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Economics Legislation Committee
Australian Prudential Regulation Authority

Australian Prudential Regulation Authority


CHAIR: I now call to the committee the Australian Prudential Regulation Authority. Thank you for joining us here today. Can I say congratulations to Ms Rowell. I believe you've been reappointed. Great news. Mr Byres, you've tabled an opening statement. Would you like to make an opening statement?

Mr Byres : I do have an opening statement. In the interests of time I will just quickly go through it. When I last talked to this committee I outlined some of the many ways that we are accountable to both parliament, including through committees such as this, and to the Australian people. They are important measures for APRA to maintain the trust of industry and the public as we aim to fulfil our mandate as prudential regulator.

The core of our mission is safety and soundness. Clearly, some of the revelations emerging from the royal commission have been disturbing and go to the heart of whether financial institutions treat their customers fairly. However, while institutions have a great deal of work to do to restore trust, I want to emphasise that Australians can be reassured that the industry is financially sound and the financial system is stable. That reflects considerable policy reform and hands-on supervision, over a long period of time, designed to build strength and resilience. We don't know when the next period of adversity will arrive, but when it does we need to have done what we could to strengthen the system so it can continue to provide its essential services when they're needed most.

The importance of accountability has been one of our key themes this year. It was front and centre with the release in April of our review of executive remuneration practices in large financial institutions. Incentives and accountability can play an important role in driving positive outcomes and also in deterring behaviours or decisions that produce poor risk-taking and damaging results. Our review found that while policies and processes existed within institutions to align remuneration with sound risk outcomes, their practical application was often weak. We've indicated that we're minded to strengthen the prudential framework to give better effect to the principles we want to see followed: less rewards based on narrow and mechanical shareholder metrics and greater exercise of board discretion to judge senior executive performance more holistically. We've also urged institutions to push ahead with their own improvements, notwithstanding some investor opposition, in light of the long-term commercial benefits that can flow from better practices.

Lack of accountability for poor outcomes was a theme that emerged in the final report of the prudential inquiry into the Commonwealth Bank, which was released this month. The report is, I think, clear and comprehensive and provides a strong message, not just to CBA but to the entire financial services industry, about the importance of cultivating a robust risk culture, especially when it comes to non-financial risks. We're keen that the report will be seen not just as a road map for CBA but as a useful guide for all institutions.

Residential mortgage lending is another area where we've been lifting industry standards. Although there is more to do, there certainly has been an improvement in industry lending practices. As a result, last month we announced we would remove the 10 per cent investor growth benchmark, which we have talked about a few times in this committee, for those lenders who could provide a range of assurances as to the quality of their lending standards and practices now and into the future.

Superannuation is an area where APRA consistently emphasises the need for trustees, regardless of size or ownership structure, to go beyond compliance with minimum regulatory requirements and aim to deliver the best possible outcome for members. We've just released the results of two thematic reviews of superannuation licensees—on board governance and on the management of related party arrangements. Both those reviews noted improvements in industry practices in recent years but also found more work was needed, including finding ways to bring fresh ideas, perspectives and skills to trustee boards. Our post-implementation review of the 2013 Stronger Super reforms, which we launched last week, should also provide us with some additional insights into how the prudential framework is performing and whether any adjustments would help to better achieve our objectives.

Many of the findings in the Productivity Commission report into superannuation released this week are consistent with the approach that we've adopted to supervising trustees, in particular with a focus on enhancing the delivery of member outcomes through our engagement with trustees with outlier underperforming funds and products.

Technology is rapidly changing the way financial institutions operate. In all likelihood the financial system will look different in five years' time, relative to the way it looks today. Much of that change will hopefully bring benefits to the community in the form of new competitors, products and ways of access, but it will also bring risks. The accelerating threat of cyberattacks to regulated entities has prompted us to recently propose our first prudential standard on information security. Industry consultation is ongoing, but certainly we hope to implement the new cross-industry standard by 1 July next year. That's an issue that is only going to grow in importance.

Continuing to look ahead, our preparations are well advanced for the commencement of the banking executive accountability regime, which begins in just over a month. The BEAR considerably strengthens APRA's existing powers to identify and address prudential risks from poor governance, weak cultures or ineffective risk management. However, I have made the point previously that, while important, the BEAR alone will not remedy perceived weaknesses in financial sector accountability. We've encouraged all regulated entities, and not just banks to whom it applies, to use the regime as a trigger to genuinely improve systems of governance responsibility and accountability.

Finally, we are continuing to provide relevant information to the royal commission to help it in its inquiries. In addition, APRA and the Australian financial system more broadly will be subject to intensive scrutiny from the IMF in the weeks ahead as part of its 2018 financial sector assessment program. That program will examine in quite some detail financial sector vulnerabilities and the quality of regulatory oversight arrangements in Australia. As ever, we will obviously fully cooperate with our international reviewers and we look forward to their report card, including any recommendations on how we could do our role more effectively in the future. I'm very happy to take your questions.

CHAIR: Thank you, Mr Byres. I'm going to cede my chair's prerogative to Senator Bushby; but, before I do, can I just say congratulations not just to Ms Rowell but also on the appointment of an additional deputy commissioner, which is very exciting. We heard your announcement today that Mr Lonsdale was appointed. I suppose, just before I hand over, I can understand now why Mr Lonsdale had such an excited face yesterday when he appeared before us at estimates as part of the markets group. Can I ask you what you feel the impact of having another deputy commissioner at APRA will have on your ability to discharge your obligations?

Mr Byres : First of all, we are very pleased that the government decided to reappoint Helen. We think that's fabulous for APRA. We think she's done a great job. In terms of the additional deputy chair role, it is caveated by the fact that legislation needs to pass the parliament to create that role. So, while the government has made the announcement about its intention to nominate, it's obviously conditional on the legislation being passed. But, from our perspective, it just brings additional skills and experience to the leadership team at a time when we've got a very, very busy agenda. I think anyone that knows John knows that he's a very capable individual, and we are very pleased to have him as part of the leadership.

CHAIR: Can you give us an idea of what you envisage his role to be?

Mr Byres : We're still thinking through how to divide up our responsibilities. I haven't had an opportunity to talk to John about it yet, so I'm wary of saying too much. We have an increasingly expanded set of activities and mandates, and more is expected of us in a range of areas. There are new things being added to it, both our toolkit and our scope of activities, and so having someone else to help cover the ground there will be very helpful from our perspective.

Senator BUSHBY: Thank you for assisting the committee today, and congratulations also, Ms Rowell, on your reappointment, and I also look forward to working with Mr Lonsdale in his new capacity. It seems to me that he has been appearing before this committee probably for the best part of 10 years with a different hat on, so it will be interesting to see him sitting here with APRA at the next one.

I have a couple of quick questions. You mentioned in your opening statement the Banking Executive Accountability Regime and that it largely strengthens APRA's existing powers to identify and address the prudential risks arising from poor governance, weak culture and ineffective risk management. But you also note that the BEAR alone will not remedy perceived weakness in the financial sector of accountability. Do you think that the BEAR, though, is, I presume from that quote, a positive step in helping APRA discharge its obligations?

Mr Byres : Absolutely, particularly the focus on clarifying accountabilities within banking organisations, which is at the heart of what the BEAR is all about: it's an accountability regime. If you look at many of the problems that have emerged in the financial system—and certainly it was a theme that existed in the prudential inquiry into the CBA—they were not necessarily because people set out to do the wrong thing but rather it was often unclear who was responsible for what. For one reason or another, either issues fell down a crack or people didn't take ownership of them and outcomes were not what they should have been. I think one of the great strengths of the BEAR regime, in requiring quite formal accountability statements for individuals and also accountability maps for each ADI, will be much more clarity about who is responsible for what. That's really quite important and fundamental.

