Following the banking Royal Commission, APRA chair Wayne Byres believes there is still hope for self-regulation in the finance industry.
Is self-regulation dead? I certainly hope not. If self-regulation is failing, we need to revive it, not write it off. Good self-regulation — in the broadest sense of the term, capturing self-discipline and restraint — is essential to providing the community with a well-regulated, efficient and value-adding financial services sector. It is not optional.
The fact the question is being asked indicates self-regulation, while perhaps not dead, is certainly not in peak physical condition. The banking Royal Commission has solidified the community’s perception that financial institutions do not value their customers, but instead take advantage of them. That is, no doubt, unfair to the majority of those who work in the industry who want to compete with honour, pursue their ends with ethical restraint and speak out against wrongdoing, in line with the (Banking and Finance) Oath’s precepts.
Regulators must — as we do — accept some responsibility for these failures, and seek, as we are, to do better. Stronger and more active enforcement of the law, as advocated by the banking Royal Commission, is part of the solution and, supported by stronger powers, both APRA and ASIC are getting on with that. Nevertheless, our regulatory framework is rightly and firmly founded on the premise that boards and executives are ultimately responsible for the activities and performance of their companies. While after-the-event punishment will act as a general deterrent against illegal behaviour, more than just compliance with the law is needed to restore the financial sector’s reputation. Individuals, companies and industries must better regulate their own behaviour — to do not only what is legal, but also to have regard to what is right.
The optimal model of financial regulation — lowest cost/best outcomes — therefore requires self-regulation to play its part. Underpinned by society’s values and norms, there will always need to be a layer of formal regulation established by government in the public interest. But it can be much reduced and, at the same time, made much more effective when reinforced by three layers of robust self-regulation: at the industry, company and individual levels.
Filling the void
Recently, I was at Sydney Olympic Park at Homebush. It’s easy to forget it was once one of the most polluted and toxic areas of Sydney. To create the space that saw Sydney at its best in 2000 required one of Australia’s largest environmental remediation programs. Over many decades prior, chemicals, heavy metals and asbestos had been dumped around Homebush Bay, slowly but steadily poisoning the water and contaminating the soil. In the 1950s and ’60s when much of this pollution took place, few laws restricted factories and businesses from such harmful waste-disposal practices. Nor was there any incentive for self-regulation. At the time, it was seen as an acceptable way of dealing with waste. It delivered a classic example of the tragedy of the commons. The perception of fairness in the financial system has in many ways suffered from similar long-term neglect.
At the heart of these sorts of conundrums is the need to balance self-interest with collective interest and temper short-term views with a longer-term perspective. Sometimes, markets can provide that balance naturally, sometimes not. Governments intervene with laws or regulations on businesses due to an inability or unwillingness of market participants to self-regulate in a manner that aligns with the broader public interest. All four levels of regulation have failed to some degree in the financial sector. You can argue the extent to which failings in formal regulation and self-regulation are to blame, but one thing is certain — the consequence of weak self-regulation has been an increase in formal regulation. The Banking Executive Accountability Regime (BEAR), APRA’s more prescriptive remuneration prudential standard, and ASIC’s product intervention power are recent examples. Undoubtedly, this additional regulation comes at a cost, and industry complaints about regulatory burden are increasingly being heard again. Thus far, not much has been offered as an alternative means of generating better outcomes.
Yet even this increase in formal regulation does not disregard the critical importance of strengthened self-regulation as part of the solution. By giving industry codes of practice real teeth, and forcing firms to embed frameworks that adequately address accountability and misconduct, governments and regulators are seeking to empower the financial services sector to more effectively police itself — and creating the opportunity for more genuine self-regulation to play a role in helping to win back that lost trust.
APRA has also needed to intervene more forcefully in areas where self-regulation has not delivered for either the financial industry or the community more broadly. For example, we began consulting on a stronger prudential standard for remuneration in APRA-regulated firms. Our intervention with a much more prescriptive framework follows a growing body of evidence that poorly designed incentives and an absence of accountability have been promoting conduct and decision-making often contrary to the long-term interests of firms and their stakeholders. A better solution would have been for industry participants to take up the challenge and not wait for regulatory intervention. Unfortunately, despite the efforts of some, stronger regulation seems unavoidable.
The 2014 Financial System Inquiry noted that self-regulation tends to work best in setting governance, customer service and technical standards that supplement — note, not replace — the law. There are promising signs industry is taking more ownership of the issue in these sorts of areas. The financial damage inflicted by so-called non-financial risks has added a strong bottom-line incentive to restore reputations and regain trust.
The real evidence of change will be when industry participants are willing to stand against the tide or, even better, stand up and call each other out for behaviour that damages the industry’s reputation and long-term standing. We often hear executives complain they would like to curb a certain practice or stop selling a particular product, but would suffer first-mover disadvantage. This was a classic excuse in APRA’s intervention in mortgage lending — many industry participants were uncomfortable that competition was eroding sound lending standards, but no-one felt they could stand against the tide. The Royal Commission also highlighted multiple examples where companies, having identified a dubious but lucrative practice, chose to wait for others to act first. Wearing short-term commercial cost is inevitably difficult, even when it is the right thing to do. A stronger foundation of professionalism, more akin to that for lawyers, accountants and actuaries, would no doubt help.
Just as regulators can’t be expected to monitor in real time every move a company makes, nor can we expect boards and executives to be across every action or decision their employees take. The buck may stop with boards in a legal sense — and it’s essential they set the right tone, policies and incentives — but as individuals we’re faced with myriad decisions every day in which we’re able to exercise our discretion. The fact that misconduct or unethical behaviour may be possible, or even inadvertently incentivised, is not a licence to take advantage of it, nor even to turn a blind eye.
Finally, it cannot be that all responsibility for delivering better community outcomes falls on government and industry. There is a role for the community to better serve itself. Shop around, exercise choice. Don’t just get mad, get even. There’s no better way to align community and commercial interests than to make the community’s voice evident through action.
More formal regulation and enforcement cannot be the only answer to the issues of community concern. It must be accompanied by a healthy degree of self-regulation — industry codes of practice with genuine force, stronger frameworks of governance and accountability within companies, and a commitment by individuals to seek to operate with ethical restraint. Everyone needs to step up to the challenge.
Wayne Byres GAICD spoke at the Banking and Finance Oath conference in August. This is an edited version of his speech.
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