, amongst other things, a new centralised unit tasked with reviewing our licensing activities to ensure that they are suited to the increasingly diverse range of applicants that want to engage with us. We expect that this review will lead to changes to our current licensing processes to better accommodate more innovative business models, structures and products.

As part of that review we are considering the benefits and risks of adopting a two-phased approach to licensing for certain types of new entrant. The key benefit of a phased approach to licensing would be to allow eligible new entrants time to establish the full complement of resources and systems necessary to be able to comply with all aspects of the prudential framework. We will seek to balance that benefit with the community's reasonable expectations that a deposit taker or an insurance provider should be soundly managed, including having sufficient levels of financial strength.

Finally, I would just like to highlight the recent collaborative efforts between APRA and ASIC to improve the understanding of claims-handling practices in the life insurance industry. That is a joint initiative in response to community concerns about current industry practices and aims to collect and publish life insurance claims data on a per-insurer basis. That will include data on claims-handling time frames and dispute levels, and will allow for meaningful comparisons of insurer performance and more effectively to inform consumers and other interested stakeholders.

So I hope those remarks are helpful background, and my colleagues and I are happy to answer your questions.

CHAIR: Thank you, Mr Byres. My apologies—I failed to acknowledge Senator the Hon. James McGrath, representing the Treasurer here this evening. I am going to kick off questions with Senator Bushby.

Senator BUSHBY: Thank you, Mr Byres and officers from APRA, for assisting us this evening. You mentioned in your opening statement that one of the new measures that was included in the budget, which is intended to strengthen one of your existing powers, relates to senior executives—that is, the banking executive accountability regime, otherwise known as BEAR. I was wondering if you could outline to the committee how APRA is approaching the implementation of that new regime.

Mr Byres : At this point we are involved in liaison and discussions with Treasury. Ultimately this is going to be a regime that will need to be underpinned by some new legislation. From our perspective it is important that that legislation works for us and that we think we can practically implement it. Our immediate task is to work with Treasury to think through some of the design challenges of the regime and some of the areas where perhaps the existing regime would benefit from strengthening and to work out how we implement those. We will then inevitably need to revise some of our existing prudential requirements to align with whatever new legislative provisions the government proposes and the parliament passes. We will then need to go through our own additional consultation process about what changes to the prudential framework and the prudential standards we want to implement to give effect to the entirety of the new regime.

Senator BUSHBY: Thank you for that. It seems to me, or as I understand it, there are two broad aspects to the BEAR: the first is introducing stronger powers to remove and disqualify senior executives who are involved in unethical or inappropriate behaviour, and the second is to do with their remuneration and effectively delaying the discretionary or the variable part of their remuneration for a period of time, with the intention of promoting longer term behavioural decisions. The first sounds like it is something that relates significantly to what you are doing now, so I imagine that the potential design of that is something that will be more straightforward than the second bit, which does sound like it is something a little bit new. Is that a fair observation?

Mr Byres : In part; yes. I actually think there are four components to the new regime. First of all there is a process of registration—sorry; I should have said: it is important to understand the four components, because they are mutually reinforcing and the individual measures will only probably work optimally if all four components work together.

The first is that there is a proposal for registration—in a sense, pre-notification of appointments—so it is clear who is in the system. The second leg is a requirement for institutions that are subject to the regime to map accountabilities to individuals, so it becomes clearer who is responsible for what. The third leg is then a set of expectations around how individuals and institutions are expected to conduct their business, and then the fourth component is what you do if people fail to deliver on that, either individually or as an organisation.

Of those four components, certainly the registration and the mapping are new. They are not things we have at present, or certainly not in the formal way that I think is envisaged. The disqualification framework is something we have, but it is being enhanced and strengthened, and the penalty provisions are clearly new as well.

Senator BUSHBY: Where do the changes to the banking remuneration fit into those four?

Mr Byres : Sorry. In addition to that—and I guess the government sees it as, if you like, a fifth component of the regime—is a proposal to legislate that a minimum proportion of variable remuneration must be deferred for a period of at least four years. That is obviously designed to allow time for performance to genuinely be assessed, to prevent the idea that people are rewarded and then risks emerge later on and appear too late. Again, it is a useful way of making sure that only genuine performance is rewarded.

Senator BUSHBY: You say it is useful. Do you think that delay will build incentives in to ensure that people do make longer term decisions rather than decisions which, arguably, could be in their interest in the short term but set institutions up for longer term risks?

Mr Byres : The short answer is yes. We have an existing prudential standard on remuneration, and that promotes the concept of deferral. That prudential standard covers a wider range of institutions, so it is necessarily higher level and more principles based. But the concept of deferral and of trying to better match the period in which risk might emerge before rewards are paid is consistent with our prudential framework. As I said, the government has determined that, for a certain class of institutions, it is going to specify a four-year time period. As things currently stand, some institutions would exceed that requirement already; some would not.

Senator BUSHBY: This is just putting a baseline in, effectively?

Mr Byres : Yes.

Senator BUSHBY: In terms of the implementation and design of that, is that something you think will be fairly straightforward given that some institutions already do that?

Mr Byres : Of that specific measure—the deferral?

Senator BUSHBY: Yes.

Mr Byres : No. Like all of these things, the devil is in the detail. You are dealing with individuals' employment arrangements and there will be all sorts of complexities associated with things that are already in train that people have entitlements to. There will be a fair bit of complexity in working out how you handle things that are already in place.

Senator BUSHBY: In terms of what to do if people fail to meet those requirements—your fourth one—is that something that is going to require a fair bit of work to identify and finalise? I am really asking: what sort of penalties would be applied? Is it too early to talk about that?

Mr Byres : The government has said that there will be penalties, which will be up to $200 million for large banks and up to $50 million for smaller banks. That distinction is not yet defined: that is something the government needs to define. The second thing that needs to be defined in the legislation is the behavioural requirements—what are the expectations that an individual or organisation needs to adhere to? Only after those things are clear can you actually identify what circumstances—

Senator BUSHBY: The types of conduct that would attract.

Mr Byres : The types of conduct that might attract that particular sort of penalty, yes. The only other thing I would stress is that, just to be clear about this, APRA would not be unilaterally applying a penalty. We would apply to a court. The courts would ultimately decide whether penalties are applied or not.

Senator BUSHBY: That is very good. The other thing you mentioned was the new powers over the provision of credit by lenders that are outside the traditional banking sector. I understand that APRA has traditionally had oversight of ADIs but not outside that. I think that is something we have probably discussed over the years. What macroprudential risks, outside of ADIs, do you think this measure will actually assist you in addressing?

Mr Byres : The government has said that, potentially, in the current environment there is a limit to our existing set of measures because they apply only to APRA-regulated institutions. It is not proposed that APRA would, in its normal day-to-day supervision, be supervising those non-bank lenders. But it is useful to have a reserve power so that, if we thought there was a threat to financial stability that was being exacerbated or compounded by things that were going on outside the ADI sector, we would have the capacity to do something about that.

Senator BUSHBY: Arguably some of the consequences back in 2008 of the deposit-taking institutions failing may well have been considered to have some prudential consequences.

Mr Byres : I think this is an important distinction: the failure of an individual non-bank institution is, without wishing to sound heartless, a fact of life sometimes. It is not APRA's intent nor is it the government's. More to the point, it is not the government's intent that we take responsibility for the safety and soundness of every individual institution. What this measure is designed to address is that, collectively, those institutions might be adding significantly to systemic risk and, if they are—if there is a systemic risk—that APRA would have the capacity to introduce some rules which might help mitigate that. But that is very different to saying we take day-to-day responsibility for individual institutions.

Senator BUSHBY: I understand that; that will still rest elsewhere. But, in terms of macroprudential risks that it might present when there are issues, that is when you get interested?

Mr Byres : Yes.

Senator BUSHBY: Just for clarity, can you give us some examples of the types of institutions that would be caught under these expanded powers.

Mr Byres : Again, I am a little bit hamstrung here by the fact that the powers in the legislation have not actually been announced by the government yet.

Senator BUSHBY: What you anticipate then without tying into anything.

Mr Byres : The sort of example which has been used in discussions is: as we see now, we are deliberately trying to promote sound lending standards and reinforce sound lending standards amongst ADIs. One potential outcome of constraints on the regulated sector is the business simply moves to the unregulated sector. The things that we are trying to do to promote system stability are undermined or eroded away by a growth in the non-bank sector and, if that became such that we thought that that was creating a threat to financial stability, that there would be a capacity to respond to that.

Senator BUSHBY: In terms of the non-bank sector, what sorts of institutions are we talking about—just for clarity for those who might be listening to or reading this?

Mr Byres : Again, it is hard to tell because it depends on the circumstances. The current topic of the day is housing lending, housing lenders—those involved in and associated with the provision of finance for housing. If this power existed today and we were talking about its use, you would be thinking about it in the context of organisations that are providing provision of finance for housing.

Senator BUSHBY: That are not currently ADIs.

Mr Byres : Yes.

Senator BUSHBY: While we are on housing, you also mentioned in your opening statement some of the changes you have made in terms of ensuring prudential stability in the housing market. Can you outline how lending risks vary across different Australian housing markets—is that something you look at closely when you are examining these issues?

Mr Byres : It is certainly something we think about, but I would say that what we have tried to do is promote good lending standards. Good lending standards apply whether, in your particular market, prices are going up, going down or going sideways. Good lending standards are sensibly assessing a borrower's capacity to repay, sensibly assessing the collateral they offer and then making a sound proposition, a sound loan, to someone who can afford to repay it—it does not matter where you are, what geography you are in. That is a sound way to conduct a business.

Most of our efforts have actually been directed to sound lending standards across the board, because we think they are generally applicable, regardless of geography. Clearly, we are mindful that there is very different experience in different geographies around the country, so it is not strictly right to talk about the housing market or the Australian housing market, because there are obviously very different markets. Even in the same geographic location, there can be different experiences between houses and apartments, for example. We do look at and think about that but, equally, what we have tried to do is make sure that there is sensible lending going on whatever the market circumstances might be at any particular point in time.

Senator BUSHBY: Did the budget look at your ability to target macroprudential regulation of standards in specific parts of Australia?

Mr Byres : In the Treasurer's budget speech he said:

And we will legislate to extend APRA’s ability to apply controls to the non-ADI sector—

as we have talked about—

and explicitly allow them to differentiate the application of loan controls by location.

So the government's intention is to do that. I do not know that we necessarily have a major constraint at present but it is useful that it is explicitly allowed, so there is no question.

Senator BUSHBY: So, in terms of being able to do that, looking at different markets around the country—or even as you say different markets within the same geographical location—where required, you have that ability and that specific reference by the Treasurer just highlighting that in the budget.

Mr Byres : The intention is to give us that explicit—

Senator BUSHBY: You do not have it already?

Mr Byres : Well, we do not have it explicitly.

Senator BUSHBY: Maybe I misunderstood what you just said.

Mr Byres : Yes.