Senator BUSHBY: What is APRA currently doing in the lead-up to 1 July to actually engage with the institutions that are subject to this?

Mr Byres : It is being implemented in two stages. The first stage, which is from 1 July this year, is the four major banks, effectively, will be subject to the regime. The smaller institutions have an additional year, so that will be 1 July 2019. We have been working over the last little while with each of the major banks, which have provided us with their draft accountability statements for the proposed accountable persons under the act, which essentially are all the senior executives and directors of the organisations—and also their accountability maps. We've been doing some compare-and-contrast and providing feedback on where we think they need to be strengthened or improved or made clearer. We're at the final stages of working through those and providing that feedback so that, on 1 July, we're ready to go.

Senator BUSHBY: So there has been an ongoing dialogue between the four big banks and APRA as to how they're going to meet their obligations; it has been tweaked over time; and, as of 1 July, APRA will go into that happy that the banks are saying they are putting into place a regime that will work. How will you test that afterwards?

Mr Byres : I think we will have a credible regime in place on day one. That's not to say it can't be improved as time goes on and we get more experience with it. The real test will be whether, as we talk and engage with senior executives in those organisations, they are very clear about what their new obligations are and what their new accountabilities are. We can see, as our supervisors are in their organisations, that there is clarity. It is changing the way that people respond to issues. It is clear that people are taking ownership of issues—

Senator BUSHBY: So you're already seeing that?

Mr Byres : I might ask Gideon if he has any observations to make. I don't know whether it's perhaps too early to say there's positive evidence of it just yet, but I think there's clear intent.

Mr Holland : I think absolutely it's already yielding benefits. An example would be as to specific responsibility for the capital management, the funding plan, stress-testing and who is the individual actually responsible for overseeing and approving, developing and looking after these really core and fundamental aspects of the prudential regime. So I think already we're seeing some benefits in defining accountabilities more clearly. I think there's a long way to go. It's a new regime and it will be in place from 1 July for the first time.

Senator BUSHBY: Do you think the banks are finding that it's actually useful for them as well—not just in terms of ensuring that there's executive accountability and that that delivers the public benefit that the act is intended to deliver, but also in the banks looking at this and saying, 'Having to go through this exercise is actually assisting us in terms of how we run this institution'?

Mr Byres : You'd probably get some mixed feedback. Initially, I think it was seen as—

Senator BUSHBY: An unnecessary additional burden?

Mr Byres : unnecessary. But where I've received some very positive feedback is from the director community, because it is very much helping them identify within their organisations who is responsible for what—some will admit that that has not always been clear—and they can certainly see business benefit from that.

Senator BUSHBY: I suspect that may well be the case because improving accountability and internal understanding of who's responsible for what improves focus, and, I would think, improves management outcomes. Do you think that the BEAR will assist to address some of the issues that have been highlighted in the CBA inquiry and the royal commission?

Mr Byres : Yes. I would give two ways in which that might happen. There are probably more, but at least two. One is, as I've already said, I think many of the issues that have come to light—operational problems and other things—have often been because there has been a lack of accountability or a lack of clarity of accountability, of who is responsible for what. We have matrix reporting structures and complexity about who owns a process from end to end, and the BEAR will obviously help in some way to cut through that complexity and become much clearer about who has accountability for different things. The second thing that I think it will do is: when things are not as they should be and there are poor outcomes, it will help ensure that there are consequences in terms of remuneration and other things which, as I touched on, I don't think have been very effective thus far in creating good behaviour and good risk culture in organisations.

Senator BUSHBY: Probably the opposite, in some ways?

Mr Byres : Probably the opposite.

Senator BUSHBY: I might change to a different subject. You also mentioned in your opening statement about the residential mortgage lending standards and that your level of supervisory intensity has led to a lift in industry lending practices. How is that realised in practice? What does that improvement in industry lending practices actually look like?

Mr Byres : I'd probably oversimplify it but, essentially, it is banks undertaking a more robust credit assessment at the time that loans are being granted, thinking much harder about the borrower's ability to repay and thinking much harder about the risk metrics of the portfolio as a whole.

Senator BUSHBY: So it is improving the overall quality of their book.

Mr Byres : Yes. We were concerned about competition that was playing out in an unhelpful way. Banks were happy to compete, but they weren't competing on price—and I don't know if they were necessarily competing on service. They were, by and large, competing to win market share by shaving credit standards. I'm talking here a few years ago. We essentially tried to dampen that competition that was leading to that erosion in standards and, over time, rebuild. I think we have achieved that. We have some more work to do—it's not complete—but the quality of loans being written today is certainly receiving much more scrutiny than was the case a few years ago.

Senator BUSHBY: Excellent. You mentioned also that you will be removing the 10 per cent investor growth benchmark for some lenders who've met certain standards. How many lenders and are they all big ones or is it a range across ADIs? How does that look, the lenders who will have that 10 per cent requirement removed?

Mr Byres : We've made that available to everybody. Any ADI that wants to give us that assurance and thinks they can reasonably give us the assurances we've asked for can. I think we were talking before about how we're expecting maybe a trickle rather than a flood, because the first deadline for providing the assurances is this week.

Mr Holland : Yes.

Senator BUSHBY: Has anybody provided that assurance so far?

Mr Holland : There've been a few applications so far, but it's probably too early to tell because we're reaching the first—

Senator BUSHBY: You're still assessing them.

Mr Holland : Absolutely.

Senator BUSHBY: But there have been some applications for this so far.

Mr Byres : There have been some. A number of organisations have said quite openly that they still have some work to do before they can provide the assurances, so we shouldn't expect one from them. When people are ready, we're happy to receive them.

Senator BUSHBY: Maybe I can ask the same question again at the next estimates, when you have a bit more evidence, to see who made the grade.

Senator McALLISTER: I also want to ask about loan serviceability. I note that your submission to the royal commission talked about the targeted review that you undertook into banking practices in 2017. In your submission, you said that you expect 'ADIs to use the greater of a borrower's declared living expenses or an appropriately scaled version of the HEM or HPI indices' and you talk about the fact that those indices represent a floor, not a replacement, and also call for prudent calibration of the HEM benchmark. I want to talk about what kind of concerns you found in that 2017 targeted review of people not being in compliance with that set of expectations.

Mr Byres : The general view we had was that the industry had become a bit over-reliant on the indices as a shortcut way of doing a serviceability assessment. The HEM, which is the most commonly used of the metrics, is calibrated to a certain level of expenditure. It would be well below the medium household expenditure but was being used in a fairly high proportion of cases. In some cases, that was because borrowers provided information that seemed too low, even with due inquiry, and therefore the banks decided to substitute it with the benchmark. That's an entirely appropriate thing to do because we'd like them to use the 'higher of' when they seem very low. But, in other cases, it did seem that either they were not necessarily making extensive inquiries or they were receiving information from a number of borrowers that seemed very, very close to the benchmark—coincidently close to the benchmark. From our perspective, we've said that we're uncomfortable with the extent to which it is being used at present.

Senator McALLISTER: When you say you're uncomfortable about the extent to which it's been used, is its use widespread across market participants?

Mr Byres : Yes. It's certainly the common metric for the large lenders. It's used in slightly different ways in different organisations. Sometimes it's scaled by income or other things, so it's not just a single number. People do other things to add buffers to it to make it a more realistic assessment of household income. I could provide you with the number after this, but, in a speech I gave last year, we did summarise the outcomes on the use the HEM. For the largest banks, it was above 70 per cent, on average.

