Working within the demands of one of the best-regulated markets 

Australia's banks plot a straight course through threatening winds

Australia’s Banking System
The regulatory framework applied to Australia’s financial institutions is based upon international standards from the Bank of International Settlement. It is managed by the Council of Financial Regulators comprising the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority (APRA), and the Australian Securities and Investments Commission (ASIC).

APRA is the prudential regulator for all banks, insurance companies and pension funds. It applies a risk-based approach to regulation that focuses on substance over form (i.e., less reliance on black letter law). APRA applies considerable resources to identify and counter the build-up of risk in the financial system as a whole (e.g., the Project Panama stress test of the banks' mortgage portfolios in late 2003 and early 2004), review and assess the risk management processes and controls within Australia’s financial institutions, and ensure that any actions taken in individual cases are consistent with the promotion of safe and efficient financial intermediation.

The regulatory framework has evolved over the last 25 years since deregulation and incorporates not only international developments such as Basel II, but more importantly, lessons learned from crises in the Australian market. Those include aggressive commercial property lending in the bank and building sectors in the early 1990’s, the failure of HIH Insurance in the late 1990’s and a rogue trader scandal in the early 2000’s.

APRA pursued an early adoption strategy of Basel II for the Australian financial system and was heavily engaged in discussions with the banking industry during its implementation. By requiring Australian banks to meet higher standards than those set out in the Basel II Capital Accord, APRA has persuaded Australian banks to conform to a more robust risk management culture. It reinforced this by applying a comprehensive approach to Pillar 2 (see explanation below), thus ensuring that Australia’s banks maintain adequate capital to support the risks they acquire, not just those addressed by Pillar 1. In addition, APRA adopted a conservative approach to subprime lending, including the introduction of a significantly higher capital charge for low-doc/no-doc loans and a requirement that broker-originators apply the same credit assessment standards as the credit provider. This approach encouraged Australian banks to limit their exposure to subprime loans.

Australia's banking system is dominated by four banks (the four majors): Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking Corporation. This market-dominant position is supported by the Australian Government’s four pillars policy, introduced in 1990, that prohibits takeovers between the four majors.

The four pillars policy has encouraged the four majors to focus on growth through prudent banking practices, sound risk management and tight expense management. This approach has enabled Australia’s banks to avoid the excesses of many banks in Europe and the US.

Surviving the Global Financial Crisis
There are three key reasons why Australia’s financial system has survived the global financial crisis when many other financial systems have struggled, and in some cases collapsed: coordinated actions by the federal government, central bank and financial regulators; sound management of Australia’s financial institutions; and proactive, hands-on engagement by the financial regulators.

The Treasury, Reserve Bank and APRA provided a coordinated and timely response to events. The Reserve Bank slashed interest rates and provided liquidity support to Australia’s financial institutions. The federal government provided both deposit and lending guarantees to Australia’s financial institutions and introduced an economic stimulus package, and APRA actively engaged with all regulated institutions in order to identify all previously unreported or unidentified risks in the financial system.

Strong corporate governance, conservative low-risk management, thorough and early adoption of the Basel II Capital Accord and prudent lending practices by Australia’s banks resulted in limited exposure to subprime and low-doc/no-doc loans - enabling Australia’s financial institutions to remain profitable and well capitalised throughout the global financial crisis.

SAS’ Relationship with Australia’s Banks
SAS Australia and New Zealand have been providing information technology solutions to Australian financial institutions for more than 26 years. Throughout this time, SAS solutions for business analytics, risk and compliance have helped financial institutions identify, measure and manage risk. Over the past few years, SAS has worked closely with its banking customers to help them comply with new regulations, including AML and Basel II.

SAS is the leading supplier of Basel II credit risk management solutions to the Australian banking industry. In addition, SAS is the only vendor that can deliver an open, end-to-end solution that includes data management capabilities (which are critical for meeting Pillar 1 and Pillar 2 requirements, including full data lineage) and support for additional Basel II requirements from APRA for both the standardised and internal ratings-based approach. In addition, Australia’s banks use SAS to support their credit decision process, enabling them to meet responsible lending obligations.

Supporting Our Customers to Achieve Basel II Compliance and Beyond
As one of the first Australian financial institutions to commence work on Basel II, the Bank of Western Australia (BankWest) required a solid basis on which to build a new regime of international banking rules compliance. Following a comprehensive evaluation of market offerings, BankWest partnered with SAS to implement SAS Credit Risk Management. In addition to enabling BankWest to determine minimal capital requirements for credit risk, the SAS solution provides the bank with excellent insights into their loans portfolio to identify initial signs of customer distress. This allows relationship managers to adopt a risk-adjusted profit approach to customer and performance management.

In addition, SAS is providing BankWest with the ability to plan better strategies that are used to counter many of the effects of marketplace changes. By creating a series of what-if scenarios within SAS, the bank can determine the likely impact on capital and risk profiles from fluctuations in interest rates, housing prices and unemployment rates. With the bank's data now regarded as "clean," the results of the stress tests are recognised as being accurate indicators of the impact arising from those marketplace changes.

Enabling Our Customers to Meet Responsible Lending Standards
Given the highly competitive nature of the banking industry, the ability to react quickly to market changes is an important feature of any bank. In retail lending, SAS provides Australia and New Zealand Banking Group (ANZ) with the ability to develop credit scoring models that support a fully automated assessment system. As a result, ANZ has the capability to better determine loan strategy, provide improved customer service and react quickly to rapidly fluctuating market conditions. The credit scoring system is regarded at all levels within ANZ as a critical component in the bank's customer protection mechanisms. The SAS credit scoring models help the bank meet responsible lending standards by identifying credit applicants who could be at risk of overextending.

Future Direction
The Australian banking system remains in relatively good health, but it faces a number of risks due to the sharp contraction in the global economy, which is dragging the Australian economy into recession. To deal with “black swan” events that may occur during 2009 and 2010, Australia’s financial institutions have recently completed capital-raising programs. In addition, like their peers in Europe and the US, they are reviewing and updating their risk management capabilities, and preparing to respond to the anticipated avalanche of regulatory changes. The four majors are also undertaking a program to replace their core banking systems and are looking to embed risk-based decision capabilities at the point of interaction with the customer.

To enable operationalized risk management within the business process, Australia’s financial institutions are increasingly requesting from SAS the capability to integrate and consolidate multiple risk forms to provide a single version of the [risk] truth across all types of risk and business units. This will allow Australia’s financial institutions to stay at the forefront of best practices, particularly when considering the latest cause-and-effect analysis of the global financial crisis and the anticipated regulatory response.

SAS Risk Management for Banking and SAS Risk Management for Insurance offer a full complement of risk management techniques and models in a fully integrated application suite, which applies a single engine and single data repository to assess a wide range of risk across the enterprise. These capabilities will allow financial institutions to focus on infusing risk insight into more business processes and to manage risk holistically across the enterprise.

Brendon Smyth is General Manager, Risk Intelligence, for SAS Australia and New Zealand. Brendon.smyth@sas.com