Senator BUSHBY: I will clarify it. You do not have it currently but, on the basis of what the Treasurer said, you will?

Mr Byres : No. We think we could do that now, if we felt the need to. But the Treasurer has said he would like to make it explicit—which is, obviously, fine by us.

CHAIR: Thank you, Senator Bushby. Senator Ketter.

Senator KETTER: Thank you very much. What role does APRA have in implementing the bank levy?

Mr Byres : In terms of the actual implementation of the levy?

Senator KETTER: Yes.

Mr Byres : We will have a data-collection role. So we have a range of data collections that we collect for a range of other agencies: the Reserve Bank, the ABS and, to date, the tax office—in relation to super we collect some information or have the capacity to share information with the tax office. There will now be added to those collections some additional data items which will inform the tax office. But we are in a sense the pass-through of information, nothing more than that.

Senator KETTER: Can you tell me what date you first became aware of the bank levy?

Mr Byres : I became aware of the bank levy in its current form or current proposal in late March. I know you are keen on the exact date and I have tried to look and see if I can pinpoint the exact date. I, unfortunately, cannot do so. But it was definitely in late March.

Senator KETTER: You became aware of it on that date. How did you become aware of it?

Mr Byres : I was informed by Treasury in a conversation. I was talking with Treasury on a range of other issues, and the information was passed to me as something that—at that stage it was on the basis of something the government was considering, and it was passed on to me just so I was aware that that was in the pipeline.

Senator KETTER: Were you asked to express a view?

Mr Byres : Not on that day, no.

Senator KETTER: In terms of that precise date, is that something you can take on notice, and perhaps have a look at your diaries?

Mr Byres : I am happy to take it on notice and look further, but I know you asked the Treasury people yesterday for exact dates so I did have a look to see if I could provide you with the exact date and I cannot quite pinpoint it but I will have another look for it.

Senator KETTER: You mentioned that it was in conjunction with another meeting that you were having.

Mr Byres : Well, it was a phone call that I had with Treasury and around that time in late March I had a number of phone calls with Treasury so I cannot quite pinpoint which one it was.

Senator GALLAGHER: Was that a request for data?

Mr Byres : No. At that point it was just—for want of a better term—a 'heads up' to me that this was something that was being considered. In early April, I got an official request from Treasury for some assistance with data and also as to whether we could provide a person to Treasury to help them with the work.

Senator GALLAGHER: In terms of any consultation, when did that occur? We have data collection. We have a secondment. When was consultation with APRA commenced?

Mr Byres : In the month leading up to the budget, I would say.

Senator GALLAGHER: And what form did that take?

Mr Byres : A range of discussions at various points as the proposal solidified.

Senator KETTER: And at some point were you asked to express a view about the bank levy?

Mr Byres : As I think the Treasurer has said today, we expressed the view that this did not jeopardise our prudential objectives and was not going to have a material impact on the resilience of the banking system.

Senator KETTER: And when did you provide that advice?

Mr Byres : As to date, I would have to take that on notice.

Senator KETTER: Sometime in the month of April?

Mr Byres : I would have to take it on notice whether it was April or just as the proposal was being finalised. I cannot tell you today. I will take it on notice.

Senator GALLAGHER: Are you able to provide the committee with the feedback you provided around the levy?

Mr Byres : I am not quite sure precisely what you are asking for.

Senator GALLAGHER: When you were consulted on it—and you provided feedback to the government, presumably. I do not know what form that took, but are you able to provide that information to the committee?

Mr Byres : I can probably provide the nature of the feedback, but it will be along the lines of what I just said: we did not think it had a material impact on the resilience of the system and it does not jeopardise our prudential objectives. That would be the gist of it.

Senator KETTER: Are you familiar with the comments of Dr Henry on 16 May?

Mr Byres : I have read various things that various chairmen have said—

Senator KETTER: In relation to his comments about retained earnings and how the bank levy cuts across your work in terms of promoting the retention of retained earnings.

Mr Byres : I do not think it has a material impact on our prudential objectives, as I have said. There is a range of things that banks can do to respond to that levy. They will make their commercial decisions. But I hold to the view that it does not jeopardise our prudential objectives.

Senator KETTER: You said there are a range of things that banks can do in response. Can you tell us what you think those things are?

Mr Byres : They will work out what they do in response to that—commercial decisions about balance sheet growth, balance sheet structure, pricing, dividends and retained earnings, there is a whole range of things that banks can do. Thus far, I have not heard them indicate what they intend to do. So it is a bit hard to tell.

Senator KETTER: Is there a risk with the current design of the levy that the banks are perversely incentivised to invest or borrow for riskier balance sheets?

Mr Byres : I do not think there is. But, even if there was, I think there are enough other compensating controls in the prudential framework. It would not concern me.

Senator GALLAGHER: Did you do any modelling of the bank levy?

Mr Byres : No. And I think it is an important point. It is not our role to provide advice to the government on whether it is a good revenue measure, whether it is the right revenue measure, whether it is the best way to raise revenue—

Senator GALLAGHER: There are plenty of people that can do that.

Mr Byres : Yes. Our narrow focus is really: does it impact on our prudential objectives; and is there anything, if the government proceeded with this measure, that we would have a significant concern about in terms of either the stability of the system, the resilience of individual institutions, or other prudential objectives that we are pursuing? And, as I said, when we looked at what the quantum of the levy was, we did not think that was the case.

Senator GALLAGHER: Did you do modelling to get that point? How did you get that point—that is a better way of putting it.

Mr Byres : 'Modelling' sounds a very sophisticated term. It is five per cent of annual profits, or thereabouts. That immediately seems to be not something that threatens the viability of institutions. Another way of looking at it is that it is six basis points added to the cost of a certain class of liabilities, so it is less than six basis points spread over the entirety of their funding structure. Funding costs move by more than that quite regularly, so it did not seem to me in that sense to be in any way destabilising or such a shock to the system that it could not be managed in a fairly orderly fashion.

Senator KETTER: At any point in the consultation did you recommend or support a profit based levy rather than a liabilities based levy?

Mr Byres : We did not provide any advice on the structure of the levy or the merits of alternative approaches. That was not something which I thought was in our mandate to provide advice on.

Senator KETTER: So what was the nature of the advice that you gave?

Mr Byres : The government, through Treasury, told us what the proposal was. Over time the calibration of the fee and the base became clear and the quantum that it was likely to raise from the industry in aggregate became clear. On that basis we reached our view.

Senator GALLAGHER: So 'consultation' means that once it was finalised or determined what the levy would be, consultation with APRA was really you saying that you do not think it will have a material impact on prudential outcomes?

Mr Byres : That is the endpoint of the process. There is a chicken and egg problem here. You cannot provide advice until you know the details of what you are providing advice on. In the early days there was a discussion about what was proposed, and we were given an opportunity, if we had any particular thoughts, to provide those. As the proposal developed and solidified and was ready to go for decision, there was a discussion about a more concrete proposal and then we could provide a more definitive view.

Senator GALLAGHER: But it was not over the merits of the levy or not?

Mr Byres : That is not our job.

Senator GALLAGHER: I understand that. And when you say it was not modelling, it was advice, was it?

Mr Byres : It was simply that we were looking at the quantum and thinking through the impact of that on the profitability of the industry. What did it do to the overall funding cost of the industry? We came to the view—certainly I came to the view—that it was something that the industry could take on. They were never going to be happy about it, obviously, but they could take it on without threatening the resilience of the system or of an individual institution.

Senator KETTER: Have you considered whether you are going to change the amount or timing of the capital that you require banks to hold as a result of the new levy?

Mr Byres : As we have said publicly, we have the first recommendation of the Financial System Inquiry, which talks about achieving capital standards that deliver unquestionably strong capital ratios for our ADIs. We flagged that in the next month or so we intend to put out an information paper which explains how we are going to view that. That remains our intention. Obviously, as we think about the capacity of the banks to meet any new targets, we would take into account most recent developments. I do not see it as having a material impact on our plans.

Senator KETTER: There have been some estimates that, in terms of the amount of capital that you are requiring banks to hold, that figure of about a third is what you might be looking at. Is it too early to suggest that?

Mr Byres : I am not quite sure how to interpret that comment that you are quoting, as to what it might mean. I am struggling to work out how to respond.

Senator KETTER: In terms of the amount of capital that you are requiring banks to hold, you are still working through that?

Mr Byres : We are still working through that. We think banks in this country are soundly capitalised. It is not a question that we have banks that are poorly capitalised, but the FSI said we should aspire to this concept of unquestionably strong, which meant, in essence, that when the rest of the world looked at us there was absolute confidence that banks in this country were unquestionably strong in their financial soundness. We have said that we think that the industry is not quite at that standard, but equally, the capital levels within the industry have improved quite a bit over the last couple of years. This information paper which we are proposing to put out in the next month or so will set out the definitive view of how we are going to define that concept of unquestionably strong.

Senator KETTER: As we were talking about earlier, if retained earnings are now going to be impacted by the levy, how are the banks going to meet their capital requirements?

Mr Byres : All other things being equal, if there is marginally less retained earnings, banks will make some decisions about how they respond to that. They could decide to pursue new revenue; they could decide to slow down their balance sheet growth; they could change their dividend policies; or they could take slightly longer to get to the position that we are going to define as unquestionably strong.

Senator KETTER: In other words, it could lead to increased interest rates, fees and charges?

Mr Byres : There is a commercial decision that banks have to make about how they respond to this.

Senator KETTER: Do you have a view as to whether banks should pass on the bank levy costs to their customers?

Mr Byres : I have no view on this issue. That is a commercial decision they have to take.

Senator KETTER: Your concerns are in terms of the stability of the system?

Mr Byres : Yes. As I said, those banks are obviously not happy about having to pay the levy. That is true. But even after that levy is paid, they will still be quite profitable institutions.

Senator WHISH-WILSON: APRA recently released a discussion paper on proposed changes to mortgage lending reporting requirements. That was in October 2016. I understand that you have recently written to banks stating that the implementation of these changes has been delayed. Is that correct?

Mr Byres : Yes, that is correct.

Senator WHISH-WILSON: Could you explain why these changes have been delayed?

Mr Byres : Pat might be able to give a more definitive answer than me, but essentially it was to do with banks' ability to provide some additional data items.

Mr P Brennan : It did not reflect any significant concern. This often happens when we implement things. The initial date we think of slips a little.

Senator WHISH-WILSON: I am specifically interested in an article in The Australian by Michael Roddan. He quotes Katrina Ellis—

Mr P Brennan : She heads up our statistics and data analytics area.

Senator WHISH-WILSON: She said, 'APRA expects that a prudent bank with material exposures to residential mortgage lending would invest in management information systems that allow for appropriate assessment of residential mortgage lending risk exposures.' Do you agree with that?

Mr Byres : Yes. It is hard not to.

Senator WHISH-WILSON: Are these institutions, who apparently do not have the capacity to provide more data on simple things like loan value ratios—LVRs—licensed to do their own internal risk weightings on mortgages?