Senator McALLISTER: What steps are you taking to address to that? You've identified it in the review. You've raised it in the royal commission. What is happening practically?

Mr Byres : We are asking all banks to have a look at the way in which they are collecting borrower expenses, and all of them have programs underway now to collect more information from borrowers.

Senator McALLISTER: Is there a deadline when they have to meet the expectations that were set out?

Mr Byres : We've told them all that, as one of the conditions for the removal of the 10 per cent benchmark, we want them to reduce the reliance on HEM.

Senator McALLISTER: So that's one of the levers.

Mr Byres : Yes.

Mr Holland : I'd add that, to reduce reliance on HEM, there's no silver bullet. There's no one way in which a bank can do that. It's a combination of making more reasonable inquiries, increasing the number of expense categories that are used to collect borrower expense information and monitoring the use of HEM at a granular level to see if there are particular lenders or brokers that are significantly reliant on it.

Senator McALLISTER: I am a little troubled by the fact that this keeps coming up. I asked about this in June 2015 and, at that time, I think ASIC was engaged in an enforcement action with one of the Queensland institutions. You said that you'd done an exercise around that time where you used hypothetical borrowers to test how banks would assess their serviceability. You flagged that you weren't pleased to see that there were banks in that exercise that decided to assess the borrowers' living expenses using a lower amount than the borrowers themselves said they needed to live on. That was three years ago. Two years later, you undertook a targeted review, and it found the same thing. Are you satisfied with the rate of progress APRA is making in addressing these issues? You had knowledge of it quite a long time ago.

Mr Byres : The first problem that we set out, which you talked about, was that people were using the HEM number even when the borrower had declared something higher. I think we tried to quickly put an end to that. The question then was: were there still too many borrowers that were being assessed using the HEM rather than proper inquiries?

Senator McALLISTER: I tracked down a speech by Dr Laker from 2007. He was the commissioner at that time and he said that many lenders were, at the time, using estimates of living expenses below the Henderson poverty index or were not regularly updating their estimates. The commissioner was talking about these issues 11 years ago. I wonder whether you're satisfied that, over the last decade, the institution really has engaged with this behaviour from the banks.

Mr Byres : I think we have, but it's hard to create the alternative. Some of the more really problematic practices—such as a borrower declaring they had expenses of X and the bank using something less than X, or banks using indices that are out of date and not regularly updated—have been stamped on. The real problem is that borrowers are not very good at providing the information. We would all like, I think, to at least significantly reduce the use of benchmarks, but the alternative is actually difficult to transition to, simply because it relies on borrowers having really good information to give to banks.

Senator McALLISTER: I appreciate the hurdles, but it's been under discussion for at least 11 years. We've finally got a royal commission which is exposing how significant these practices are, both from a consumer perspective and potentially from a systemic perspective. I just really do wonder whether we've done enough. I've been asked a lot, 'What were the regulators doing?' And I really wonder if you've given any thought to whether you could have done more over the last 11 years.

Mr Byres : That's sort of a hypothetical. You can always think, with the benefit of hindsight, that you could have done something different. The other thing that we've been conscious of trying to do is manage a transition in lending standards. I'm focusing in my response on the last three or four years, when we've had our most recent intervention. That continued to allow credit to flow, didn't produce material step change in the volume of credit or cut credit off sharply in any way, but it allowed the market to adjust in an orderly fashion. It's not the only thing that we've been doing to reinforce the financial system. We've also been raising capital requirements. We've put out prudential practice guides. We've done a raft of things along the way. We've been active. I would say we've devoted huge resources to this. Certainly when we started on this most recent round of interventions back in late 2014, I would have liked to have made more progress than we have made now. But we've done what we can with the resources we've had, and we've had a good impact.

Senator McALLISTER: I want to ask too about some of the issues that have emerged from the royal commission and their impact on shareholders. Class actions are underway against AMP. A number of analysts have given unfavourable ratings to the retail banks. I note that, in the Australian case in particular, the broader Australian public is quite exposed to bank equities through the super funds. Do you think that APRA needs to rethink its approach to its obligations to shareholders in terms of disclosing what it is finding out about ADIs' activities?

Mr Byres : Not particularly. The role of the prudential regulator is to protect depositors, not protect shareholders. Our task is to make sure that depositors' money is safe. In fact, shareholders are there to absorb losses and act as a buffer to protect depositors. So I'm comfortable with the way we fulfil our mandate. We do have confidentiality provisions. I think they're helpful to allow us to do our job. They allow us to get a considerable amount of information that we wouldn't otherwise get. If everything we did was in the public domain, I suspect information wouldn't be made available to us that is currently made available to us. I'd also fear, to be honest, that there's always a risk of overreaction to regulatory issues. So it's a nuanced position, but I start with the proposition that we're here to protect depositors, not shareholders.

Senator McALLISTER: When we talked about this last time, which again was back in 2015, our conversation recognised that there is a balance between the ability to obtain information from those that you regulate, your primary responsibility to depositors and some of the broader issues around market information.

Mr Byres : Yes.

Senator McALLISTER: I acknowledge that those things remain in tension with one another and need to be balanced. Do you think that, given what has emerged from the royal commission, there is a need for some rebalancing and some reconsideration of whether you have got the balance right on those questions?

Mr Byres : I don't quite think about it as a rebalance, but I do take your point about trying to improve transparency. We have tried to do more to flag some of the issues that we are investigating, not at an institution level but certainly at an industry level. If you want to see the stats on the use of HEM that came from the targeted review, we included them in a speech where we talked about some of the industry trends that were existing. So I think we're trying to be more visible about what we're doing. Indeed, it would have been possible, at least in theory, for us to deal with the whole issue of investor growth and interest-only loan benchmarks behind the scenes by talking to individual institutions, but we decided that the best way to achieve this was to be quite transparent about what we were doing for everybody. I'm not sure that that was the traditional way of doing things. As I'm saying, we're trying to be more transparent and balance these things.

With the CBA prudential inquiry, releasing the report was clearly not the traditional way of doing things, but in the particular circumstances we thought that there was broader interest and a need to produce that report and make it public, so before we saw it we committed to making that report public. We committed when we announced the review. So we are mindful of the issues you talk about. We do think about them. We are trying to be, where we can be, more transparent where it is not likely to create undue concern or undue volatility.

Senator McALLISTER: Thanks.

Senator WHISH-WILSON: Welcome, Mr Byres. I want to ask about your media release in relation to the report you released on the CBA in your culture review. I found the language quite extraordinary, but in a good way. You were certainly very direct in the summary of your report. You did say in a media release, which I have a copy of in front of me:

In response, CBA has acknowledged APRA's concerns and has offered an Enforceable Undertaking (EU) under which CBA's remedial action in response to the report will be monitored. APRA has also applied a $1 billion add-on to CBA's minimum capital requirement.

Can you detail the conditions of the enforceable undertaking that you have reached with CBA?

Mr Byres : The enforceable undertaking is a public document. I'm happy to make it available to you if you haven't seen it. Essentially, there are four components of the undertaking. The first is that CBA needs to provide to us by the end of June this year a remedial action plan that deals with each of the recommendations in the report—what will be done, who's going to be accountable for doing it and when it will be done by. That's not just a report, but a plan that we approve. That's the first one. The second one is that they have to appoint an independent reviewer—again approved by APRA and on terms approved by APRA—who will do some independent validation of progress against the remedial action plan every three months and report that to APRA. Also by 30 June this year the board needs to give us a report on how the findings of the report have impacted on executive remuneration, both of current and past executives, and also to make sure that the delivery of the remedial action plan is given material weight in the performance scorecards of the executives going forward, so there is skin in the game. And then the fourth component is the capital adjustment you talked about, which will be removed as and when CBA shows that it has completed the remedial action.

