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CORE PRINCIPLES FOR EFFECTIVE
SELF-ASSESSMENT FOR AUSTRALIA
Australian Prudential Regulation Authority
This document outlines APRA’s self-assessment of its supervisory policies and practices against the Core Principles for Effective Banking Supervision, issued by the Basel Committee on Banking Supervision in October 1999 1.
Although supervisory practices and processes are always evolving and, we hope, improving over time, it is nonetheless invaluable to take stock now and then; to subject our supervisory arrangements to scrutiny against internationally accepted benchmarks, and to consider where improvements can be made. To be effective, any such assessment must be undertaken with a critical eye. It is too easy for supervisors to assert that existing arrangements represent best practice when closer analysis would reveal otherwise.This document has been prepared with that thought firmly in mind.
In preparing the assessment, it should be noted that APRA is responsible for supervising all authorised deposit-taking institutions (ADIs) in Australia (including banks, building societies and credit unions).
However, reflecting the objective of the Basel Committee, this document has as its focus the supervisory regime surrounding banks. In practice, the legislative framework and much of APRA’s supervisory processes are applied equally to all deposit-takers. Where this is not the case, the supervisory standards applying specifically to banks have been used as the basis for assessment (with references to the approach adopted for non-bank ADIs included as a footnote).
Comments and views on the self-assessment are welcome, and should be directed to:
Mr Brian Gray Executive General Manager Policy, Research and Consulting Australian Prudential Regulation Authority GPO Box 9836 SYDNEY NSW 2001 1 Details on the Core Principles can be found on the Bank for International Settlements website (www.bis.org) APRA APRIL 2000 1
CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION:
SELF-ASSESSMENT FOR AUSTRALIA1. INTRODUCTION The development of criteria against which supervisory systems can be assessed, both in absolute terms and relative to those in other countries, has long been a goal of prudential regulators. However, practical impediments to establishing appropriate benchmarks (for example, the difficulty in adequately quantifying the “quality” of supervisory arrangements, as well as inherent differences in supervisory systems throughout the world) have made for slow progress. Nevertheless by the late 1990s work on this topic, commissioned by the Basel Committee on Banking Supervision (BCBS), had begun to take form, and the Core Principles for Effective Banking Supervision were issued in September 1997.
The Principles were developed by the Committee (which comprises the central banks and bank supervisory agencies of the G10 countries) in co-operation with supervisors from non-G10 countries.2 The Principles were endorsed by the international financial community during annual meetings of the IMF and World Bank in Hong Kong in October 1997.
Soon after release, a first attempt was made to survey a large number of countries, with a view to assessing the degree of adherence with the new Principles. This was done in the lead-up to the October 1998 International Conference of Banking Supervisors (ICBS) in Sydney. Results of the survey were mixed however, and pointed to the need for further refinement of the Principles and greater rigour both in the detail and presentation of the Principles. Because of the subjective and high-level nature of the Principles at that stage, direct comparisons of results from country to country proved to be unreliable.
The Sydney ICBS, therefore, called for more work to be done aimed at producing a more precise and useable form of guidelines. The Committee responded, and a revised Core Principles Methodology was issued in October 1999.
1.1 The New Core Principles Methodology There are two elements to the Core Principles. The first is macroeconomic/macroprudential in character and requires a broad assessment of the so-called “Preconditions for Effective Banking Supervision”. Here the focus is on those structural or other features of the economy or financial system, against which the detailed day to day microeconomic work of the supervisor takes place. In the absence of these fundamental preconditions, any system of prudential supervision is unlikely to achieve the objectives of institutional and system-wide safety and stability for which it is designed.
The preconditions include:
• sound and sustainable macroeconomic policies;
• a well-developed public infrastructure;
• effective market discipline; and • mechanisms for providing an appropriate level of systemic protection.
The second aspect of the methodology is the 25 Core Principles. These represent the agreed set of highlevel Principles against which systems of prudential supervision can be measured and assessed. To aid the assessment, detailed criteria – deemed “essential” and “additional” criteria – have been established.
The essential criteria for any particular principle are defined as the elements that must be present in order to demonstrate compliance with the Principle in question. The additional criteria are requirements that, in conjunction with the essential criteria, act to strengthen supervisory systems and the prospect for financial stability.
2 The Core Principles Liaison Group was set up to assist in the development of the Principles. APRA is represented on that group which comprises selected G10 and non G10 countries.
1.2 Core Principles Assessments
In practice, Core Principles assessments may be conducted in a variety of contexts:
• self-assessments of local supervisory regimes by domestic bank supervisors;
• peer reviews conducted, for instance, within regional groupings of bank supervisors;
• reviews conducted by private third parties such as ratings agencies and consulting firms; and
• reviews in the context of IMF surveillance or World Bank lending programs, or via the joint IMFWorld Bank Financial Stability Assessment Program (FSAP).
Self-assessment is viewed as an informal but nonetheless valuable means of establishing the current stateof-play of bank supervisory systems, and identifying areas where improvements may be required to bring arrangements closer into line with international best practice. If an assessment is sufficiently rigorous, it will help identify deficiencies even if there is little evidence of those deficiencies having caused actual problems (ie. it is proactive rather than reactive).
