The Prudential Inquiry Case Study Report


The Australian Prudential Regulation Authority (APRA) on 28th August 2017 had announced establishing a prudential inquiry on CBA Group to inspect the company’s operations in relation to governance, culture and accountability. The report was prepared and submitted to the chair of APRA later, identifying weaknesses within the company’s practices and frameworks, especially in the dealings of non-financial risks. Numerous recommendations were made by the panel to reinforce these frameworks.

Issues identified in the prudential inquiry

The continuous financial success of the CBA Group led to the dulling of the senses of the institution management in relation to its operations. One of the incidents is the money laundering scandal in the mid-2015, where 3 men channeled $4. 5 million to Hong Kong through 11 different CBA accounts. This occurred due to the negligence of the CBA staff to perform a background check on the account holder. Reasons for the APRA inquiry was mainly due to insufficient measures taken by the management of the group with regards to the non-financial risks in the company’s operations. Some of the reasons for the inquiry are:

  • Wrongly selling of the margin loans to invest in other financial products advised by Storm Financials.
  • Misconduct of the financial advisors.
  • Charging fees for incomplete services provided.
  • CommInsure (CBA’s insurance subsidiary) using an outdated definition of heart attack.
  • Anti-money laundering breaches.
  • Mis-selling of credit cards.

As mentioned earlier, the inadequate measures taken by the management led to the loss of customers’ confidence in the FI. The panel was able to identify several key points about the company’s operations, they are mentioned below:

  • Management level overseeing the emerging non-financial risks.
  • Debatable accountabilities.
  • Issue escalation and the level of urgency shown for responding or clearing the matter within the company’s dedicated teams.
  • Inefficient operational risk management and Remuneration framework having “little sting” for the senior managers and higher.

Effect on financial institutions and customers

Financial Institutions form one of the most important parts of an economy, they operate in a sector that carries huge risks. The management is required to carefully act on their decisions weighing the risk to return. Also, management is compensated for the risks taken when they are materialised. The remuneration policies can materially affect the way management operates and in turn the company, leading to higher risk taking among the firms. The above-mentioned reasons leading to the inquiry are a result of such management. One of the examples of the above risk-taking actions in return for the remunerations is the breaching of responsible lending laws by ANZ Bank. According to one of the articles by ABC News on this issue, the bank was lagging in verifying the living expenses declared by the applicants as a result the bank is exposed to high risks where non-financial risks lead to financial risks and losses.

The banks play a major role in the country’s economy. Statistics show that an average increase in bank’s domestic balance sheet is 13 per cent annually since 1985. They are funded by depositors and hold most of the financial assets in financial markets, insurance, interbank businesses, etc. in addition to the traditional deposit activities. Since banks have numerous dealings with one another, it leads one bank’s activities to affect the other banks, bad decisions could lead to a domino effect. Hence, a bank’s exposure to any kind of risks impact other financial intermediaries and the customers (businesses and individuals) apart from themselves.

Importance of regulation

For the financial system stability to exist, ADIs need to function appropriately and morally. Post credit crunch, modifications were made to the Basel II and new regulatory frameworks called Basel III accord were released. Australian Prudential Regulation Authority (APRA) helps ADIs in maintaining their level of operating efficiency, competition, contestability and competitive neutrality by enforcing strong prudential frameworks with the sole intention of protecting the interest of their depositors and other stakeholders.

Regulation frameworks enforce higher level of governance in the ADI’s system. This results in better management that in turn resolves the culture and accountability problems. The regulatory body APRA also has come up with various recommendations for CBA Group to rectify the issues.

Post inquiry rectifications

After the prudential inquiry, CBA had come up with a remediation program called the Big Rocks in the early 2018 for the improvement of its risk management. Improvements on the Three Lines of Defence model are also included in the Big Rocks program. In the first half of 2017, principles describing the roles and responsibilities of each line in the Three Lines of Defence had been released as their first step towards issue rectification. Also, CBA has also embraced a wider financial and non-financial risk focus. Early this year, evidence demonstrating the feasibility of the program was also undertaken Wealth Advice and Financial Crimes department. As part of the process, the risk function in the Retail Banking Services was revamped, to explain the roles and responsibilities of Line 1 and 2. This resulted in significant reduction in the Line 2 staff. Similarly, the committee demanded the consistency in the roles and responsibilities of the operational and compliance risk functions. CBA Group had provided a deadline of 30th June 2018 for the re-alignment of the activities and resources. A similar process for the issue identification and escalation was released.

How successful were the rectifications?

A good progress on the plan would be deliverable in the next 12 months dating from 29th June 2018, said CBA Group CEO Matt Comyn. Accordingly, CBA has released APRA’s endorsement providing a reasonable basis for addressing the inquiry’s recommendations. CBA has taken a step further by appointing Promontory Financial Group as an independent reviewer for its remedial action plan. Regular checks against the progress that was promised will be made, also CBA will report public the progress of the remedial action plan. CBA has also decided that there must be collective and individual accountability for the executives regarding the poor outcomes of risks and customers. The remunerations have also been revised accordingly.

Improvements in the industry practices in future

APRA has recommended various, in particular, 35 recommendations to improve the company’s efficiency and competency. Some of them are mentioned below:

  • CBA must strengthen its operational and compliance risk management
  • The processes and practices be aligned with global better practices
  • The board must ensure strong coordination between its Audit, Risk and Remuneration Committees.

The board must also ensure that they receive enough non-financial risk information. CBA must strengthen its Risk in Change process to ensure that there is efficient risk-based supervision.

In general, financial institutions must always act in the interest of its depositors, which are the reason for the banks to function. FI’s must make it their mission to serve customers better in every possible way. The following points outline the ways banks can function effectively:

  • Educating the customers of the financial products
  • Updating themselves with the latest technology
  • Empowering employees at the same time having unbiased management leads
  • Acting as a genuine advisor and not just a lender or a sales person.
18 May 2020
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