Mr Byres : Pat may have a view, but I think the challenge is not that they do not have the data but that they do not necessarily have the data in the precise form that we want to define it so that we can aggregate, compare and contrast. Pat, did you have anything to offer?

Senator WHISH-WILSON: The kind of metrics you have asked for are fairly simple, aren't they?

Mr Byres : There are things that we are currently collecting through an ad hoc informal data collection—a spreadsheet based system that we get from larger institutions. We are trying to move that into a formal collection, which also makes sure that, amongst other things, it is subject to audit and other quality control. That has therefore focused attention on definitions and precision in what is being reported. There are some banks that have to make system changes to be able to accommodate reporting in the form that we want it reported.

Senator WHISH-WILSON: But you are comfortable that they have the data in place for things like their own internal risk assessments—it is not a lack of data; it is just the format in which they are required to give it to you?

Mr Byres : I am reluctant to give them a clean bill of health on everything they do, but in many cases the issue is simply that they have a slightly different definition or there are things we have asked for that are actually challenging to standardise, so we have given the institutions a bit more time to modify their systems to allow it to be reported the way we want it.

Senator WHISH-WILSON: I am not sure how to probe you on that 'clean bill of health' thing—maybe later, as I have a couple of questions I might ask in relation to that. I want to ask about their own assessments of mortgage risk weights. The FSI report talked about narrowing the difference between the average mortgage risk weights for ADI institutions using IRB. The S&P downgrade of the second-tier banks last week brought this issue into close focus. You can take this question on notice if you do not have the information with you. What is the average of mortgage risk weights now applied to the major banks?

Mr Byres : Unless Pat has the figure—at present we are working towards an average of 25 per cent.

Senator WHISH-WILSON: Which you stipulated previously.

Mr Byres : Yes. It may not be precisely that at the latest quarterly data, but that is the aspiration we are working towards, and there are some modelling changes working through the system.

Senator WHISH-WILSON: How long will that take?

Mr Byres : I will take that on notice, but the plan was certainly to have it at around the middle of this year—so it is not that far away.

Senator WHISH-WILSON: What is the average mortgage risk weight that is now applied to smaller lenders? Is that also a work in progress?

Mr Byres : No, that really has not changed a lot. That is in the order of 39 to 40 per cent.

Senator WHISH-WILSON: Would you say that the competitive advantage the major banks have had on mortgage risk weights have contracted since the FSI, in 2014?

Mr Byres : To the extent that the number that is now around 25 used to be 16 to 18, then yes, and to the extent that created a competitive advantage, then that has been reduced.

Senator WHISH-WILSON: Are there any further changes planned to mortgage risk weights?

Mr Byres : Yes. We have announced that part of the way in which we will deliver the unquestionably strong concept is a review of mortgage risk weights to recognise that we are in an environment of heightened risk. It is the biggest asset portfolio on bank balance sheets and there is a very big concentration of housing risk in the Australian banking system and risk weights in their current form do not really take into account that concentration.

Senator WHISH-WILSON: As an aside, you were talking about an environment of heightened risk. What was your reaction to the reporting in the media in the last few days of Altair Asset Management pulling out of Australia because of the impending housing bubble bursting. Did that surprise you?

Mr Byres : I guess it did. That is why it attracted headlines—because it was a fairly extreme response to the circumstances.

Senator WHISH-WILSON: It is an outlier?

Mr Byres : Did it surprise me? I guess it did.

Senator WHISH-WILSON: Did S&P's downgrading of the credit rating for the smaller banks surprise you—based essentially on assumptions of mortgage credit risk and housing price exposure?

Mr Byres : I cannot say it totally surprised me, because I knew they were thinking about it and they had flagged concerns they were thinking about it. I think the timing certainly surprised me, because the way they had presented their views previously suggested that they might take a little bit longer to see how some of our measures were taking effect, before they made a decision. So the timing certainly was not expected.

Senator WHISH-WILSON: Are smaller banks too big to fail, as well? Would you be prepared to comment on that?

Mr Byres : First of all, we will not say that anyone is too big to fail. The whole objective of a number of the regulatory initiatives is to try to improve our crisis management powers so that if an institution of whatever size gets into difficulty we are better able to deal with that.

Senator WHISH-WILSON: There was certainly a recognition that the big banks had an implicit guarantee. That was fairly clearly stated by—

Mr Byres : The implicit guarantee is implicit in the sense that it is perceived to be there. It is very difficult to do anything about the perception. The way in which the regulatory community—I am talking here about the global regulatory community—is responding to that since the financial crisis is to try to introduce measures for the largest banks that reduce the probability that that perceived guarantee would ever need to be used anyway. If you think it is never going to be used it has no value.

Senator WHISH-WILSON: If I have time I will come back to that. When S&P downgraded the smaller banks and kept the majors on hold, interestingly, within a couple of weeks of the announcement of the bank levy, the Bank of Queensland responded. Their CEO, Jon Sutton, came out and said, 'The big banks put about $2 behind every mortgage for the funds they lend. We have to put about $3.50 against each mortgage.' Do you believe that differential is correct?

Mr Byres : I don't know that I would agree with it to the last cent, but, conceptually, with a 25 per cent risk weight versus a 40 per cent risk weight the ratio of 2:3 or thereabouts is not too far apart.

Senator WHISH-WILSON: What impact do you think that differential in mortgage risk weights is having on the competitiveness of the Australian banking system?

Mr Byres : We have been asked that question in a different forum. The House of Representatives Standing Committee on Economics asked us that question in the context of how we would estimate the pricing differential that might result from those things. Our estimate was about 10 basis points of pricing difference, all other things being equal and with a raft of assumptions built into any modelling. That is a question on notice that is publicly available.

Senator WHISH-WILSON: I will look up that source. What is it about the major banks' loan books that means their mortgage exposures are less risky—in a nutshell?

Mr Byres : The issue is not so much about less risky, although clearly they are more diversified. The real issue is that those banks have invested, and are able to invest by virtue of their scale, in much more sophisticated risk management systems. They have better databases and better capacity to model risk and as a result of that the regulatory system tries to take advantage of the fact that they have those better metrics that allow you to more precisely measure risk.

Senator WHISH-WILSON: In relation to the $2 to $3.50 differential I mentioned that Jon Sutton had talked about, what hope do you have that that differential would be reduced to—

Mr Byres : At this point I could not tell you, other than to say that the likely outcome is that it narrows further. But I would say that the regulatory system is such that it is unlikely to close to zero. So it would narrow.

Senator WHISH-WILSON: Mr Summerhayes, since our last discussion, in Sydney, with this committee concerning carbon risk, have there been any developments at all with APRA or with your consultation or discussions with the organisations you supervise?

Mr Summerhayes : I think when we were together talking at the carbon risk disclosure committee I had only recently delivered the speech.

Senator WHISH-WILSON: It is still being talked about, by the way.

Mr Summerhayes : We believe the speech had its desired effect—that is, putting a marker down about the issues. It has enabled our supervisors to have conversations with the entities that they supervise to test their awareness of the issues and their understanding of issues and the extent to which climate change risks are being considered in the context of their overall risk management framework. Of course, you would expect a range of responses to that, and we are certainly seeing within the superannuation sector, particularly at the bigger end, good engagement on the issue. In the insurance sector the understanding is strong as it relates to physical risks and perhaps less the case with transition and liability risks. In the banking sector, as it relates to credit risk and other risks, there is a good understanding. The desire was to start the conversation and put it on the agenda. It seems to have had that effect and our work continues in that area.

Senator WHISH-WILSON: Are there any milestones or any events on the horizon that we could look forward to in terms of how that might have progressed?

Mr Summerhayes : Not immediately from APRA. As I have said to this committee previously we did not want the risk to suddenly send a signal that APRA was elevating the risk to the top of its list. It is like other emerging risks that we feel we have a role to bring to their attention and put them on the agenda, and to the extent to which entities are considering those and making their own decisions, then that is appropriate.

Senator WHISH-WILSON: At last estimates you stated that banks are bringing in external auditors to look at their mortgage lending practices. Have all institutions been required to do this evaluation, and when do you anticipate releasing the outcomes of the investigation?

Mr Byres : The work was requested of the banks that are authorised to use their internal models for risk rating purposes—that is common knowledge. That is the four major banks and Macquarie. The reason we focused on those banks is that if they do not have their data right then the risk weights are not as accurate as they might otherwise be. Obviously, those five banks, and particularly the majors, control 80+ per cent of the market, so if you get that right you are well on the way to looking after the system. To the credit of the audit profession they have taken a while to get those done but that is because they seem to have done a fairly thorough job. Those reports have all now come in to us and we are reviewing them. We also plan to have a meeting with the auditors and the banks concerned, individually—each bank and its auditor and APRA—to talk about what the bank proposes to do in response to any observations the auditors have made. Then we will think about how we communicate the broad themes that have emerged from that.

Senator WHISH-WILSON: Will you release those?

Mr Byres : The broad themes. Obviously we will not release the bank by bank reports as they are confidential. But we will find some way to communicate the broad themes and the extent to which we think the industry needs to lift its game in some regard—where that is.

CHAIR: I have some questions about some of the integrity measures in the superannuation industry. I should give you a heads-up that I used to work in this industry. I have great respect for the organisation I worked for and the people I worked with, but I have some concerns that some industry players, potentially, pose threats to the reputation of those who are doing the right thing. I would like to ask first whether APRA has a fit and proper person test for superannuation funds.

Mrs Rowell : Yes, we do. There is a prudential standard for fitness and propriety in the superannuation industry, which requires trustees to establish a fit and proper policy and framework.

CHAIR: Who does that standard apply to?

Mrs Rowell : APRA-regulated superannuation entities. It applies—

CHAIR: Who within the entity?

Mrs Rowell : to the trustee.

CHAIR: Does it apply to the CEO?

Mrs Rowell : The trustee has to put the framework in place for directors and responsible persons, so it would cover the senior group of employees within the organisation.

CHAIR: And how does that standard operate? Is everybody aware of the standard? Is it something that the board and executive are made aware of?

Mrs Rowell : Absolutely. The standard was introduced in 2013 as part of the implementation of all of the prudential standards for the superannuation industry. There are obligations on trustees to develop the framework and policies, to implement those policies and to communicate those policies through their organisations.

CHAIR: And that is something that APRA oversees?

Mrs Rowell : Yes, that is a focus of our supervision.

CHAIR: Would APRA consider that standard—SPS 520, I believe it is—to be relevant to an individual that is being investigated by ICAC, and potentially by a state government department, for alleged wrongdoing?

Mrs Rowell : We would expect matters like that to be considered by the relevant fund and trustee.

CHAIR: If in fact a senior member of a fund, a senior executive of a fund, had been sacked from the Public Service as a result of management decisions and was the subject of an investigation, would APRA consider it necessary that the fit and proper person process of that fund be invoked?

Mrs Rowell : We would expect the trustee to give consideration to their policy and the individual's conduct in relation to that policy.

