APRA’s actions might not cause Westpac too much pain and suffering
A significant question posed by the actions taken by the Australian Prudential Regulation Authority (APRA) against Westpac this week is just how effective and painful the sanctions it is threatening might be. They may not be as effective or as painful as it might have appeared at first glance.
Earlier this week, responding to AUSTRAC’s allegations of millions of breaches of anti-money laundering laws, APRA imposed a $500 million capital surcharge on Westpac and formally started an investigation into whether the group breached the Banking Act, including whether its directors or executives breached the new and intimidating Banking Executive Accountability Regime (BEAR).
The increase in Westpac’s capital requirements adds to the $500 million imposed on the bank in July for increased operational risk, following its risk governance self-assessment.
APRA raised the capital requirements for ANZ and National Australia Bank by the same amount for the same reason. It had earlier applied a $1 billion capital “add-on” to Commonwealth Bank after its landmark prudential inquiry into CBA.
What’s the impact of the latest operational risk capital surcharge on Westpac? It was presented as a form of penalty by APRA and received as something akin to a fine by some media.
In practice, it is probably going to have little, if any, impact on the bank, just as the capital add-ons for the other banks will have minimal impact.
All the major banks are carrying core capital – common equity tier one capital (CET1) – comfortably above the 10.5 per cent of risk-weighted assets that APRA regards as “unquestionably strong”.
In Westpac’s case, after its recent $2.7 billion capital raising, it has a CET1 capital ratio of 11.15 per cent. The $500 million is equivalent to about 15 or 16 basis points of that ratio.
The increased requirement for operational risk doesn’t remove that $500 million from the bank. It just means that Westpac can’t deploy it.
The $1 billion or so fine that Westpac is thought to be facing as a result of the AUSTRAC action over the money-laundering breaches is more meaningful. It would represent an actual reduction in capital and cash, lopping an actual 23 basis points off the CET1 ratio.
Even if the AUSTRAC-related fine were of that magnitude and APRA’s capital add-on was regarded as frozen capital, Westpac would still have a capital adequacy ratio of a fraction under 11 per cent – still comfortably above the 10.5 per cent minimum required to be regarded as unquestionably strong.
The point about APRA’s add-ons is not that the capital somehow disappears but that it can’t be used.
In the past, when the economy was growing strongly and there was double-digit growth in demand for credit, that might have hurt. It would have constrained the banks’ ability to lend and therefore had an impact on their potential profitability.
Today, with the economy limping along and demand for credit weak – whether because of the state of the economy or because the banks’ response to the royal commission and the Australian Securities and Investments Commission’s (ASIC) views on responsible lending, or a combination of the two and the credit crunch that combination appears to have created – Westpac and its peers don’t need the extra capital anyway. Their lending and balance sheets aren’t growing.
Given they are already holding the capital and generating very modest returns on it, it shouldn’t have any discernible effect on profitability.
The Banking Act threat has more teeth. APRA has always had the ability to declare bank directors or their most senior executives “not fit and proper” persons to be in responsible positions in a bank and its prudential standards provide further enforcement powers.
The BEAR regime, which created accountability and liability for, not just the institutions and their boards but for named individuals with specific responsibilities within the various areas of the bank’s operations, would appear to be more threatening and impactful than the capital surcharge.
With AUSTRAC claiming more than 23 million breaches, those responsible for Westpac’s financial crimes unit, its risk and compliance function and its senior executives and board could all potentially be targeted.
A small problem with BEAR’s application to Westpac, however, is that most of the breaches are alleged to have occurred between January 2011 and September 2018, with only a relative handful after that period.
BEAR was enacted in February last year but only came into force from July 1 last year. It isn’t retrospective.
That means for the bulk of the transactions AUTRAC’s statement of claim covers, there is a window of only about three months where they are exposed to BEAR. (APRA, incidentally, only published guidance on how it proposed to implement BEAR in October last year).
The majors are still finalising the designation of some of their “accountable persons” but even where the executives have been nominated, there is a very significant question as to whether someone designated as accountable under BEAR within the past 18 months could be held responsible for breaches that date back to 2011.
Some of, perhaps even most of, the executives who have had responsibility for financial crimes or risk and compliance are no longer with the bank. There have been a number of changes at board level over that period too. Can you hold executives, or directors, responsible for the failures of their predecessors?
APRA does have a lot of authority over banks. Its review of Westpac’s risk governance will inevitably uncover numerous failings – the breaches uncovered by AUSTRAC signal that very clearly – at a number of levels of the bank, as will the external inquiry Westpac has itself commissioned.
While BEAR might have limited application, APRA can, as CBA discovered, force powerful changes within an organisation because it is a prudential regulator with a lot of discretionary authority and enormous capacity to exert moral suasion.
It could force individuals from the bank board and the executive ranks even if BEAR can’t be used to impose financial penalties on individuals.
Given that Westpac’s CEO, chairman and another senior director have already gone or are going and that some of the key executives in risk and compliance and financial crimes are relatively new to their roles, that pre-supposes, of course, that they are still there.
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Source: Thanks smh.com