1.3 Assessing Australia’s Compliance with the Core Principles Our starting point, therefore, was to look at the system of bank supervision in Australia from the position of an independent, informed, outside party. Our goal was an assessment sufficiently rigorous to stand up to any outside scrutiny. We then sought to assess the extent to which any apparent shortcomings should be addressed through changes in practice or policy (this resolves to a question of determining the relative costs and benefits of changing existing arrangements). In areas where we have identified a shortcoming against the Principles, we have also indicated the remedial action required to bring arrangements into compliance.
2. PRECONDITIONS FOR EFFECTIVE BANKING SUPERVISIONA sound system of banking supervision requires, as its foundations, a range of preconditions to be in place.
As noted above, these preconditions include sound and sustainable macroeconomic policies; a welldeveloped public infrastructure; effective market discipline; procedures for the efficient resolution of problems in banks; and mechanisms for providing an appropriate level of systemic protection. While these are largely beyond the control of the bank supervisor, they may nevertheless significantly affect the supervisor’s ability to implement the Core Principles. Hence, it is necessary to assess the extent to which these preconditions are satisfied before any assessment of compliance with the Core Principles takes place.
Our assessment is that the preconditions for effective banking supervision are satisfied fully in the case of Australia.
Australia is a modern, deregulated, open economy. The macroeconomic policy framework is generally perceived to be sound and sustainable, with monetary policy guided by an independent central bank with a clear policy objective focusing on maintenance of low inflation, and the absence of significant fiscal imbalances.
There exists a strong public infrastructure, including:
• effective supervision of markets by the Australian Securities and Investments Commission (ASIC) and of the payments system by the Reserve Bank of Australia (RBA);
• a sound legal system with strong enforcement of laws associated with contract enforcement, bankruptcy, collateral and loan recovery; and
• accounting standards which are broadly consistent with internationally accepted principles, and disclosure requirements that ensure markets remain well-informed.
As described in the detailed section on the Principles (see below) APRA has at its disposal a range of powers, equal to any system in the world, to assist with the prompt resolution of problems in a bank.
Furthermore, arrangements are in place to permit the RBA, on advice from APRA, to provide a lenderof-last-resort facility to a solvent bank that has encountered liquidity constraints, if there is potential for systemic problems to emerge. These specific arrangements are in addition to the general powers of the RBA to inject liquidity into the financial system in the event of financial disruption, whatever the cause.
To the extent possible, therefore, the financial system and the economy more generally are insulated from the side effects of problems in the banking sector.
It should be noted that Australia does not have any form of deposit insurance scheme to protect depositors in a failed institution. Though the absence of such a scheme is unusual by world standards, this must also be read against the background of the Australian system in which no depositor has, since the passing of the Banking Act in 1945, ever lost funds held in an authorised bank.
3. CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION – ASSESSMENTThe assessment of compliance with each of the 25 Principles, set out in detail below, is made largely on a qualitative basis. A five-part assessment system is used, outlining the extent to which Australia can be considered compliant, largely compliant, materially non-compliant, or non-compliant with each of the 25 Principles. The fifth category, “not applicable,” is for cases where a Priniciple is not relevant to the banking system in question.
To achieve a “compliant” assessment in relation to a Principle, all essential criteria generally must be met without any significant deficiencies. However, there may be instances where it can be demonstrated that the Principle has been achieved through different means. Where appropriate, such additional information should be taken into account in reaching an overall assessment. Conversely, satisfying the essential criteria might not always be sufficient to achieve the objective of the Principle, and therefore one or more additional criteria and/or other measures may also be deemed necessary by the assessor to judge that compliance is achieved.
A “largely compliant” assessment is given if only minor shortcomings are observed, and these are not viewed as sufficient to raise serious doubts about the authority’s ability to achieve the objective of that Principle. A “materially non-compliant” assessment is given when the shortcoming are sufficient to raise doubts about the authority’s ability to achieve compliance, but substantive progress towards compliance has been achieved. A “non-compliant” assessment is given when no substantive progress towards compliance has been achieved.
3.1 Results Details of our assessment are set out below with identification of the respective Principles, our assessment, background to the assessment and action required where some shortfall is identified. To summarise those
findings, we believe that the supervisory framework covering Australian banks can be considered:
• compliant with 11 Principles;
• largely compliant with 12 Principles; and
• materially non-compliant with the remaining 2 Principles.
For many of the key Principles, APRA regards Australia to be fully compliant. For example, there are clear responsibilities and objectives for each agency involved in the supervision of banks – primarily APRA, but other agencies as well – as required by Principle 1. The capital requirements imposed on Australian banks are consistent with those produced by the BCBS (Principle 6). APRA requires that banks establish and adhere to adequate policies and procedures for evaluating the quality of assets and the
adequacy of loan loss provisions and reserves (Principle 8), and APRA’s supervisory approach includes both on-site and off-site components (Principle 16).