Albert Einstein is reputed to have said that “the definition of insanity is doing the same thing over and over and expecting different results”.
An excellent example of Einstein’s observation is the ongoing state of financial regulation in Australia and the latest finding that APRA is just not capable of regulating the financial institutions that it is tasked with supervising.
Following the disastrous appearance of APRA chairman, Wayne Byres, at the Hayne royal commission, the government initiated a ‘capability review’ of the regulator by a high-powered independent panel.
To the surprise of no-one, the result of the review found that APRA was not capable of fulfilling its most basic mandate.
As a bit of background, ASIC, the conduct regulator, was subject to a similar capability review in 2016 which concluded that ASIC too was just not fit for purpose.
The recommendations of the APRA review were insane, consisting of statements that the prudential regulator is not currently up to the job, but then stating that they must start to do not only more of the same, but also quite different, work.
If APRA cannot do what they are tasked with today, what are the chances of doing more tomorrow with extra workload; merely shifting the deckchairs is not going to work.
For example, the report states that APRA “should retain its focus on maintaining financial safety and stability but focus more intensely on governance, culture and accountability (GCA) in the financial sector”. Then, in another breath the report states that “APRA’s capability to regulate and supervise GCA risks is at an early stage i.e. they really don’t know what they are doing”.
The report adds that “the Panel is concerned about some scepticism in APRA of the need to change and to allocate resources to areas that are not perceived to have large prudential risks” i.e. even after Hayne, APRA still doesn’t see the need to change.
The review goes on “GCA risks are core to prudential supervision and, for an ex-ante regulator like APRA, should already have more prominence in its work. Embedding new resources and developing a culture that supervises GCA risks as rigorously as traditional financial risks should be one of APRA’s priorities” i.e. APRA must refocus its efforts.
Similar suggestions are made in the area of technology – “APRA is seen by the industry as slow in providing guidance on new technologies and not sufficiently cognisant of commercial perspectives” i.e. APRA doesn’t really understand technology.
On superannuation, the panel found that APRA “has been slow to broaden its perspective on superannuation” and “needs to lift its effort … and shift its thinking and focus” i.e. needs to run rather than amble.
No simple solutions
The report summarizes the situation. “There are no simple solutions to raising APRA’s capabilities. It operates in a complex, uncertain and dynamic environment. It requires highly skilled staff with good judgment and courage. They need to be supported by strong leadership and technology. APRA also needs to use its independence, powers and authority to greater effect to shape its future.”
So, APRA has to change, despite not wanting to and not knowing what to do – this is a recipe for achieving precisely nothing. It’s insane, doing the same as before with zero chance of success.
The government’s response to the review’s recommendations was predictable: agree with the recommendations; possibly throw a bit of money at the problem; and promise more legislation to help regulators enforce the law.
But we have heard that before with ASIC and, as the Hayne Commission revealed, the regulators are still incapable of regulating the industry.
Maybe throwing money at the problem and twiddling with existing laws is just insane?
Maybe the underlying problem is not with the regulators but with the regulatory system itself?
It should be obvious to everyone, after Hayne, that the Australian financial regulatory system is broken; it does not work; it is set up to fail; it is a dead parrot!
Why? No one knows what they are doing or even what they are supposed to be doing.
Both APRA and ASIC have, over time, acquired a furball of responsibilities, many unrelated to regulation of financial entities. For example, ASIC as the corporate regulator, is pulled hither and thither by every large corporate bankruptcy/scandal; and APRA has responsibility for (part of) the superannuation system and bizarrely the private health insurance system.
As an example of failure to engage with real problems, in its core business of banking regulation, APRA was desperately forced to look elsewhere for corporate governance expertise when the Commonwealth Bank was sanctioned by the money laundering regulator, AUSTRAC. This was despite the fact that as head of banking regulation, Wayne Byres was supposed to be all over bank governance issues. Not for nothing was APRA dubbed the ‘do-nothing’ regulator at the royal commission.
An expensive mess
Australia follows a Twin Peaks model of financial regulation with APRA taking the role of ‘prudential’ regulator and ASIC that of ‘conduct’ regulator, supposedly concentrating specialist expertise in different regulators. But over time, responsibilities have become blurred, with the royal commission adding to the confusion by inventing something called ‘co-regulation’, which actually undermines the rationale for Twin Peaks. The capability review has also abandoned this approach, recommending that APRA be split not on functional but industry lines, creating a specialist superannuation division, but one held back by APRA’s dysfunctional organisation.
It’s a mess and, as the royal commission showed, a very expensive one.
A successful economy needs an efficient and fair financial system that is supported by an effective financial regulatory system.
Hayne showed that Australia does not have an efficient and fair system nor effective financial regulators.
The system is broken and what is needed is for someone to stand back and ask the most basic question – how should the financial system in Australia be regulated to cope with the enormous economic and technology changes facing the economy?
Regulation of the financial system is about enacting laws that ensure that the financial system is fair to consumers while being efficient and flexible – a very tough trade-off. And when laws are transgressed, there should, unlike today, be consequences for the firms and shareholders involved. Regulators need real teeth to enforce the laws.
The way to achieve this is to initiate a royal commission to investigate the financial regulation system, including whether the Twin Peaks model is working effectively.
It should be noted that the Hayne commission could well have done this important work, but were specifically precluded from doing so by their terms of reference – leaving the job half done.
On schedule, APRA showed why regulation needs to be reviewed. On the day that the report was published, Byres, held a bizarre press conference (refusing to answer questions) claiming that everything was working well and no change was needed.
Einstein was right – it’s insane.
Patrick McConnell was an honorary fellow at Macquarie University Applied Finance Centre and a former contributor to The Conversation