CHAIR: It is my understanding that a senior executive of a very large superannuation fund, a fund managing $2.6 billion of compulsory retirement savings on behalf of Australian workers, is in this exact circumstance. I think it is a matter of public record that that senior executive was sacked as the general manager of a New South Wales public entity as a result of a referral from ICAC to the relevant department and subsequent internal and external investigations into his conduct. That was 13 years ago. Is APRA aware of this particular case?

Mrs Rowell : I am not aware of the—

CHAIR: I can name the superannuation fund if you like. I have parliamentary privilege. I am just concerned I might end up in concrete boots.

Mrs Rowell : I cannot think, off the top of my head, of the specific circumstances to which you are referring, so it is hard for me to comment.

CHAIR: First Super is a fund that has been backed by the CFMEU, a union that is subject to countless lawsuits due to its blatant disregard for the rule of law. First Super has an executive that is subject to those claims. Is this something that APRA is aware of?

Mrs Rowell : We would have to take that on notice.

CHAIR: In APRA's view, are members properly being protected in this case, do you think, or does more need to be done to protect superannuation funds' members from poor governance among superannuation funds?

Mrs Rowell : I cannot comment on the specifics of the case, and so I cannot give a view.

CHAIR: Does APRA think that more powers and tougher legislation are needed to prudently protect consumers from poor outcomes as a result of poor governance in the superannuation industry?

Mrs Rowell : We have previously been on the record as saying that there is room for strengthened powers in the superannuation industry for us to deal with individuals in particular. We do not have the same breadth of directions powers in super as we do in other industries. That is under consideration at the moment. Obviously, the strengthened disqualification powers and the ability for us to directly disqualify, which was part of the budget measures, will potentially assist as well. It is quite challenging for us at the moment to pursue individuals within the industry, because of the constraints under the legislation.

CHAIR: I might also ask some questions about the sole purpose test if that is all right. Is APRA aware of the ongoing Industry Super Australia political advertising campaign about the changes to default superannuation that are not, in fact, currently proposed—the fox in the henhouse commercials?

Mrs Rowell : We are aware of those commercials.

CHAIR: Do you have an opinion on those commercials?

Mrs Rowell : I do not have a specific view on the commercials per se—no.

CHAIR: Has APRA sought any confirmation from super fund members of that ISA lobby group about the source of funds that are paying for that advertising?

Mr Glenfield : We would have asked each of those funds whether they are involved in payment for it—but more involved in: what the purpose of the advertising is and how that goes to the sole purpose around the fund and, then, to the interest of members.

CHAIR: So this is something that—

Mr Glenfield : This is something that we would actively be asking questions for. I do not have details of the outcomes of those discussions. But, like all the advertising that we see, we speak to the trustees about what the purpose of it is, how it is in the interests of members and how they came to the decision to make that expenditure.

CHAIR: It is an extraordinary politically motivated advertising campaign, particularly about a piece of legislation that does not actually exist.

Mr Glenfield : Again—and to Helen's point—I would not discuss the politics of it. That is not my place, but I would be discussing the reason for the expenditure.

CHAIR: But APRA has a particular concern with the use of members' money for political advertising. Potentially, that may be a breach of the sole purpose test.

Mrs Rowell : APRA has broader concerns about the processes, frameworks, decision-making and transparency around use of members' monies as they currently exist in the superannuation industry. So I think this is an area where there is room for industry, generally, to lift its practices around having clear views around not just advertising but other expenditure as to: its purposes; how they satisfy themselves that that purpose has been achieved; what their process is for considering whether a particular expenditure is in the best interests of members; how transparent they are about those different types of expenditure with members and stakeholders, more broadly.

CHAIR: So you will actually be hearing back from each of the superannuation funds involved in Industry Super.

Mr Glenfield : It depends where this money came from in the first instance, as in the payment for it—whether it is from the funds or external to the funds.

CHAIR: So you are finding the source of the funds first.

Mr Glenfield : The question to the funds will be: what the purpose of the campaign is, if they have paid for it. If it is external, then it is external.

Senator XENOPHON: Chair, can I ask if [inaudible] line of questioning?

CHAIR: Certainly.

Senator XENOPHON: Mrs Rowell, you have mentioned issues of transparency in terms of the use of funds—for instance, for a political campaign. What do you say is a level of transparency so that members should be able to have a say about that campaign—if it is over a certain amount or that it be reported on an ongoing basis or only when the annual report comes out? What do you say the level of transparency ought to be, particularly if it is for purposes that, ordinarily, would not be seen as directly related to fund management, for instance?

Mrs Rowell : Disclosure and transparency is primarily for ASIC rather than APRA, so we do not have any specific views, necessarily, on means of promoting enhanced transparency. Our observation really is more about the practices we see and the information that we are able to access and that we see is available to help us inform our supervisory views where we see that there is room for improving practices across the board.

CHAIR: Can I just follow up. You are hearing back from each one of those superannuation funds? You have actually requested information from them?

Mr Glenfield : No. Part of our regular supervision when we go on site and part of looking at the operations of each trustee is, if they have advertising on, to understand what the purpose of the advertising is and how they satisfied themselves that it was for the sole purpose and in the interests of members. And those can be arguments around retention of members, economies of scale—whatever it happens to be. What was the purpose of the advertising? And, in looking back, did it achieve what you thought it would? There is no guarantee that all advertising is going to produce what you thought. That is in any business. But we are looking to see that they had a rational thought process for reaching the decision to make that advertising.

Mrs Rowell : I think is also important to note that there are complex structures around payments within the superannuation industry. So, for example, some funds would pay membership fees to organisations like industry bodies. And out of those membership fees, advertising campaigns may be funded at the industry body level rather than at the fund level. So there may not have been as—

CHAIR: But it is the funds that fund the industry body?

Mrs Rowell : Yes.

CHAIR: So if the funds contributed to the industry body, and in whatever proportion—I have asked the ISA how are they funded, and they give me very fuzzy answers. But if it is the industry body that is saying, 'We fund the advertising campaign', well then, by virtue of that, the funds that fund ISA are funding the advertising campaign, I would imagine, in direct proportion to the way they fund the ISA, whatever that might be.

Mrs Rowell : Yes, but in that particular circumstance our conversation with the funds would be around decision-making about participation in the body, the level of funding that they were providing and any ongoing views about that in light of the activities that were being undertaken.

CHAIR: You probably are unable to confirm this, but I suppose it is worth putting it out there: I actually understood that there was a split between the funds and that some of the funds that contribute to the ISA have been quite upset about this campaign.

Mrs Rowell : I am not aware of that specifically. I cannot comment on that specifically. I do know that there is a range of perspectives and views within the superannuation sector generally, both in the industry fund sector and in the retail sector, about policies and approaches. Some difference of view within a segment does not necessarily surprise me.

CHAIR: I would not be surprised if some of those industry funds would not like to be involved in overtly political advertising. Does APRA believe that that particular advertising campaign adheres to the sole purpose test?

Mrs Rowell : I do not think we have a view on particular advertising campaigns. Our approach, in terms of the sole purpose test, is really to—we think that there is a case for reasonable expenditure on advertising by the industry. The decision as to what is appropriate really rests primarily on the trustee board. It is up to them to form a view about the appropriateness of—

CHAIR: Let me put it another way then: does APRA believe that that particular advertising campaign, or one of this nature, it is a good use of members' money?

Mrs Rowell : I am not sure that is something I would want to make a specific comment on.

CHAIR: If you would take this on notice: I would be very interested in the feedback you get from those funds as to what the purpose of their advertising campaign specifically is. Senator Bushby has some follow-up questions.

Senator BUSHBY: Mr Glenfield, you said that if it is external, it is external. I understand what you mean by that: if the funding is not coming from the members, then that is external and it is really up to them what they do that money. How would you classify the funds that are taken out of members' accounts to pay administration fees for industry super funds? Once that money is removed, would you classify that as external?

Mr Glenfield : In what context?

Senator BUSHBY: The context that you just said, that if it is external then it is external. If it was money that was being used from fees that are garnisheed or taken out each year, would that be constituted as 'external'? For it to be internal, would it need to come directly from the members' funds?

Mr Glenfield : Okay. I was talking in terms of the advertising campaign. If they are a member of the ISA or the industry fund network, similar to if you are a member of another industry body, those bodies are presumably lobby bodies or providing services and you pay a membership fee. For them, it is their decision then what they do with that and how they manage that business, based on the fee that you have been charged.

Senator BUSHBY: So if enough distance is put between—

Mr Glenfield : No. For us though on this sort of advertising campaign, if it is not being paid out of the funds, it will be a question around: okay, this body is advertising on behalf of a bigger group, so are you comfortable that that is in the interests of your members and achieving an outcome for the members?

Mrs Rowell : It is a more indirect sort of view, I guess.

Senator BUSHBY: What I am trying to understand is that there are three potential levels in the scenario we are talking about where those funds could have come from but still be members' funds: (1) they are directly taken out of a member's fund to fund it; (2) they are from the annual administration fees that are taken from those funds for managing it, so it is taken out of the pool of funds in a fund for that; or (3) some of those funds are handed over to the ISA and then pooled together with similar money from other funds and taken from there. In reality, there is probably little difference in terms of who is paying for it ultimately, but does it make a difference to you in terms of your consideration?

Mr Glenfield : No. It made a difference in terms of the original question, which was: did it come directly from the funds? The answer at this point is I do not know the answer to that question. Do I have a different conversation? I do, because with the fund it is direct money out of the fund, whereas if you have joined a representative body and that body is doing its own advertising, you are not necessarily directing that advertising.

Senator BUSHBY: But ultimately it comes from the same source.

Mr Glenfield : It is part of your fee, and you have to make a decision whether that is in the interests of your members.

Senator BUSHBY: So that raises the question of whether there is a need for greater transparency in how these funds are actually handled from industry super funds, and from superannuation funds generally. An ability for APRA to have a better understanding of what money comes out, where it goes and what it is used for.

Mrs Rowell : It is not just APRA. All stakeholders would benefit from having more consistency and more transparency around expenses in particular, but general transparency around member money and the use of member money.

Senator BUSHBY: Thank you, Chair.

CHAIR: That is fine. You just eat up my time; no problems, Senator Bushby!

Senator XENOPHON: Ms Rowell, you said it is up to the discretion of trustees. Surely that discretion must be fettered by some duties? It is not an untrammelled discretion, is it?

Mrs Rowell : There are legislative requirements—I am trying to remember the specifics of your question, Senator. It was about the method of transparency?

Senator XENOPHON: Yes, but also as to what trustees do with the funds. They have got a fair degree of—that discretion surely must be fettered by appropriate duties?

Mrs Rowell : It is the SIS obligations around acting in the best interests of members, and the limbs under that in the legislation that they need to consider in making decisions about the expenditure of moneys.

Senator XENOPHON: And that acting in the best interests of members should also include some provisions in respect of transparency, should it not? Is that not implicit?

