In a recent speech APRA Deputy Chairman Ian Laughlin discussed APRA’s approach to risk management and governance of ADIs (Authorised Deposit-taking Institutions) and insurers.

He specifically discussed APRA’s formal system for rating the institutions which it regulates: PAIRS – Probability and Impact Rating System. This system helps APRA to identify risk priorities, and is also used for organisational planning and resource allocation.

The speech gives an overview of how APRA builds up the rating in the areas of risk governance and the board. APRA regards a board as ultimately responsible for the establishment and maintenance of an effective risk management framework.

The quality assessment of the board considers the following broad areas:

•Board charter and self-assessment.
•The quality, skills and experience of all directors.
•The board composition and independence.
•Fitness and propriety matters.
•Conflicts of interest.
•Dominance of individuals.
•Key person risk for the board.

APRA meets with boards of regulated institutions at least once a year. For the larger institutions APRA also has meetings with the chairs of the board and the main committees.

Mr Laughlin described the process:

“We meet with the board for a few different reasons. First, it is an opportunity for the board to hear first-hand APRA’s views on the particular business and what is important to us as prudential supervisor. At the same time, these meetings give APRA insights into the board’s thinking about the business – strategy, operations, people and so on.

It is also an opportunity to exchange views on the industry, which again is of benefit to both parties.

We form a view about the board itself based on experience at these meetings. This might be anything from a feeling of unease to quite strong positive or negative opinions based on objective criteria. These views are obviously important in a subjective sense in that they consciously or otherwise influence our attitude to the institution. Also, they feed into the formal assessment of the board under the PAIRS process …

We also don’t expect the board to have a detailed understanding of APRA’s prudential standards, but we do look for a working knowledge. ….

… it is fundamentally important for the board to set clear bounds and expectations for management about acceptable levels of risk. So we look to see if the board has a good understanding of the importance of the clear articulation of its risk appetite, and is able to talk sensibly and with purpose about it. We also look to see that the risk appetite statement is used in a meaningful way in the management and governance of the business. ….

It is always good to see directors that are highly engaged in their board work. This comes through with the way individual directors contribute to the discussion – the quality of their comments, the knowledge and understanding they demonstrate, their enthusiasm for the business and their role, their willingness to stand up for their position when challenged, and so on. More than anything, this is what influences my own view of the board. It is what most strongly contributes to the “gut feel” when I walk out of the meeting.”

Although Mr Laughlin cautioned against a structured preparation by the Board to these meetings, it is clear that Boards need to educate themselves about what will happen at these meetings and APRA’s expectations.