Senator WHISH-WILSON: Okay. We talk about enforceable undertakings a lot with ASIC. In this case, do you often take enforceable undertakings with corporations? Is it solely in relation to systemic-risk-related issues rather than misconduct issues?

Mr Byres : I wouldn't say they're common, but they're not rare. I don't know whether—Warren, do you know offhand how many we've taken over what period? It's a relatively small number. Warren?

Mr Scott : It's all on our website. We don't enter into any enforceable undertaking unless it's made public. And the entity has to admit that APRA's concerns were valid and that they needed to make changes. It's mainly been with some insurance companies, but there have been two banks that have entered into enforceable undertakings. I think there are about seven on the website. I'm not sure of the exact number.

Senator WHISH-WILSON: In this case—perhaps rather than the other cases where you may have had other enforceable undertakings—were more punitive actions considered, such as civil or criminal convictions?

Mr Scott : There is always a balance that's made, and it's usually done with the management of APRA as to the cost benefit. We're mainly interested in forward-looking changes by entities. At times we have thought about remedial plans being more effective for APRA's mandate than going to court to get a disqualification or a penalty.

Senator WHISH-WILSON: I'd like to get into that in more detail, but, unfortunately, I have such limited time. In relation to the capital penalty of a billion, will this be permanent? Is this the kind of thing you've levied on other institutions?

Mr Byres : Yes. We have the power to put capital add-ons on all sorts of organisations that have capital requirements. They could be banks, they could be insurance companies. We do that as a matter of course in supervision, where we think it's needed. It helps provide some extra incentive for people to get things fixed when we want to get things fixed. In this particular case it's not permanent; it's permanent until they've satisfied us that the 35 recommendations in the report are addressed. And then the reason for having it will—

Senator WHISH-WILSON: It will be reviewed. Right, I'll come back to that.

Mr Byres : It's intended to act as an incentive to get things done. If you want to get rid of it, you get things fixed.

Senator WHISH-WILSON: In relation to the targeted reviews—and I must say that I have asked when you're going to release those at several estimates now, but the royal commission has forced the release of those reviews. Can I just run through things fairly quickly? So the major banks—by the 'major' banks I mean the big four—are authorised to use an internal risk base in respect of mortgage risk weights. Is that correct?

Mr Byres : Not just the major banks, but it's true for the major banks, yes.

Senator WHISH-WILSON: Being authorised to use the IRB requires a bank to have a strong and sophisticated risk management framework. Is that correct?

Mr Byres : Yes.

Senator WHISH-WILSON: The Productivity Commission estimated that using IRB amounts to a funding advantage—I actually asked them in the last session—in the order of about 15 basis points. Would you agree with that? Or have you chatted to them about their work on this?

Mr Byres : I've seen their work. It depends on assumptions you make. It's not an estimate that I would challenge.

Senator WHISH-WILSON: Okay. What we saw at the royal commission—and Senator McAllister touched on some of this—was that the targeted reviews detail extensive problems within the big four, regarding their mortgage books and particularly in relation to income and liability verification of customers and the collection and management of data. Did the findings of the targeted reviews accord with the requirements for a bank to have a strong and sophisticated risk management framework to use the IRB?

Mr Byres : The results are clearly not ideal. The issues of the targeted review are a broader subset of risk management of the portfolio and also a broader subset of the way in which banks assess the risk of their borrowers. It was a narrow perspective, but it's not a good report card, so I'm not complaining about that. The response to that, though, is to say that there's a range of ways you could deal with that. Essentially, the way it's being dealt with at the moment is, in the case of all of the banks, because we have imposed this through different means, they're running, for want of a better term, higher capital requirements than their models would naturally produce. We have overlays and a raft of interventions that have pushed their risk weights up.

Senator WHISH-WILSON: We've also heard CBA lost the data of 20 million accounts. It fell off the back of a truck, according to what I read. We've had your review of the culture with CBA, which found them to be arrogant in their risk management or seriously deficient. Once again, how does that kind of thing accord with the requirements to obtain IRB accreditation?

Mr Byres : The IRB accreditation is specifically focused on credit risk. There has been, until recently, a separate accreditation for operational risk. Many of the issues you touched on are operational risk related. That whole framework for operational risk, consistent with the international views, we have decided is not really a workable system anymore. So we flagged our intent to remove the capacity to model operational risk as part of our capital reforms.

Senator WHISH-WILSON: Not long ago and late last year, I met with representatives from regional banks, and one of them said to me that they'd spent in the order of $40 million on modelling to try and get IRB authorisation themselves, to no avail. What is it about a major bank that makes their management of their mortgage books so much more sophisticated and less risky than a regional or tier 2 bank?

Mr Byres : I think it is the investment they have made in systems and the investments they have made in risk management and portfolio analytics. That's at the heart of it. It is deliberately a high standard because what's happening with IRB is essentially there's a default method—the standardised method—and the bank needs to demonstrate that it is producing better measures of risk and, in a sense, better quality predictors of risk than the regulator's default settings. That does take investment.

Senator WHISH-WILSON: True, but the targeted review shows that these systems are flawed, though, doesn't it?

Mr Byres : It showed that there are certainly weakness in some components of it. It is not showing it necessarily, because that's only one part of the risk management framework and the risk modelling process. Banks use a range of other things to assess the quality and probability that a borrower defaults, including the borrower's behaviour over the life of the loan. The serviceability is a point in time before the loan is granted.

Senator WHISH-WILSON: I'd have liked to have had more time to ask you about that. I may have to come back to you, Mr Summerhayes, if I don't get any more time. I wanted to ask you, after your very famous speech on carbon accounting and carbon pricing, whether there have been any advances broadly in Australia on the Australian stock exchange around moving towards a framework on carbon risk?

Mr Summerhayes : There has been good progress on disclosure as it relates to a transition to a low-carbon economy. One of the motivations for us making the speech was the release of the TCFD's disclosures. Two of Australia's major banks, I'm happy to say—the ANZ and NAB—are part of a pilot of banks globally piloting TCFD disclosure. There is about to commence a global pilot of insurers, for which a couple of major Australian insurers have nominated. APRA certainly is supportive of TCFD disclosure; it aligns very nicely with risk management standard CPS 220, which asks institutions to have appropriate governance strategy, risk management and metrics around the risks that they confront, and climate risk fits in that along with other risks. What I would say is that there has been considerable movement since those speeches made last year on other forms of pressure on institutions to improve disclosure. Proxy firms, certainly major investors, rating agencies and, in many cases, shareholder action are pushing firms to accelerate progress, which APRA welcomes.

Senator KETTER: Thank you, Mr Byres, for your opening statement; and congratulations, Mrs Rowell, on your reappointment. I want to come back to macroprudential measures for a moment. We know that in the budget papers it was identified that there is risk for household spending being affected by an unanticipated tightening of financial conditions, possibly as a consequence of the royal commission. Are you seeing any tightening of financial conditions at the moment, given what is coming out of the royal commission?

Mr Byres : Not particularly. All of the APRA regulated lenders are being more diligent than perhaps may have been the case a few years ago, but that doesn't need to be materially impacting on the flow of housing credit. For the last few years, the flow of housing credit has hovered between five and seven per cent despite all the actions that we and others have taken. So I think we have been able to manage that in a fairly orderly manner. As I said, we have indicated that we are willing to remove the 10 per cent benchmark for those who are lending with good standards and practices. So that is, in a sense, us stepping back a little bit. To the extent that there are other factors at play that are creating a bit more caution, I don't think that is a bad thing just sitting where we are in the cycle. I do not think at this point there are signs of anything excessive. As I said, housing credit growth may be slowing a little bit but it is still rising above household income growth.

