APRA has released the results of a review of remuneration practices at 12 regulated institutions across the ADI, insurance and superannuation sectors which found considerable room for improvement in the design and implementation of executive remuneration structures.
The review found that the policies and practices did not consistently and effectively promote sound risk management and long-term financial soundness as required by Prudential Standard CPS 510 Governance and Prudential Standard SPS 510 Governance.
The report identified the need for improvement in:
- ensuring practices were adopted that were appropriate to the institution’s size, complexity and risk profile;
- the extent to which risk outcomes were assessed, and weighted, within performance scorecards;
- enforcement of accountability mechanisms in response to poor risk outcomes; and
- evidence of the rationale for remuneration decisions.
In response to the findings, APRA will consider ways to strengthen its prudential framework. A future review of the relevant prudential standards and guidance will take account of the forthcoming Banking Executive Accountability Regime (BEAR), as well as international best practice.
APRA observed that remuneration frameworks and the outcomes they produce are important barometers and influencers of an organisation’s risk culture, providing insights into the extent that risk-taking is likely to be conducted within reasonable bounds.
In a separate speech APRA Chairman Wayne Byres observed that:
“A key lesson from the financial crisis was that prudential supervisors need to take a much greater interest in the attitudes towards risk-taking – the risk culture – within the institutions they oversee. What has become clear from this work is that a key driver of risk culture are the formal and informal incentives that individuals face within their organisations, and the accountability (or lack thereof) shown when outcomes are not what they should be…
When working effectively, incentive arrangements are a win-win: companies generate higher productivity, more sales or better quality output, and staff are financially rewarded for their efforts. But the equation is not risk free. Improperly designed incentives can encourage actions or attitudes that are contrary to the long-run interests of the company itself…
On the prudential front …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. 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. This obviously has the potential to create adverse outcomes for customers, but also in extremis for the areas of APRA’s interest: the safety of the depositors whose money is being lent out, and financial system stability more broadly.”