Mrs Rowell : Yes, and there are disclosure obligations that are linked through the Corporations Act and other requirements.

Senator XENOPHON: Senator Whish-Wilson asked questions in relation to a fund manager, Australian asset manager Altair Asset Management, getting out of the property market. The heading in this morning's TheAge was 'Calamity warning on property'. I take it, Mr Byres, you have seen it?

Mr Byres : I have seen the article.

Senator XENOPHON: He is a 30-year veteran of funds management. He said he had 'disbanded the team'. He said:

We think that there is too much risk in this market at the moment, we think it's crazy…

Valuations are stretched, property is massively overstretched and most of the companies that we follow are at our one-year rolling returns targets—and that's after we've ticked them up over the past year.

He said there is 'no more juice' in his company's valuations—these are property trusts. This is someone who has hundreds of millions of dollars in the property market. To what extent you dig deeper into those statements? To what extent do you investigate the fact that a portion of the market is acting in this way—that is, getting out of property? To what extent do you investigate that? Do you take it seriously? How do you deal with comments as strident as these?

Mr Byres : I will answer the question, but first just a point of clarification: I think he was talking more broadly than just property. He was talking broader equity valuations being very high as well. But the combination of the two—

Senator XENOPHON: He did cite the 'impending property' disaster.

Mr Byres : I think he was saying both property and equity prices were high. It was not just in property trusts; I think he was saying in all equities. He had an equities portfolio and he was liquidating it because he thought there was no more upside in it.

But to the heart of your question: yes, the whole issue of housing and property is a big issue on our agenda. There is a lot of discussion in APRA about the risk. There is a lot of discussion with the Council of Financial Regulators, with Treasury, with the RBA and with ASIC about the risk. We have never hidden behind the fact that we are in an environment of heightened risk. Prices are high, household debt is high, interest rates are at historical lows, income growth is low, competitive pressure is strong in the housing market: everyone needs to be fairly careful about how they operate in that environment.

Senator XENOPHON: This is in respect of the issue of the property market being overheated, particularly in Sydney. I am sitting next to a Tasmanian senator where the median price is, I don't know, $350,00 or $400,000, and in South Australia about the same or a bit over that, and about a third of the median price in Sydney. Do you think there is a case for a regulatory framework or regulatory approach that takes into account the very different property markets around the country—for instance, in the various capital cities between Sydney and Adelaide, Sydney and Hobart, Melbourne and Adelaide and Hobart, and also in country areas where the price of property is much, much less?

Mr Byres : I will repeat two comments that I made before you arrived. The first: there is an initiative in the budget to make our power to do that—to have some sense of geographic differential in the way that we apply the prudential framework—explicit in the Banking Act, so that power is there and if we felt the need to use it to be able to do so. Coming back to what we have tried to do: we have tried very hard to focus on lending standards. Good lending standards apply whether house prices are going up, down or sideways.

Senator XENOPHON: Taking into account geographical considerations.

Mr Byres : Yes, but house prices in Perth are falling at present. That is what all the statistics show. High LVR lending, one could argue, is just as risky in Perth as it is in Sydney or one of the eastern coast cities at present. Our focus has been good lending standards, banks taking into account conditions and the borrowers' circumstances and making sound lending decisions.

Senator XENOPHON: I asked this of John Fraser, the secretary of the Treasury, yesterday. Our household debt to GDP ratio in the first quarter of 2016—these are the figures I have in front of me—was the second highest in the world just behind Switzerland to the second decimal point and, due to a revision in household debt for the second quarter of 2016, our household debt to GDP ratio has fallen to 123 per cent—still incredibly high. Aggregate debt in the private nonfinancial sector worldwide is 140 per cent of GDP but in Australia it is at 197 per cent. The AMP NATSEM survey says that household debt has quadrupled since 1988, rising from $60,000 to $240,000 after inflation. Do you consider that there is a point at which the household debt to GDP ratio in this country becomes problematic? When I asked Mr Fraser that yesterday he would not be drawn on a figure. Do you have a figure?

Mr Byres : He is a wise man, then.

Senator XENOPHON: I am not suggesting you are foolish by suggesting a figure. There must be some point when APRA would be concerned about the household debt to GDP ratio.

Mr Byres : We would say it is one of our higher risk factors at present.

Senator XENOPHON: So at what point—200 per cent?

Mr Byres : The issue is that it sort of depends on what else is happening in the system. It is high, yes, and that is a concern in and of itself. When you put the other things around it, including the fact that income growth is relatively low, it is a very different thing to have a high level of debt but high income growth because you can grow your way out of the debt. We do not have that at present. So a given level of debt is of higher concern now than it might otherwise be.

Senator XENOPHON: In your view, at what point do you see an amber light or even the alarm bells go off? So it is 123 per cent for the household debt to GDP ratio. Would you be concerned with 140 per cent?

Mr Byres : We already think it is high and are responding because it is one of the factors that we think that leads to concern.

Senator XENOPHON: Should it be lower?

Mr Byres : It would be more comfortable if it was lower, yes. Exactly how you achieve that is a very good question.

Senator XENOPHON: When do the alarm bells go off for you—at 140 per cent, 150 per cent; what level?

Mr Byres : I could not tell you a figure. It is the combination of things that lead you to conclude—

Senator XENOPHON: You must have some figure. There must be some figure that you have.

Mr Byres : The metric that we focus on is the household debt to income level.

Senator XENOPHON: What is it now? What is that level now?

Mr Byres : It is 170-something per cent. Perhaps 180 per cent.

Senator XENOPHON: So when do the alarm bells go off for you? At 200 per cent?

Mr Byres : I would say they are going off softly. That is why we have been intervening in the sense that—

Senator WHISH-WILSON: Could I ask you a follow-up question on that point? I will perhaps rephrase Senator Xenophon's question. You say you have been intervening and you have put some restrictions on lending and interest-only loans and stuff in place. At what point do the alarm bells go off for you that they are not working—that those things are not cooling the market off?

Mr Byres : Again, just to be clear, our objective is not to cool the market in the sense of determining what house prices should be.

Senator WHISH-WILSON: You reduce risk.

Mr Byres : Yes, reduce risk. What we are trying to do is tighten up bank lending in response to a heightened risk environment so there is more prudence in the lending activity that banks are undertaking. We think we did that when we instituted the measures in 2014, when we put the higher interest rate buffers into serviceability calculations and we put the benchmark on investor lending growth. Those worked their way through the system through 2015 and 2016. What we saw then, particularly in the latter part of 2016 and early in this calendar year, was that all of the things we were watching continued. Things that were high continued to get higher and things that were low continued to get lower. So the concern level was rising and that is why we took the additional steps we did around interest-only lending to try to add an additional level of prudence in bank lending.

Senator WHISH-WILSON: Are you winning? Do you think you are winning?

Mr Byres : Our objective is to have the financial system stable, our institutions sound and lending happening on a sensible basis. As I said up-front, I think we still have a fundamentally sound banking system and financial system, but there are risks in the environment. It is inevitable that if there is any economic adversity or financial shock the financial system is always impacted by that.

CHAIR: I am highly conscious of time. We are going to have to call APRA back after dinner. I am terribly sorry, but there are some more questions to be asked. We might suspend now until half past eight and return again with APRA for another 20 minutes or so.

Proceedings suspended from 19 : 32 to 20 : 30

CHAIR: We will now resume our hearing. I welcome officers of APRA back to the committee. We will continue questions with Senator Gallagher.

Senator GALLAGHER: I have some questions on superannuation. It follows some questions I asked last time. APRA were very good to reply on notice around how profits earned. APRA's level of understanding or vision on how profits are earned from for-profit superannuation entities. In that answer, APRA replied that currently the superannuation data collection does not include information that would enable profit that the bank-owned group may earn from its superannuation funds and products to be determined. I just wanted to pick up on that, particularly in light of some of the media articles in the last five days or so around superfund performance fees and revenue, so trying to link that a bit.

My interest is really around what information APRA does have or what your level of interest in this is, mindful of the fact that there are foreshadowed changes potentially coming to superannuation, through various reports and reviews that are being done, and mindful of the fact that it is a $2.2 trillion industry that will be growing to over $6 trillion by 2030. It is big stakes; that is the point I am making. In response to superfund performance, we have got quite extensive data now going back years that have the for-profit banks and a lot of the individual bank-owned funds returning less than three per cent. I think that is the point that Alan Kohler was making: this is below term deposit rates. Does APRA have any concerns with this? In particular, there are many in the for-profit sector that are returning less than term deposit rates over the 10 years to June 2016. The questions are whether you are responding to that, whether it is on your radar and whether you think it is a problem. If you could respond to that for me.

Mrs Rowell : Certainly. Thank you for the question. I have a number of comments to make in response to what I think you are asking. It is very broad question.

Senator GALLAGHER: It is.

Mrs Rowell : Clearly, APRA is very focused on ensuring that there is confidence in the superannuation industry and that it is delivering good outcomes for members. I think our view, as we have expressed here and in other forums, is that in assessing whether the superannuation industry is delivering that there are a range of measures that need to be focused on. The rate of return at a fund level or at an average across an industry segment level is not an appropriate measure of member outcomes, because it is not comparing like with like.

Senator GALLAGHER: Yes, I have heard you say that.

Mrs Rowell : We were somewhat disappointed with some of the recent research that was released, because we do think confidence in the super industry is so critical. The commentary by industry stakeholders, in our view, potentially undermines that confidence based on analysis that is quite narrowly focused. Making very selective use of APRA statistics is quite disappointing. As I said, we think a much broader view of performance assessment is appropriate.

We do consider investment performance as a measure of outcomes for members, and we have been having conversations with funds across the industry in all segments about areas where it would appear that they are underperforming in relation to investments. We are also, though, raising issues around fees, around insurance, around governance and around the quality and strength of their operations.

Senator GALLAGHER: Is that both in the for-profit and not-for-profit sectors?

Mrs Rowell : It is across the whole industry, and we are somewhat agnostic as to the segment that a fund comes from. Our concern is whether the trustee and the funds under their oversight are delivering outcomes for members—how they are assessing that and how they are setting benchmarks. We also think that performance relative to peers is not necessarily the best measure of delivering outcomes for members either and that actually performance relative to the target that is set for the particular product or option is a more relevant, or as important, measure.

I would sum up by saying that performance in the superannuation industry is a fundamental concern of ours because of the prudential and retirement income policy role. It is something that we focus on and discuss with trustees across the board. We would also note that from our review of performance, and even looking at some of the material that was in the research that was published and formed the basis of the media articles, you can see that there has been some relative improvement in performance in the retail sector, which was the focus of that research, in more recent years. We have seen a number of funds in the top quartile of median returns over, say, five-year periods. The MySuper performance in the retail sector, which is a more like-for-like comparison, is looking reasonable and fees are coming down. Our messages to those trustees, and also to some of the not-for-profit trustees, about the need to actually lift the standards of their delivery of outcomes to members is getting some traction.