Senator KETTER: If you saw a further tightening, how would you deal with that in the context of your actions in the macroprudential area?

Mr Byres : We have to be a bit careful in saying it is okay to go back to lending sloppily just because housing credit slows down; I do not think that is the response. Nor do I think we would necessarily rush the only other instrument that we have initiated, the benchmark on interest-only lending, where we ask lenders to slow down the proportion of lending occurring on an interest-only basis. The industry now, relative to our benchmark of 30 per cent of the flow of new lending, is currently running at about 20 per cent. So there is opportunity there. It is not as though they couldn't do more of that lending if they wished to do so. So I don't think our benchmark is particularly constraining at this point. I am wary of suggesting that somehow we are able to readily adjust the flow of credit in the economy; that is not the case.

Senator KETTER: No, but you have measures available to you. For instance, if credit tightened substantially, would you consider further loosening your macroprudential policies?

Mr Byres : I don't like the term; I just think they're prudential policies. The only significant measure we have in place at present, beyond just asking people to do some good housekeeping in their lending practices, is the 30 per cent interest-only benchmark. I don't think it would be in the community's interest to see us go back to much higher levels of interest only lending. So I guess my answer to you is that I don't think I have a large number of instruments that could somehow pump credit back up if it did slow significantly.

Senator KETTER: Given your mandate on financial responsibility, how responsive will you be to the circumstances in the economy in terms of how you calibrate your prudential policies?

Mr Byres : We are trying to be to some extent countercyclical. We saw a situation back in 2014 where we saw very rapid credit growth, particularly for investors, and we saw an erosion of credit standards. We tried through 2014, 2015 and 2016 to throw some sand in the wheels and urge a bit more caution in that space. We think those measures have had an effect, so now we are starting to ease them off again, and that is really the measure we took with the 10 per cent benchmark being potentially removed. So I think we are trying to be countercyclical. We are also trying to do things that create an orderly adjustment in the market and, as I said, don't all of a sudden make a contraction of credit by the industry. Thus far, I think we have been able to do that, as evidenced by the fact that the flow of credit to housing overall has been pretty stable.

Senator KETTER: I would now like to turn to the issue of superannuation returns, particularly in the context of the members of the BT Business Super fund. There was a recent report in The Australian which quoted internal industry data by analyst SuperRatings which suggested that, over the past five years, people in this fund who selected the cash investment option received an average return of just 0.5 per cent a year after fees and taxes. This is despite the fact that the five-year cash rate and the federal government five-year bond yield, both of which are benchmarks for cash investments, averaged 2.03 per cent and 2.48 per cent at that same time. Is APRA concerned about the very low returns being given to members of some superannuation funds?

Mrs Rowell : Yes, we are. Indeed, we are undertaking some work at the moment to look at the returns on various cash options and the composition of various cash options across the sector. The work we have done so far highlights a couple of different issues. One is that some cash options seem to be returning much higher than we would expect from what you might call a pure cash option and there are others that are returning much less. Our initial work seems to suggest that part of it goes to the types of instruments, if you like, which are in those. They are not just term deposits; they may be enhanced cash, RMBS or other types of securities that are cash-like but not cash. And in other cases it does come down to the level of expenses that are being charged for the management of those cash options. Those are all issues that we are pursuing with the relevant funds where have identified them as being outliers in that regard.

Senator KETTER: Does APRA consider that the current regulatory arrangements are appropriate and sufficient?

Mrs Rowell : The superannuation framework relies on trustees to set the investment strategy and to set the fees and charges that they apply for those investments and the management of those investments. The focus of our member outcomes work, and the proposals that the government has considered around enhancing member outcomes, is really about pushing trustees to think a lot harder about some of those decisions. In that sense, I would say that there is room to strengthen the regulatory framework both in terms of putting tougher requirements on funds in terms of how they look at and assess member outcomes and what they are delivering at a fund, product and investment option level but also in terms of the reporting and disclosure and the information that is available that enables us and other stakeholders to get more visibility of these types of issues more quickly.

Senator KETTER: Has APRA approached the government to seek strengthening of the laws to address circumstances like these arising?

Mrs Rowell : The whole focus of the bills that were previously introduced into parliament was in part driven by a number of these issues—the proposals to provide enhanced powers to do look-through reporting and the like, the member outcomes proposals. There are some matters that we can deal with ourselves, and we are taking steps where we can through reviewing our prudential standards and reporting frameworks. But there are also some measures where getting the government bills through parliament would be very helpful to us.

Senator KETTER: I will now turn to the review of the prudential framework. Could you update the committee on what this review will cover.

Mrs Rowell : This is a post implementation review of the Stronger Super reforms. Its focus is looking at the prudential standards, the prudential practice guides and the reporting standards that were introduced in 2013. So it covers the whole suite of prudential standards and the reporting framework. The objective of this review is to get feedback and to assess for ourselves whether the original intent of those Stronger Super reforms is being delivered and, if not, what room there is to amend the framework to better deliver the original Stronger Super objectives.

Senator KETTER: You have just announced that. What is the background to this review? I think you have touched on that to some extent. Is there anything further you want to add?

Mrs Rowell : We committed to doing a post-implementation review a few years after the framework had been fully implemented, when we actually introduced the prudential standards. The prudential framework was new to superannuation and therefore we felt it was appropriate to have a post-implementation review a couple of years after it had been fully implemented.

Senator KETTER: Can you tell us when you gave that commitment to have a post-implementation review?

Mrs Rowell : I believe it was in the original discussion papers and the finalisation of the framework at the time we completed our consultation. That would have been back in 2012 or 2013.

Mr Byres : It is probably best that we take that one on notice. We can give you the reference.

Senator KETTER: At any time before your announcement of the post-implementation review on 23 May, did APRA discuss this review with the Treasurer or the Minister for Revenue and Financial Services or either of their offices?

Mrs Rowell : I don't recall any specific conversation other than in the general context of a general update on our work program. But we might take that one on notice as well.

Senator KETTER: Okay—when and with whom. Did APRA ever raise this review with Treasury officials before it was announced?

Mrs Rowell : We would have provided an indication to Treasury that we would undertake the review, because we regularly inform them of our policy agenda and program.

Mr Byres : in fact, we have a Treasury official helping us with this review. We wanted some people independent of those who had been involved in the design of the framework to be involved in the review of the framework, so Treasury provided an official to help us with that.

Senator KETTER: Can you tell us on notice when that occurred and with whom.

Mrs Rowell : Yes.

Senator KETTER: Does APRA have any prudential changes that it would like to be considered as part of this review?

Mrs Rowell : There are a few areas of the prudential framework that we are aware need to be strengthened or revisited. There are some issues around reporting, particularly around expenditure reporting. There are also some issues around the reporting of related party arrangements that we think need to be strengthened and clarified. Other than that, the prudential framework seems to be operating quite well. So this is really just about whether there is room to tweak it.

Mr Glenfield : A lot of what we are looking at is whether it is fit for purpose. It came in in 2013. We have had a period of bedding it down and working with trustees and RSEs. We are now looking at whether it actually delivers what we wanted it to do. Other things we are looking at are around strategy and viability assessments—which is that member outcome work that wasn't considered earlier. And it is particularly going back to industry and to the public and saying, 'Did we get it right in the first instance, or are there other areas that we need to think about?'

Senator LEYONHJELM: Mr Byres, I would like to take you to a couple of points in your opening statement. Can you explain in some more detail what you mean by encouraging boards to exercise greater discretion to judge senior executive performance more holistically? What are you referring to there? What is holistic judgement?

