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Finance sector has 'large carrots' and 'brittle sticks', encouraging risky behaviour: APRA

Photo: APRA chairman Wayne Byres says, unlike bankers, pilots have a strong, inherent incentive not to crash. (Reuters: Jason Reed) Photo: APRA chairman Wayne Byres says, unlike bankers, pilots have a strong, inherent incentive not to crash. (Reuters: Jason Reed)

The banking, insurance and superannuation regulator has reviewed how financial sector executives and staff are paid, and the results are not good. APRA surveyed 12 of the largest banks, insurers and super funds and found that they all ticked the boxes to comply with the regulator's rules about remuneration.

But its report also concluded that the institutions surveyed "often fell short of the sound practices set out in the relevant prudential guidance, and were therefore some way from better practice".

"The institutions we reviewed by and large had the required frameworks, policies and processes that could provide the basis for a sound system of remuneration," APRA's chairman Wayne Byres observed.

"But in many cases their practical application left something to be desired."

In a speech to the AFR's Banking and Wealth Summit in Sydney, Mr Byres told the regulator that there was "considerable room for improvement" in how their staff and executives were paid.

Key points:

• Wayne Byres: "Not only are rewards generous, but there are seemingly few repercussions for poor outcomes

• Risk management was given an average weighting of just 14 per cent in the total performance measure for bonuses

• APRA founds cases where people with "very poor" risk management scores still got more than 90 per cent of their bonuses

He pointed to numerous instances already uncovered by just two weeks of royal commission hearings that had exposed how commissions, bonuses, promotions and incentive payments had caused bank staff to act against the best interests of the customer, and even the long-term interests of the financial institution.

"APRA has been raising concerns for some time that the competitive drive for market share and profits in lending for housing has produced incentives to lower credit standards," he warned the bankers in the room.

"Coupled with some borrowers' own incentive to 'do whatever it takes' to get a loan, and the excessive comfort that comes from a period of rapidly rising house prices, there has been inadequate incentive hard-wired into the system to seriously scrutinise applicants' ability to repay the loans they take out."

Mr Byres contrasted the situation APRA faces with air safety watchdogs.

"I envy aviation regulators for one advantage they have over financial regulators: that the desire passengers of planes have for a safe flight is highly aligned with those flying the plane. Pilots have no incentive to take off in an unsound plane," he said.

If a plane crashes, killing all on board, the pilot dies too. But if a bank collapses, it is the shareholders, bondholders and depositors (and potentially taxpayers) who wear the cost, while the staff and executives whose risky behaviour caused the failure walk away, often retaining large bonuses they earned in the process.

In this context, APRA found remuneration frameworks and practices did not consistently and effectively promote sound risk management and long-term financial soundness.

'Few repercussions for poor outcomes'

The survey found that risk management was given an average weighting of 14 per cent in the total performance measure for bonuses, while at one institution it accounted for just 5 per cent of the score.

As a result of these typically low weightings, APRA found cases where people with "very poor" risk management scores still received more than 90 per cent of their short-term incentive payments.

The regulator found that in half the surveyed institutions, the short-term incentive metrics for chief risk officers (CRO) were the same as the wider executive team.

APRA argued that this is not consistent with the CRO's role to challenge the activities and decisions of the institution, putting long-term safety ahead of short-term profitability.

Mr Byres was also concerned that financial and other penalties for risky or unethical behaviour are low.

"If incentives are the carrot used by companies to boost staff performance, accountability mechanisms are the stick," he said.

"However, the perception in the community is that in the financial sector, particularly at senior executive level, the carrots are large and the sticks are brittle.

"Not only are rewards generous, but there are seemingly few repercussions for poor outcomes. It's in the industry's interests that this perception changes."

The Federal Government has made an attempt to address this perception, and reality, with the Banking Executive Accountability Regime (BEAR), which takes effect on July 1, 2018 for the major banks and July 1, 2019 for all other deposit-taking institutions.

BEAR requires the deferral of a proportion of variable remuneration for at least four years, and the reduction of incentive payments for senior executives who do not meet their accountability obligations.

'Less incentive to say no'

Mr Byres attacked investors who criticised some financial institutions for moving away from firm earnings targets to so-called 'soft' targets based on other measures, such as customer satisfaction and regulatory compliance.

"If variable remuneration is rewarded based primarily on 'how much', without sufficient regard to the 'how', it creates incentives for short-term risk taking, and a disregard for risk and control frameworks," he warned the audience.

"Financial organisations are adept at designing financial incentives for staff to say 'yes' to taking risk — after all, taking risk is how profits are generated.

"Far less incentive exists to say 'no', even when it is the right thing to do for the long-term interests of the company itself."

The Commonwealth Bank narrowly escaped a second strike against its remuneration report at last year's AGM, following a first strike in 2016 when the bank was criticised for setting executives "soft" targets to get their bonuses.

This article was first published by: http://www.abc.net.au
Author: business reporter Michael Janda
Last modified onWednesday, 04 April 2018 22:41

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