Senator GALLAGHER: Taking up your point there, you mentioned particularly MySuper. Is it correct to say that in terms of retail, the figure for MySuper is still very high—over 80 per cent—for those that are not invested in MySuper products?

Mrs Rowell : But that is the nature of the industry, and the fact that—

Senator GALLAGHER: I know, but you specifically used it as an example of where it is improving, and I am saying that is great but still the vast majority of funds are not invested in those MySuper products.

Mrs Rowell : Sure, but there has been an improvement in performance across the retail sector—and in the choice area as well.

Senator GALLAGHER: Yes, but in that five-year return that you speak of, too, there is still a full two percentage points difference between the returns on those five-yearly returns between retail and industry funds.

Mrs Rowell : There are different views about how you assess that relative performance, and I think you have to look at industry aggregate numbers and make sure that you are comparing like for like. There is a number out there that is two per cent. If you talk to Chant West, for example, they say that it is more like 0.7 per cent. There are different ways to look at this but our fundamental view would be that looking at aggregate retail fund performance is meaningless in terms of actually understanding whether good outcomes are being delivered to individual members.

Senator GALLAGHER: In relation to fees and revenue, have you acquainted yourself with the Rainmaker Consulting report?

Mrs Rowell : We have not had time to go through the Rainmaker report in any detail.

Senator GALLAGHER: I would really welcome your response to that. I do not know how you do that, whether it is on notice or in some other formal way, but I would genuinely be interested in your interpretation of that research. I think my other issue is with the answer to your question on notice where you said you do not have the data collection which would enable you to understand how profits are generated from superannuation. I think, then, you pointed out that you do collect profit after tax based on the assets in a fund, rather than an amount that a licensee may potentially pay from a fund as a dividend. That would imply to me that you know that there are superannuation funds that are returning dividends to their parent company. Am I right to take that from that answer?

Mrs Rowell : There are payments, obviously, from a fund to a parent—different fees and charges and the like. That is just the structure of the retail sector: that there would be payments from the superannuation fund for the services provided by the parent, whether that is for administration, insurance or—

Senator GALLAGHER: Do you keep an eye on that? That is what I am asking. Do you watch that? After I got your answer, I went away and tried to have a look at a few. I looked at Colonial First State. They are a fund related to the Commonwealth of Australia. In their financial accounts they report that they provided a financial dividend of $268 million back to the Commonwealth Bank in 2016, which is more than double what they reported the year before. It seems like a lot of money coming out of a super fund. There might be a logical explanation for it—I do not know—but the way I read the financial statements it looked like this super fund has $66 billion in assets and it is returning a dividend of a quarter of a million dollars in one financial year to the Commonwealth Bank. How do we explain that? I am not asking you to explain it right now without having a look at it, but is that something APRA would be interested in?

Mrs Rowell : At a general level, our focus for superannuation is on the trustee's management of the funds under their operation. As part of that, we would consider the arrangements they have with service providers and related party service providers. So we would look to see how those arrangements were structured and the general processes, benchmarking and controls around that—again, that is in the context of how the trustee is determining who their service providers are and what the appropriate fees for those services are. Then, when we look at the banking groups as a whole, our focus is on the prudential soundness of those groups and how they are managing their business at that aggregate level. We would not necessarily focus in detail on particular flows from parts of the group. Wayne may want to respond as well.

Mr Byres : I am not sure whether I want to respond or just take it on notice. I may have misheard you, Senator, but I thought I heard you use two different numbers there for the dividend.

Senator GALLAGHER: There were two years in which a dividend was paid. In one year it was $121.5 million. That was 2015. Then in the 2016 financial accounts it is $268 million.

Mr Byres : Were you saying that dividend was coming from the fund or from the RSE?

Senator GALLAGHER: I think it is from the fund. That is my reading, but again—

Mr Byres : It is safest if we take it on notice and make sure we understand what the facts are. Then we will explain the way we would view that and how we would assess it.

Senator GALLAGHER: I want to move to the issue of managing conflicts of interest. Superannuation funds are both corporations governed by Corporations Law and trusts governed by trust law, so there are two frameworks that super fund trustees and directors have responsibilities under. That is correct, is it not—both under Corporations Law and with their trustee duties?

Mrs Rowell : I am not as familiar with the conflict of interest requirements under the Corporations Act, but certainly there are requirements for managing conflicts of interest under the superannuation legislation.

Senator GALLAGHER: What I am trying to understand is this: when directors have a duty to a company to act in the best interests of the company but they are also trustees who are required to put the interests of beneficiaries above all other interests—how does that work when you have those two conflicting responsibilities? Does APRA have any guidance material on that? Do you provide advice on that?

Mrs Rowell : We have a prudential standard on conflict management. We require trustees to have frameworks and policies in place to manage actual and perceived or potential conflicts of interest. That is something that we talk to trustees about. We did a thematic review on it a couple of years ago. We provided some recommendations for improvements to industry practices as a result of that review. We are in the process of undertaking a slightly narrower scope around related party arrangements—a thematic review on that—which we expect to be able to provide some responses on later in the year. It is an area that we are keenly interested in because we think it is important that those conflicts are effectively managed by the superannuation industry.

Senator GALLAGHER: It will be good to understand more of that as that work progresses. Again, when I look at how some of the bank super funds are managed—the actual practical management of it—it seems to me that the executives that manage the super funds are not directly employed by the super funds; they are employed by the parent company under the bank. So some of those issues like the remuneration reporting arrangements and things like that are only declared in relation to the portion of time that they are delivering services through the super company, not linked to all the other duties they have within the organisation, which again to me seems to be a difficult arrangement which would require management of conflicts. Do you again actively monitor that? Do you review some of those remuneration disclosures? Do you see the fact that those remuneration arrangements attach to the other parts of their duties as presenting a conflict for their role as trustee under the superannuation fund?

Mrs Rowell : You have asked a number of questions there. We do get information on remuneration. There are requirements around reporting and disclosure of remuneration which we review. And we are undertaking some work this year to look a little bit more deeply at remuneration practices across all APRA regulated industries, and superannuation will be a part of that. More broadly, our focus in talking to trustees around conflicts of interest and the role they play in relation to remuneration decisions and other decision-making is part of our engagement with them as to how they manage those conflicts and make sure that the focus is on decision-making and that, when they are operating as a trustee and making decisions around outcomes for members, it is the members that are front and centre in that decision-making.

Senator GALLAGHER: Again, from looking at it since we last met, it would seem that where banks have multiple superannuation entities it is often the same directors running those multiple entities who are also executives of the overarching parent bank.

Mrs Rowell : And there is a need for them to understand that, to have processes and frameworks in place to manage that and to ensure that those conflicts are effectively managed. Again, that is part of our engagement with the industry when we talk to those providers.

Senator GALLAGHER: You talked earlier about looking at issues of fees and governance—I know you say across the board. Can you give me any comfort that you are looking at some of these issues that I have raised tonight?

Mrs Rowell : Yes. Our engagement with the industry touches on most of the things that you have raised. The degree to which we focus on those particular issues with any individual organisation will depend on the circumstances and what we think of their practices and their arrangements, but we focus on conflicts, fees, performance—all of those aspects—as part of our normal engagement with every superannuation entity.

Mr Glenfield : Specifically, our on-site review process will very much look at the conflict management around a group and how you manage a conflict within a group. As Helen touched on, we are doing a thematic at present on conflict management across industry, which will give us views on better practice, which we will share with industry when that review is complete. It is very much a focus.

Senator GALLAGHER: I hear you when you say it is about the members' best interests, I just guess there are so many risks attached to this growing industry. It is good to know that you are looking at it and we will look forward to talking with you again about it. If you could take those things on notice, when I asked for a bit more information, and particularly where you say you have had some concerns with the research that was released—again, it is very useful to understand other perspectives.

CHAIR: You were speaking, Mrs Rowell, about confidence and outcomes, and I know that you have spoken before about the desire to see some of these smaller funds, whether they be industry or retail, merge because they are not necessarily at critical mass and they are not returning the best outcomes for members. How is that project progressing?

Mrs Rowell : Whilst we do have a particular focus on that at the moment, it has actually been a focus of our normal supervision activity for some years. What we are doing at the moment is I guess putting in place a more structured process that is better leveraging the data that we have. We have used analysis of that data based on a number of different metrics and also our understanding of the operations of the individual funds and their standards of governance to, if you like, identify a target group of funds—some of whom we have already had conversations with, others for whom the conversations are to happen in the near future. We will also be writing to industry more broadly to explain our approach and the sorts of measures we are using to get them thinking themselves about how they should be assessing their performance. To date I would think I would say we are getting some traction, and we are seeing boards focusing on this more, thinking about their standards of performance, and some discussions are happening about what we might call plan B.

CHAIR: I note that the government has extended its capital gains tax exemption for funds that merge—which was terrific; I was very pleased to see that; I was worried that it is going to end on 1 July this year but it is not going to now. Can you tell me how big that target group of funds is? How many funds are involved in your target group?

Mrs Rowell : We have identified maybe 20 to 25 MySuper providers and a similar number of other RSEs that we have a particular focus on.

CHAIR: Can you give us an indication of whether that is corporate funds versus industry funds versus retail funds?

Mrs Rowell : It is a mix across all segments.

CHAIR: That is a very diplomatic answer. You have not got anything that is less diplomatic?

Mrs Rowell : If I was honest about it I would say that there is a higher proportion of retail funds—or retail products—but I think that just goes to some of the questioning earlier, that there are some typically legacy, old choice, retail products that are not necessarily performing well and are relatively expensive. There is work under way within the industry to rationalise those products.

CHAIR: So what is the obstacle in the superannuation funds' minds to progressing those mergers?

Mrs Rowell : There are various legislative hurdles that mean it is not straightforward necessarily to just close down a product and shift members to another product—you have to go through appropriate processes and the like. Some of it is about just biting the bullet on rationalising systems and trustees and taking that step to address the legacy and the complexity that exists in the system that has built up over time, and I think there is an increased recognition now that that needs to be tackled.

Mr Glenfield : There is also a better awareness. The reporting metrics we have now put us in a better place to show trustees where they sit comparative to the whole of industry, which in many cases they may not have been as aware of, and the ones that Helen touched on that we have had success with to date, it has been presenting those metrics, which has galvanised them and caused them to say yes, you are right, it is sensible and in the interests of members that we go. We are in a better position with the tools we have today to achieve more than we have previously.

CHAIR: That is true. I think, for the sake of members, continue the galvanisation process—that is very good. I might not be asking the right group about this; this might be a question for ASIC, and you are allowed to redirect me to ASIC, but I will just throw out a hypothetical. We know that some union representative board members pay their salaries back to their union, and we understand exactly why that is: the union lends their time to the superannuation fund. Just as a hypothetical, if a board member of an industry superannuation fund paid their salary back to the union and then ran for political office, and that union funded one of its union officials to become a staff member to work on the campaign for that board member, is that something that you would be concerned about? We were talking about related party arrangements. Is that something that APRA would deal with, or is it something that ASIC would deal with? I imagine it would be highly inappropriate.