Mr Byres : To give you a specific example, there are some aspects of the senior executive remuneration which are quite mechanical in nature. So if the share price performance relative to a group of peers is above the median, the award will be granted. There is no discretion. There is no discussion about whether the factors that led to that share price outperformance were attributable to the executives or whether they were just a factor—say, other people had poor performance and you were the last man standing, in a sense. We're very keen to move away from those sorts of mechanical things and have boards exercise more discretion in thinking about not just what the financial performance was in dollar terms, but, 'How did we achieve it? Is it sustainable? Are we generating good value for shareholders over the longer run, and are we running the business in a sustainable and prudent fashion?'

Senator LEYONHJELM: But it's always in the context of financial performance?

Mr Byres : It's in the context of the performance of the entity. Financial performance will be one factor, but if, in the current environment, we're achieving good financial results but being badly damaged reputationally then that's not necessarily a positive outcome in the broader context.

Senator LEYONHJELM: Do you mean prudential reputation?

Mr Byres : We're saying boards should look at everything. I think our particular focus is around making sure that issues of safety and soundness—the prudential matters that we're responsible for—are part of the consideration. It's easy for financial organisations like banks to generate high profits by taking high risks. We're saying that, if you're going to reward people purely on financial outcomes without regard to how they're being achieved, that's a risky proposition.

Senator LEYONHJELM: Also in your statement you said that you're focusing on the importance of cultivating a robust risk culture, especially when it comes to non-financial risks. What non-financial risks were you thinking of there?

Mr Byres : The particular reference came from the Commonwealth Bank report. The findings of the panel were essentially that the CBA had a good focus on its financial metrics; it had a good focus on its financial risks—credit risk, market risk—but it didn't have a good focus on operational and compliance matters The most public and well known example of that were the breaches of the AML legislation, which were not given the appropriate attention. Those sorts of operational and compliance matters are really what we're talking about in that regard.

Senator LEYONHJELM: You also discussed the BEAR bill. Feel free to disagree, but it seems to me that the BEAR bill is very close to taking APRA into matters of management. They relate to how a bank or an ADI manages its business. Would you agree?

Mr Byres : With respect, not really. It does impose a set of obligations such that people have to be very clear about what they're doing. It does impose a set of obligations—that people obviously have to have the honesty and integrity, competence and character to do the jobs that are required of senior roles in the financial system—but it doesn't tell anyone how to do their job. It's up to organisations to decide who is going to be accountable for what. We don't prescribe that. We don't prescribe, and the legislation doesn't prescribe, how people should be paid or how much they should be paid, and we don't have the power to prescribe how much an individual should or shouldn't be paid. I think it does stop short of APRA prescribing—or the legislation prescribing, because in fact most of the requirements are in legislation—exactly how a bank is to be run.

Senator LEYONHJELM: All right. Yes, I suppose I'd agree with you—it doesn't enable you to tell a bank exactly how it should be run—but you certainly have more significant influence over how an ADI is run than ASIC has over any other business, for example. Then, in the CBA report, you made quite a number of recommendations that led to an enforceable undertaking. You're getting quite close, if not over, the border, into management, are you not?

Mr Byres : I think I'd make a couple of observations—first of all, the general observation for prudentially regulated entities, which in Australia are banks and other deposit takers, insurance companies and superannuation. The prudential regime has been designed by the parliament to say there are a set of financial organisations that certainly should have higher requirements and more stringent supervision than the other corporations that are managed under the Corporations Act by ASIC. To your point about: do we have higher requirements and more scrutiny than non-APRA-regulated institutions? Absolutely. That's the intent of the regime. The prudential framework is built on the fact there are these certain sorts of financial institutions where, given the sorts of promises made to the community, it's very important those promises are delivered, that deposits are safe, that insurance policies are paid and that super fund members have their best interests looked after. They should be subject to higher requirements. That's the genesis of the prudential framework.

When it comes to the CBA report, you are right: there are a lot of recommendations in there that are, in some senses, fairly detailed; they're not the sorts of recommendations that we would normally put, with that level of detail, in a prudential standard that we would issue. But the panel identified a range of issues that needed to be fixed. It called out what they were. It did, though, quite deliberately stop short of saying exactly how those issues were to be addressed. That's the task that we've now given the CBA under the EU: 'How are you going to fix these things? It's up to you to tell us how you're going to do it, when you're going to do it by and who is going to do it.'

Senator LEYONHJELM: Have any of the staff of APRA previously worked for the institutions that they are involved in at that level of—what word should I choose?—supervision, if you like, in relation to the CBA recommendations and the BEAR bill implementation?

Mr Byres : Most of our staff come from the financial sector broadly defined. I include in that accounting firms and law firms as well as financial institutions. I'd have to take this on notice, but I don't think there was anyone on the CBA inquiry that had previously been a CBA employee, if that's the specific question that you have.

Senator LEYONHJELM: Would that be an issue if there had been?

Mr Byres : We're very careful to try and avoid those sorts of conflicts. Part of the way we do that is think very hard about delegations for decisions within APRA and who has responsibility to take decisions. As you would expect, we've got very clear policies—code of conduct, et cetera—that deal with conflicts of interest. I couldn't say that we haven't got anyone that wouldn't somewhere in their past have worked with an organisation that they're supervising, but very rarely do we have anyone who can take a material decision on their own where that might be a particular issue.

Senator LEYONHJELM: The corollary of that is also: do you have people who have management experience themselves relevant to the level at which they are placing obligations on the ADIs that affect management?

Mr Byres : To the extent that we're placing obligations on the chief executive of a major bank, we don't employ a former chief executive of a major bank. There will be issues, but collectively with regard to the senior leadership team, we have senior industry experience, including Geoff beside me, who in a prior life has been a senior executive with a number of financial institutions.

Senator LEYONHJELM: The question, I suppose, is whether you're comfortable that your personnel have sufficiently senior experience—and I'm thinking of the salaries that are paid in the financial industry. I presume you don't attempt to match them. Therefore, the question is: do your staff have the level of management experience or seniority of management experience that allows them to look at an ADI and say, 'Okay, this is a weakness in that ADI, and therefore I'm going to issue some kind of direction, undertaking or something'? In making that decision, are they in fact sufficiently qualified to make it?

Mr Byres : My general observation would be that I think we're well placed in that regard. We would never say no to more skills and experience, but I think we are well placed in that regard. In fact, over the last few months we've recruited three senior and highly regarded people from the banking sector into some of our executive roles.

Senator LEYONHJELM: Is this a poacher-turned-gamekeeper situation?

Mr Byres : As you rightly point out, people don't come to APRA for the salaries.

Senator LEYONHJELM: I wouldn't have thought so, no.

Mr Byres : People come because what they think what we do is important. They feel alignment with the purpose of APRA and its role protecting the community. So we are always looking for good people. In recent times, if we could find good people, we've got the capacity to bring them on, but, as I said, our experience has been that we have been able to get good talent into the organisation. When we do surveys of our regulated institutions—we do a major survey every couple of years—on the issue of whether your APRA supervisor is sufficiently experienced, we never get a particularly concerning result out of that.

Senator LEYONHJELM: Could your pre-existing powers or the BEAR bill have allowed you to have prevented the CBA from failing to report its cash transactions?

Mr Byres : Not particularly, no. Partly that's because we would not necessarily go looking at AML issues. AUSTRAC is the regulator; they have a regulatory framework and a surveillance program. In the normal course of events, an APRA supervisor would not go looking at those issues.

Senator LEYONHJELM: Under your various powers, either existing or what you are gaining, would you have been able to save or prevent any of the banks from charging for services they fail to provide?

Mr Byres : Would we have been able to prevent that? No.

