Here's a devastating one-line critique of banking culture by Australia's top bank regulator

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Australia’s banks have been raising billions of dollars in capital recently. That’s because they need to shore up their balance sheets against the slings and arrows of the Australian banking regulator (APRA) who says that they can no longer use their own models to make up the risk quotient on their home loans.

Of course, it’s more than just a recalibration of the internal ratings-based models and the establishment of a minimum capital holding threshold that has taken the interest of APRA and other global regulators.

According to APRA chairman Wayne Byers, there are 4 core tenets that have driven the increased regulatory oversight and intervention that we have seen in banking here in Australia and around the world recently.

In a speech in Hong Kong last week Byers said:

We want to design a regulatory framework founded on a degree of reliance on:

  • internal models;
  • supervision;
  • market discipline; and
  • internal governance and culture

I’ll leave to you read and savour what is probably Byers’ best speech since he became APRA chair because I want to focus on one line I was reminded of when I read about the retail shortfall in Westpac’s $3.5 billion rights issue published earlier today by Chris Pash.

To recap, Chris wrote:

Westpac has closed its $3.5 billion capital raising by selling shares not taken up by retail investors at a premium.

In the shortfall sale, 22.7 million shares were sold at $29.50 each, well above the offer price of $25.50, raising almost $667 million.

A retail shortfall for one of Australia’s big four, a bank which has just demonstrated their adherence to shareholders, and a 15%+ return on equity, above all else with the 0.20% increase in home loan rates recently is curious. That some of those very same shareholders bank management was trying to favour opted out is a strong signal about where the banks stands with its shareholders – arguably what management sees as its core stakeholder.

Westpac Daily –

Now of course, there could be myriad reasons why the investors passed, not least of which was the chance at a quick capital gain by reselling their entitlement. Equally they might be spooked by the recent price action and big fall.

But, whatever the reason it’s probably only a short cognitive hop to see a correlation between this withering critique Wayne Byers delivered on bankers’ culture and why the decision by Westpac retail shareholders to pass on the capital raising might be a game changer for Australian banking.

It’s all about culture and how that impacts behaviours and in the end regulatory scrutiny, capital and profitability.

In his speech Byers said culture was the “final frontier” in banking regulation. He’s not a man who wants proscriptive black letter law. He probably realises that a Russian rocket scientist with a flash Phd and a good model can get around that anyway. Rather Byers wants a cultural change at the banks.

Byers said;

I recently met with the CEO of one of the larger [global banks], and we spent some time talking about the efforts underway in his institution to strengthen the bank’s culture. There was certainly a major program of activity underway but, to be frank, none of it was particularly innovative or unusual. That prompted me to ask two questions:

  • why was it not done before?
  • what is to stop it being forgotten again once the current program has been rolled out?

I have had similar discussions and asked similar questions of a range of banks I have met with, and I am yet to get a really convincing answer. But I think it boils done to the fact that ‘doing the right thing’ has not, at least until more recently, been seen as strategically important. And, coming back to the role of market discipline, managers were not being rewarded for putting long-standing principles ahead of short-term profit.

The challenge for the industry is therefore to show genuine leadership and commitment on this issue, and not put it in the too hard basket. I do not pretend this is an easy task, and fully acknowledge that standards of behaviour are far more difficult to define than standards of capital adequacy. However, it is critical to establishing confidence – amongst regulators, let alone the wider community – that the current focus on establishing a strong, ethical culture across the industry is not just a passing fad. That will be the case when, amongst other things, developing and maintaining the right culture is seen as a core part of the organisation’s strategy, and critical for its long-term success. If that occurs, then it is more likely reality will match expectations.

Did you get that? Banking culture has not been about doing the right thing. It was not strategically important.

Hats off to Wayne Byers, his cohort at central banks around the world, and Westpac shareholders for recognising that increased regulatory scrutiny might cost them, and the bank, money.

There seems little chance “doing the right thing” won’t be strategically important in the future. At least up to a point. We are talking about bankers here.

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