Mrs Rowell : I am not sure I know how to respond to that.

Senator WHISH-WILSON: You do not have to answer hypotheticals.

CHAIR: No, you do not need to answer hypotheticals. It might be better put to ASIC. Moving on, you might be able to explain something that I do not understand. A lot of superannuation boards have alternate directors. I understand why they have alternate directors, but there seem to be large numbers of alternate directors on superannuation boards, sometimes mirroring the number of actual directors. Do you know whether those alternate directors get paid, even if they do not actually attend the board meetings?

Mrs Rowell : I would need to take that on notice.

CHAIR: I am not sure either. I have not been able to find it anywhere, but it is something I have pursued.

Mrs Rowell : We will take that on notice.

CHAIR: Thank you, that would be terrific.

Senator WHISH-WILSON: I have a couple of documents that I will ask the committee to give you. These are given to you in confidence; they are not going to be tabled at this stage. You do not necessarily need to look at them in-

CHAIR: Have you tabled the documents?

Senator WHISH-WILSON: No, I am not tabling them at this stage.

CHAIR: You are not tabling them?

Senator WHISH-WILSON: No, they need to be considered by the committee and redacted.

CHAIR: I think we were going to give the document to APRA after the hearing, not during the hearing. You were allowed to speak about it hypothetically; you were not allowed to actually give it to APRA until after the meeting. That was what was discussed.

Senator WHISH-WILSON: I was not made aware of that. We had better take them back, then. We are going to mix it up a bit here and have a little case study with some questions. This is to show that it is ridgy-didge and there is some detail around it. This is a question about mortgage lending standards. I noticed that you mentioned twice today, Mr Byres, a focus on lending standards. We like to promote good lending standards—sound loans where people have the ability to afford those loans and pay them back.

This is an example of a lady who came to my office. She was advised through a friend to buy an investment property, so she went to a mortgage broker, who put her in touch with one of the big banks. She is single. She was lent $445,000 by one of the big banks to buy land and to build. She had a home that was paid off, with $300,000 in collateral. She had $20,000 in cash and $60,000 in superannuation. So she had approximately $380,000 in assets to back a $445,000 mortgage. The bank took her monthly expenses, including interest and cost of living, to be around $5,300, and her monthly income, remarkably, including salary and rent, tallied to $5,293. It was basically $9 more than her expenses, so essentially she had a $108 a year buffer. That is just to give you the basic detail. It also happens that the lady in question was 64 years old and one year away from retirement, and it was an interest-only loan. This was in 2012. You have a practice guide on residential lending, I will not quote it to you, but you do talk about future changes in borrowers' circumstances, likelihood of lower income, repayment capacity and impending retirement of a borrower. How long have those practice guides been in place for now?

Mr Byres : We put the practice guide on residential mortgage standards out in November 2014.

Senator WHISH-WILSON: Is a bank required to take into account someone's age when they are issuing an investment loan? Is it one thing they would consider?

Mr Byres : It is not an explicit requirement on age, but it reflects the capacity to repay and likely sources of income in the foreseeable future to meet the obligations of the loan.

Senator WHISH-WILSON: Does a prudent banker lend $445,000 to 64-year-old single woman on a $9 a month buffer?

Mr Byres : Just based on you reciting that, it sounds like something we should have a look at.

Senator WHISH-WILSON: You will get a copy after this from the committee, in confidence. I would like to seek the committee's permission to table it, at some stage. The interesting bit is that you have cracked down on interest-only loans. Is that correct? How prevalent are they? Are you able to drill down into the data in terms of age groups, for example?

Mr Byres : No, I cannot tell you age groups. But I will give you a few high-level bits information. Interest-only lending has been running at about 40 per cent. So, of total lending, 40 per cent would be interest only and 60 per cent would be principal and interest. We have said we would like to see the proportion that is interest only come down to 30 per cent. That is the benchmark we have set, and we are paying particular attention to interest-only lending that is also high LVR, because that is a borrower who neither has equity nor is building equity in the loan, which is a higher risk proposition. Most interest-only lending is to investors, but there has been a material proportion of interest-only lending to owner occupiers, and that has also caught our eye because you want to make sure that people are not using an interest-only option just because it slightly improves their cash flow.

Senator WHISH-WILSON: If you could take it on notice when you get the document, I would be interested to know exactly how you define predatory lending, and whether that would be an example of predatory lending.

Mr Byres : You might share the same example with ASIC. We can compare notes with ASIC, because they would also probably have a perspective, given the responsible lending obligations under the Corporations Act.

Senator WHISH-WILSON: One of the reasons the lady came to see us is that this issue is before the ombudsman, because, basically, she is having trouble paying, she is 69 and she wants to stop working. Is the reason you are cracking down on interest-only loans because this kind of lending does not form the operations of an unquestionably strong bank?

Mr Byres : No, I do not think that is true. And if we really thought interest only-lending was bad—full stop— we would not have set a target benchmark of 30 per cent. There are some jurisdictions that have banned interest-only lending. We do not think that is the right thing to do. There are legitimate reasons why borrowers will want an interest-only arrangement, but we were concerned that it was a growing proportion of lending, and there was a concern that was, potentially, because people were, in a sense, using it as a way to free up cash flow and avoid having to repay the principal. As I said, particularly where it is a combination of interest only and high LVR, the borrower neither has any equity nor is building any equity in the loan, and that is the high risk proposition. So, for us, it was simply a case of encouraging a bit more prudence and encouraging the marginal borrowers onto principal and interest lending, which we think is probably better for everybody in the long run.

Senator WHISH-WILSON: Would this kind of thing still be happening—as per the case of this 69-year-old lady? Or do you think your change from 40 per cent to 30 per cent means the banks are being more stringent in the application of their loans?

Mr Byres : Based on what you have described, and not having had a chance to look at the document and investigate it, I would hope this is a fairly rare, if not unique, event.

Senator WHISH-WILSON: An isolated example. I certainly hope so, too, because I can see why this kind of thing, on a bigger scale, would introduce systemic risk. Anyway, I will leave that with you and perhaps give you some more specific questions on notice to follow up when you get the document.

Mr Byres : Happy to do so.

Senator WHISH-WILSON: I have a couple of other quick questions. I want to ask you about shadow banking. Did APRA make a request of the government for increased powers in relation to shadow banking?

Mr Byres : It is a good question. The genesis was a discussion that we had. We obviously keep the Treasury informed about the sorts of steps that we have taken and about our progress and impact. The Treasurer came to the February meeting of the Council of Financial Regulators, where we discussed housing. One of the things that we have said is that there are limits on our ability to promote good lending standards because of the potential for lending to be done by unregulated lenders. Through the course of that discussion—I do not know whether it was a suggestion or a request—it was said, 'Would this power be a good idea for financial stability purposes?' That is how it emerged.

Senator WHISH-WILSON: So it is in no way in response to unintended consequences from limits placed on investor lending?

Mr Byres : It is, in some sense, in response to it. I do not know whether it is 'unintended consequences'. It is possible consequences in that if you constrain the regulated sector in various ways, credit will find ways to flow. Whenever you have any sort of quantitative constraint, then people who want finance will end up searching elsewhere for it, and other players might well step into the breach. There is always a risk that the things we do have limited capacity because there will be leakage.

Senator WHISH-WILSON: Have you been able to measure whether there has been any direct effect?

Mr Byres : I would struggle to be precise in terms of measuring it, but I think it is pretty clear that the non-bank housing lenders, in particular, are enjoying strong volumes at present. Presumably that is because a number of people who would have traditionally got a loan from a bank are finding that the banks have done two things: they have tightened up their lending conditions—reduced maximum LVRs and other sorts of things—and they are charging higher rates on certain sorts of loans. To the extent that that deters some customers, they may well go to the non-bank sector to get their finance.

Senator WHISH-WILSON: You will be surprised how many people around the country are actually listening in to the broadcast of this! So could I ask you to, in 30 seconds, explain what shadow banking is. I think I know what it is, but I think most people think it is illegal banking and kind of shady and dodgy.

Mr Byres : It is not illegal banking. In many cases, it is legitimate finance, but it is done outside of the regulated banking sector. It is the provision of credit through other sorts of intermediaries and means than through the regulated banking sector. The term 'shadow banking' is somewhat pejorative, and it need not be. It is called shadow banking because it is somewhat in the shadows of the regulatory community; they cannot see it as well as they see the activity that is going on in the regulated sector.

Senator WHISH-WILSON: I look forward to seeing how that progresses. Thank you.

Senator McALLISTER: I have a couple of follow-up questions and then I will hand over to Senator Ketter. Mrs Rowell, I want to follow up on some of the conversation that you were having with Senator Gallagher. Over the last couple of years, we have asked APRA on a number of occasions about published material that draws conclusions about the performance of different superannuation funds. I think on most of those occasions you have dismissed that published material, though, and said, 'That's not the way we'd approach the analysis.' And you have talked this evening, as you have in the past, about the kind of analysis and engagement that you do have with the funds. Where is APRA's analysis documented, though? Can we have access to it, are you in a position to provide it to us in written form—because there are these comparisons being made, and there is analysis being undertaken. It is in the public domain, but you dismiss it and say that it is not accurate. But, in the absence of any competing analysis, it is hard to know where to go from there.

Mrs Rowell : There is different analysis that is published and in the public domain. There are a number of providers that publish different forms of research and publication material—

Senator McALLISTER: But APRA does not—

Mrs Rowell : like Chant West super fund ratings. We publish much of the data that we collect, but our role in that regard is more about putting the information out for stakeholders who have an interest in analysing and looking at the performance of the industry in different ways. Because of the role that we have as a prudential regulator, we do not necessarily see that we should be undertaking analysis and commenting on the relative performance of different superannuation funds that we regulate. Our particular analysis is something that we use to inform our supervision activity, which is something that we undertake with the regulated population. Again, we have had conversations in this forum before about having to be balanced and fair and not creating undue concern where there should not be concern in relation to particular institutions. If we published a particular analysis that purported to say that this institution is performing better than this other institution, that is not necessarily helpful for confidence in the system.

Senator McALLISTER: In the past, APRA has been a lot clearer about what good performance looks like. You said this evening that benchmarking against peers is not necessarily the approach—that benchmarking against a fund's own goals might be more appropriate. Back in 2008, APRA said:

APRA considers that fund net ROAs—

returns on assets—

are the best starting point from which to assess trustee performance.

My question is: what has changed?

Mrs Rowell : The available information, and having a better ability to look in a more granular manner, based on more comparable and consistent data, across a range of other measures than was available, with a focus on member outcomes. The sector itself has changed a lot since 2008 as well.

Senator McALLISTER: It is not beyond the realms of imagination that a fund, for a range of reasons, decides to set a performance goal in terms of return on assets that is very modest indeed—say, below inflation. I just wonder whether you would be concerned under those circumstances, because the evidence you gave earlier sounds like you would not be, as long as they met the target they had set for themselves.