Senator LEYONHJELM: Would you have been able to do anything to avoid Bankwest causing hardship to small business by revaluing property and calling in loans?

Mr Byres : To stop them revaluing property and calling loans? No. Those issues are not really issues that fall within our domain. We would obviously want Bankwest to be making good loans, but, equally, once a loan is impaired or likely to be impaired, the goal we have is to make sure that the depositor's money which is being used to make that loan is safe. We do want Bankwest—or any other bank, for that matter—to make sure it is pursuing that money when it needs to.

Senator LEYONHJELM: If I have time for one final question—

CHAIR: You're very much pushing the friendship, Senator Leyonhjelm!

Senator LEYONHJELM: I appreciate that I'm here on forbearance. The customers of a bank such as those of Bankwest could potentially go to the banking industry ombudsman to complain about their treatment. Would you get to know about that? There are a couple of other options, I suppose. Would you get to hear about that?

Mr Byres : Not in the normal course of events. Sometimes people do make a complaint to the ombudsman, and they choose to copy that to APRA or to ASIC.

Senator LEYONHJELM: You don't have an automatic communication with them?

Mr Byres : No, and that's because, by and large, most customer-related matters are more in the domain of ASIC rather than APRA. We're dealing with safety; they're dealing with fairness, and most of those things will be an ASIC issue.

Senator LEYONHJELM: Understood. Thank you.

CHAIR: I have a couple of questions. I think they're more specifically to Mrs Rowell. I know we've covered a few of these issues in previous estimates, Mrs Rowell. I know APRA provided evidence on the record during a Senate Economics Legislation Committee inquiry into the government's member outcomes and accountability reforms, so I won't ask you to repeat your support of those here, but I wonder if you could give us an example of how APRA might use the enhanced powers provided in that reform package to improve the outcomes for super members and to protect their retirement savings.

Mrs Rowell : There were a number of different aspects of those proposed reforms, so I could give a few different examples. I think for us the key would be, firstly, a directions power, because a stronger directions power would give us the opportunity to intervene earlier and more appropriately than we do at the moment. There's been a lot of debate and discussion about poor outcomes, mergers not proceeding and those things. At the moment, the trigger for us being able to take action on those is a fundamental concern about the solvency and safety of the assets of the superannuation plan rather than poor outcomes for members. If we had a directions power, if there were higher My Super authorisation criteria with equal cancellation powers, we would be able to step in based on poor member outcomes rather than having to wait for that concern about the safety of the superannuation assets.

CHAIR: You've actually touched on a point I was going to get to a little later, which was that my office were vociferous in their support for the extension of the CGT extension for super fund mergers, but there seems to be so little activity in this space. Why do you think that is?

Mrs Rowell : It's a vexed issue. I think there are a number of entities out there who believe that they're providing value to their members, that they have a future and, to the degree that APRA or other stakeholders may raise concerns about their performance, that that can be addressed over time. And so there is often a lack of willingness in the industry even to contemplate the thought that they might merge and not continue in their own right. There are some other issues raised from time to time around the costs of mergers, the need to be able to demonstrate that it's in the best interests of members, tax and other issues, but fundamentally I think the biggest barrier is the boards being open to the idea of merging.

CHAIR: I'm jumping all over the place here, but another thing I know you and I have discussed is governance issues. You say the boards being open to the idea of merging is an issue. Do you think that the issue of governance we have discussed before, whether it be things like expertise, tenure, the boards having fifty-fifty composition or whatever it might be, is part of the problem with getting boards to be open to the idea of fund mergers?

Mrs Rowell : I think the composition, the skills and capability and the mindset of boards are issues that need to be addressed and are very difficult to address under the current legislative framework. We would strongly support some change to ensure that there are appropriate skills and the right people on boards.

CHAIR: You've just done a review on the deficiencies in super fund board governance, haven't you?

Mrs Rowell : Yes.

CHAIR: What was it you specifically highlighted in that review?

Mrs Rowell : Well, there are a number of aspects to that review. Across the spectrum of the funds that were covered by the review, it did raise concerns about how they source directors; their ability to get directors with the right skills and experience; the long tenure; and the lack of appropriate renewal on some boards. Regarding board assessment processes, objective, independent assessments are often not being done to determine whether the board is actually performing well and meeting its obligations as well as it could be. There were a number of issues that were in the letter that we released to industry just a couple of weeks ago.

CHAIR: In APRA's view, would the government's proposed reforms to superannuation fund governance—which predate the APRA report—help address some of these issues?

Mrs Rowell : Our longstanding view is that there is value in having independent directors on boards. I think it would help to address some of these issues by bringing a different perspective and different skill sets to the table.

CHAIR: I note that that was supported by the Productivity Commission's findings.

Mrs Rowell : Indeed.

CHAIR: You probably haven't had a chance to digest the whole of the Productivity Commission report?

Mrs Rowell : I've done my best.

CHAIR: Do you have some initial reflections for the committee?

Mrs Rowell : I think it's a very comprehensive report, as you have noted. It has a number of interesting recommendations. We see a lot of alignment in the observations of the Productivity Commission with some of the issues that we have been raising and talking about and focusing on in our supervision of the superannuation industry. So we welcome the report and we think a number of the recommendations certainly have significant merit.

CHAIR: Just finally, I know that there were a number of superannuation changes in the Protecting Your Super package that were announced in the budget. I don't need to go into each one of those individually, but I wonder if there are any that align with the work you are doing, whether it be the fee changes to low balances; exit fees; the insurance premium; removing compulsory insurance; or making insurance opt-in for under 25s? Or are there any that set off alarm bells for you?

Mrs Rowell : There's clearly an alignment in terms of trying to address issues that are not delivering good member outcomes with the work that we are trying to do with enhancing member outcomes. We have made observations to industry in the recent past about concerns with undue erosion of balances through insurance premiums. There is the issue of industry needing to do more to tackle multiple accounts. So I think that the issues being addressed by those proposals are real issues in the industry that need to be addressed, and the budget proposals would be helpful there.

CHAIR: Are the causes of multiple accounts, in your opinion, the current rules surrounding default super products?

Mrs Rowell : I think there are a number of causes of multiple accounts, in part due to the way people get offered superannuation products as they change employment, which go to the heart of why you end up with multiple accounts. There is also a degree of inertia from members in not taking the steps that can be taken to consolidate, and funds not doing more to try and encourage consolidation as well.

CHAIR: They have a vested interest in seeing a greater number of accounts, haven't they, because that's their source of fees?

Mrs Rowell : Any individual fund obviously benefits from retaining assets and members. Someone loses when you consolidate—one fund gains and one fund loses.

CHAIR: The member is the one who gains the most, aren't they?

Mrs Rowell : One of the points about the budget proposals, and also some of the recommendations in the Productivity Commission report, that we and the industry and the other stakeholders need to be mindful of is the transition and the implementation. All of those proposals would create a reasonable amount of change for the industry to absorb, and it's very important that it's done in a way that doesn't have unintended consequences or adverse outcomes for members.

CHAIR: Thank you, Ms Rowell, that's sage advice.

Senator WHISH-WILSON: In relation to the Productivity Commission's draft report Competition in the Australian financial system, there was one statement there that caught my interest:

The Australian Prudential Regulation Authority’s (APRA’s) actions to slow interest-only lending on residential property in early 2017 resulted in higher interest rates on both new and existing residential investment loans, despite the regulatory objective being to slow new lending.

This led to a windfall gain for the banking sector.

Then they went on to say:

Up to half of this gain is in effect being paid for by taxpayers, as interest on investment loans is tax deductible. The Commission estimates that the cost borne by taxpayers as a result of APRA's intervention was up to $500 million a year.

I supported that measure because I felt like it was important. How do you respond to the Productivity Commission's report and comments on APRA?

Mr Byres : We made a couple of comments. We made a submission on that, which is public. I have a couple of comments. First of all, on the general issue of impact on the taxpayer, I think, it's very difficult for regulators to be expected to take those sorts of things into account. We made this comment—and I think it's been supported by other submissions, including from Treasury—that it would not normally be the case that regulators would think about these sorts of things. In the same way as when the Reserve Bank moves interest rates up and down it doesn't work out what the impact is on the budget bottom line; it does what's right for the community. The budget will be the budget.

On the issue specifically of the increase in interest rates, you're right the observation is we did set out and, indeed, we deliberately designed the measure to impact the flow of new lending. Given our experience with the investor lending, we did deliberately set out to design the instrument a bit differently and to focus on new lending. The fact that the banks chose to apply it to more than just new lending is partly a product of the fact that there's more than one thing moving here. Not only did we put in place this benchmark around the flow of new lending but we also flagged to the industry, as part of our changes to capital requirements, that we would be raising capital requirements on higher risk types of lending and flagged that that would be likely to include interest only lending. We've subsequently put out proposals that would produce higher risk weights for interest only lending relative to principal and interest lending. Banks, in a sense, are anticipating some of those changes as well in the way they price their book.

Senator WHISH-WILSON: Do you think that reflects a lack of competition in the market? I will read to you the from the ACCC—I wanted to ask you this, because I did ask them this directly and they said to ask APRA next—Residential mortgage products price inquiry: Interim report. A couple of the preliminary findings were that, 'new residential mortgage borrowers often pay a lower interest rate—32 basis points on average—than existing borrowers'. The report says:

The pricing behaviour of each of the…banks appears more consistent with 'accommodating' a shared interest in avoiding the disruption of mutually beneficial pricing outcomes.

They said that's not anti-competitive behaviour; it's rational behaviour. Nevertheless, does it also signal lack of competition in the banking sector that these kinds of things are occurring?

Mr Byres : It signals a reluctance to compete on price. When you're the dominant player and you have an important profit stream, you're careful about how you manage that. It is part of the flip side of the concern we had, because in terms of what we were seeing we have always said that the housing lending market is competitive—people have disputed whether it is or it isn't. I think the ACCC would say it's not competitive in terms of pricing. Our concern was that it was competitive in terms of lending standards, and people were competing fiercely to grow market share, but they were doing to it by eroding lending standards rather than, perhaps, other ways of offering something better or cheaper to the customer. These are two sides of the same coin—the ACCC issue, reluctance to compete on price and our concern about competition that eroded lending standards.

Senator WHISH-WILSON: Both the Productivity Commission and the ACCC found that the banks, and major banks in particular, are subsidising cheaper loans to new customers by charging existing customers higher rates. Once again, that might have a competitive angle to it, but I'm interested in the macroprudential implications of this kind of front-book, back-book strategy. Shouldn't someone with a lower LVR get a better home loan rate? Isn't that the way it should work in a risk neutral setting? Do you think there are any macroprudential implications to these kinds of findings?

Mr Byres : I am not sure I think there are macro prudential issues; there may be fairness issues but I don't know they go to the safety and soundness of the system. It's beyond my mandate to comment on these sorts of things. In one sense it's perverse that long and loyal customers don't get the same deal as new customers. But lots of businesses will argue they compete with special deals for new customers, and the banks will say, 'Well, that's all that they're doing.'

Senator WHISH-WILSON: Fair enough. Mr Summerhayes, in relation to your answer to my question just before the break, around carbon risk or, more broadly, around frameworks, is there anything on the horizon we should be looking out for in terms of benchmarks or developments?

Mr Summerhayes : The transition to the low-carbon economy, as you point out, is underway so the transition risks aren't avoidable. It's important therefore that organisations, particularly APRA related organisations where we have an interest, assess, manage and disclose those risks. As I mentioned, the TCFD recommendations are relatively new and there are issues around taxonomy and how it's done. We have a couple of major Australian banks in that pilot and some insurers are about to start the insurance pilot. That said, people are voluntarily improving their disclosure through the range of pressures I mentioned earlier. APRA is about to commence, which I flagged in a speech last year, a survey of banks, insurers and superannuation funds to assess their maturity as it relates to assessing these risks, and we'll play back the insights from that to help develop an advance market practice on risk management of climate-related risks.

Senator WHISH-WILSON: Do you feel the leadership role you played and the speech you gave conceptualising what a framework would look like and why it's important have been an important catalyst in stirring the pot a bit and getting some activity?

Mr Summerhayes : There's been a range of positions put by a range of stakeholders, not just APRA, which I think has advanced the broader community's realisation of both the transition—physical and liability risks—and APRA's interest is in the entities we regulate. And certainly there has been considerable progress since those speeches were made last year but more needs to be done.

Senator WHISH-WILSON: I think I may have asked you this way back when we had our Senate inquiry into this but it probably wasn't that long ago. I believe you have stimulated a lot of interest and a level of public debate and I applaud you for that but I wonder if at any point, it will need to lead to some kind of perception there may be some kind of regulatory framework in the future; otherwise things won't happen—in terms of stick and carrot. Is it still way too early to talk about that?

Mr Summerhayes : I think so. I'm encouraged by the weight of money, and commercial implications are actually driving a lot of the change. Regulators have an obligation to highlight where we see risks and that's what we sought to do. There's a lot of smart money that can see where the transition to a low-carbon economy is going—that is, whether it be investors, ratings agencies, proxy firm, that's driving more disclosure and identification of the risks. APRA will continue to take an interest in this area.

Senator PATRICK: I'm not sure if you heard the questions I asked the ATO in relation to the disparity between the use of Qantas and Virgin by public officials on travel.

Mr Byres : I didn't.

Senator PATRICK: Okay, I will give you some context in that case. Minister Cormann has provided me in response to questions on notice details of the use of Qantas and Virgin. In a situation where we have a lowest practical fare booking code, there's a fairly significant difference. In government spending overall Qantas is $201 million in 2016-17, and for Virgin it was $61 million. So there is quite a big difference. If I divide the numbers through, although I know it's not perfect, in my experience Virgin are significantly cheaper in many instances. I've got it by department. I'm just having a look at your numbers. Your numbers come in at $429,000 to Qantas in 2016-17 and $122,000 to Virgin. I'm wondering if anyone can explain the difference. It's quite a reasonable disparity, noting the policy. Can you say whether there's some explanation you may be able to offer, or whether it's something you need to take it on notice?

Mr Byres : I don't have the figures in front of me. They sound reasonable in term of $500,000 or a bit more of domestic travel. I couldn't give you a detailed explanation. I'm happy to take that one on notice and come back to you.

Senator PATRICK: It might be helpful if you look at Finance's codes. There may be legitimate reasons.

Mr Byres : We'll look at those and come back to you.

Senator PATRICK: A number of agencies have responded by saying, 'Thank you, we'll have a long, hard look at what's going on.' There's only one agency that has Virgin flying more than Qantas. That seems a bit unusual. Secondly, in relation to the Chairman's Lounge and Virgin's The Club, I have no criticisms if anyone has accepted a membership, but in the circumstances where they have accepted that membership because of their official position, if they have only selected one—so they only have either the Chairman's Lounge or The Club—in that circumstance, for any officials in that position can I have a breakdown of their split between Virgin and Qantas?

Mr Byres : I am neither. But we'll take that on notice and come back to you.

Senator PATRICK: Thank you very much.

CHAIR: Thank you very much to the officers of APRA. We'll return with ASIC after the break.

Proceedings suspended from 18:17 to 19:00