Mrs Rowell : Part of our engagement with the trustees is to look at the particular targets that they are setting themselves, and we do look at targets and the range of targets across the industry, and if someone was setting themselves an unreasonably low hurdle then that would be something that we would raise with them.

Just in terms of putting information in the public domain about our analysis and our approach, we did publish an article in our Insight in March which talked about our general views on strategic and business planning and the sorts of factors that we thought trustees should be considering and measuring themselves against in terms of setting their strategy and measuring their performance. We will be shortly, in June, publishing another Insight article which will talk about our approach to assessing member outcomes, and the factors that we are looking at. So, rather than necessarily publishing information—our analysis—using those factors, we are saying, 'This is the approach we take; these are the factors we look at,' and that enables other stakeholders to go through a similar process and form their own view.

Mr Glenfield : It is driving at the point that looking at one metric is probably not going to give you the answer. We are trying to say that we are looking across a series of metrics, of which net return is one, performance against the stated target that you have told members that you are operating to is one. It could be net member outflow. It could be whether you are cashflow positive or cashflow negative. We are looking across a range of metrics. In the discussions that I referred to earlier when we are talking to trustees, it is not purely on one outcome, because that can get you to focus on just one thing. There are a range of metrics that determine whether they are performing well or not.

Senator GALLAGHER: I guess some of our concern—just to finish up on this point—is when you look at, say, for an individual fund member, if they are hanging around the bottom quartile of fund performance for the period of time, it is going to cost them in retirement lots and lots of money, sometimes of hundreds of thousands of dollars. I guess what we are trying to ensure is that when you are looking at members' outcomes surely fund performance or return on assets has to be right up there in terms of how you—

Mrs Rowell : It is.

Senator GALLAGHER: if I just finish on that point around Colonial First State. I have just gone back again to have a look at it. It has been in the bottom quartile of performance. In the 10 years to June 2016 it had an average return of 3.38 per cent—very low It is a $66 billion fund and, for some unexplainable reason, it is returning a quarter of a million dollars to a parent company as a dividend out of the fund. Surely there is something to look at there and question whether members' interests are being managed effectively under those arrangements. I guess this is some of our frustration. Going back to Jenny's point, if it is not return on assets or fund performance then what is it?

Mrs Rowell : Return on assets is a component of the assessment. The question is: at what level are you looking at that?

Senator GALLAGHER: How do you weight that?

Mrs Rowell : Our view would be you need to look at it at option level, at product level and at fund level, not just at fund level and certainly not all retail funds versus all industry funds. You need to pull it apart a little bit and understand what is going on and what is driving the underperformance, because that $66 billion fund contains a lot of different options and a lot of different members, with a lot of different risk profiles that will be driving the outcomes. So, yes, we would be concerned about underperformance in any particular segment of that fund, but we want to understand better and at a more granular level where that is and what the trustee is doing about it.

Senator KETTER: I just have a few more questions which I will try to whip through as quickly as possible. Mr Byres, I will try again on the bank levy and just suggest to you that, in terms of competing designs for the bank levy, is it true that a profits based model would minimise balance sheet risks as compared to a liability based model?

Mr Byres : A profit based model, I presume, just means an increase in the corporate tax rate. Is that equivalent to what you are suggesting?

Senator KETTER: Something along those lines, yes.

Mr Byres : I would have to think that through. I am not sure. The answer is not obvious to me. Is your question, 'Is one worse than the other or some way more risky than the other?' I would have to think that through. It is not obvious to me—

Senator KETTER: The question was in relation to balance sheet risks. Would a profits based approach avoid the issue of banks preferring riskier lending?

Mr Byres : I am not sure I agree with the starting proposition that it encourages more risky lending, but I will take it on notice and provide you with a considered response.

Senator KETTER: Thank you very much. Earlier tonight when we were talking about the implementation of the levy and your role in that I think you mentioned that there were some compensating controls that APRA could use in that. I know you talked mainly about your information data collection role. Did you talk about compensating controls?

Mr Byres : In the context of your concern, which was that the structure of the levy might encourage higher risk activity, my comment was to the effect that—I cannot remember my exact words—I did not think that was a material problem. But if there was some incentive that encouraged higher risk behaviour, there are other compensations within the prudential framework, including the fact that capital requirements increase as risk increases, which would act as a disincentive or a balancing item for any such incentive.

Senator KETTER: If you perceive that banks are engaged in riskier balance sheet behaviour, are there things that you can do as a result of that?

Mr Byres : Yes. The first thing is that there are some inbuilt responses in the prudential framework. As I said, higher risk tends to attract higher capital requirements. That is just a feature of the system. We can overlay that or amp that up if we feel there is something specific that the standard capital regime is not capturing or responding to.

Senator KETTER: I will just touch on the Banking Executive Accountability Regime. I have a couple of questions there. Earlier tonight we heard from Treasury that the approach that underpins the BEAR is a prudential one rather than a customer focused outcome, if I could describe it that way. Is it fair to say that some of the financial scandals that we have experienced, such as the fee-for-no-service scam, could well not be picked up by the BEAR approach because there may not be any prudential breaches associated with that, whereas there are quite horrendous outcomes for customers?

Mr Byres : You are right with the starting proposition of the executive accountability regime. APRA will be doing that. APRA's mandate is prudential, and so it must come back to prudential—but understanding that prudential captures things like governance, risk management, internal controls, remuneration incentives et cetera. So, ultimately, for any particular episode, it will depend on what was considered to be the underlying cause or failings that led to that: if it were failings in governance, if it were failings in risk management, if it were failings in internal control or if it were failings from poor remuneration arrangements then they all have prudential lenses to them. So I think there is plenty of capacity there to look at those issues. When there are misconduct issues, quite often there are issues that are of interest to APRA and issues that are of interest to ASIC. That is not unusual. It is quite common. Usually for those instances we will work together, and we will see for the particular circumstances who has the best powers and investigative abilities et cetera to respond to those things. So there may be instances where the circumstances mean it is better dealt with through the ASIC enforcement provisions and there may be circumstances where the decision is that the issues are better dealt with through APRA or some combination of the two.

Senator KETTER: I am not sure if you heard them, but earlier tonight I did put some questions to Treasury on some of the mechanics around the suspected breaches and when the ADI should be required to report on those. Do you have a view about those types of issues?

Mr Byres : I heard the question. Ultimately, that will be something that is prescribed in the legislation. There is always a challenge to get that reporting regime right. You want prompt notification. You do not want 1,001 red herrings that distract you with lots of useless activity. But if you wait until every 'i' is dotted 't' is crossed on an investigation then it can take a very long time before you are alerted to something. My comment would be that we need to find a sensible middle ground that encourages prompt reporting but does not lead to a whole lot of what I will term 'false reports' that do not lead to anything.

Senator KETTER: So this work is still being done to determine that?

Mr Byres : Yes.

Senator KETTER: I am going to come back to some of the macroprudential issues. Are you concerned that the tax system provides an incentive for the proliferation of interest-only loans?

Mr Byres : We take the tax system as a fact of life. It is a given, exogenous and variable, and we have to work within that.

Senator KETTER: Presumably you provide advice to government about these types of issues?

Mr Byres : When we were going to institute the constraints on interest-only lending, we certainly briefed the Treasurer on what we were doing, why we were doing it, why we were choosing to do that and potential reasons—within the environment—why people were keen to use interest-only lending.

Senator KETTER: Can you give us a breakdown on the interest-only loans with property investors as compared to owner occupiers? Presumably it is a fairly wide margin.

Mr Byres : I would probably take it on notice but, for the purposes of this evening, it is about 20 per cent of lending to owner occupiers is interest only, and about 60 per cent of lending to investors is interest only.

Senator KETTER: At the last estimates hearing, I asked about the potential for warehousing facilities to circumvent the macroprudential measures. We were told at that time that we should not be overly concerned about that. However, I note that you are now monitoring these types of arrangements. Could you please give us an update on that.

Mr Byres : In our letter that we wrote to the ADIs at the end of March, we flagged to them—we were quite transparent about it—that we wanted to make sure that they were not in a sense funding lending through the back door or facilitating risk taking through the back door. Therefore, that warehouse facility they are conducting for other lenders, be they regulated lenders or non-bank lenders, should not be growing faster than their own portfolio—or materially faster than their own portfolio—and also should be of a similar quality to loans they would be prepared to write themselves. So we are continuing to watch that.

Senator KETTER: My final area of questioning is in relation to the Senate Economics References Committee inquiry into cooperatives, mutuals and member-owned firms. One of our recommendations was that APRA should set a target date for the outcome of discussions with the mutual sector on issues of capital raising and bring those discussions to a timely conclusion. Could you please give us an update on what is happening with that.

Mr P Brennan : Before that inquiry and since, we have been having ongoing discussions with the mutual ADI industry. We have discussed the merits of setting a date but have explained to industry, and they have accepted, that we think it is better to progress the issues and bring it to a conclusion without setting a date before we have done the homework. Those conversations with industry are well progressed. We expect to be consulting sometime this year on the potential for some other form of CET1 equivalent issuance by mutual ADIs.

Senator KETTER: Have you issued a formal response to recommendation 16 from that report?

Mr P Brennan : I do not think we have issued a formal response but we have been on the record as saying that we think it is better for the industry to progress this issue. If we had quickly arrived at a date before we had worked through the issues with the industry, that date may have come and past. The industry wants flexibility to create a capital issuance management flexibility, and we are trying to work through that.

Senator KETTER: Do you think it is good practice to respond to Senate report recommendations on issues involving APRA? Perhaps that is a question for you, Mr Byres.

Mr Byres : Usually we would deal with these things through Treasury and whether the government wishes to respond to the report in its entirety or whether individual agencies are left to respond to individual recommendations. I am not clear on how this one was handled, but as Pat said, we probably have not put out a formal response other to say publicly, 'We're working on it.' As Pat said, it is our intention to consult on a proposal before the end of the year.

Senator KETTER: You have said you want to work through the issues rather than set a target date, but you are expecting to finalise discussions before the end of the year?

Mr P Brennan : To reach the point of consultation, yes.

Senator KETTER: Do you accept that mutual banks and credit unions are disadvantaged at the moment by being able to use only retained earnings as their highest class of regulatory capital?

Mr P Brennan : It certainly means from a capital management and planning perspective there is less flexibility. At the same time that is reflective of the corporate structure. They are not able to issue shares. At the start of this process I was not clear that it is are mostly of the view that the prudential framework was an impediment, but at the same time we have been open minded that if there is something in the potential framework that we can accommodate then it makes sense to consider that.

Senator KETTER: Are you reasonably hopeful that you will be able to come to a good outcome here?

Mr P Brennan : The progress we have made with industry has been pleasing. I would not want to pre-empt the outcome of that consultation, but if we end up presenting something that works for industry then the consultation may work well.

CHAIR: Are there any more questions for APRA? If not, the officials of APRA are free to go. Thank you very much for your attendance tonight. My apologies for keeping you so late.