AFIAA CONFERENCE APRA PRESENTATION

1. AFIAA CONFERENCE APRA PRESENTATION Shayne Dargusch 27 May 2010

2. Introduction • The current economic environment • APRA’s focus – smaller ADIs • The regulatory environment • APS 310

3. The Current Environment IS THE FINANCIAL CRISIS OVER?

4. Economic Environment as at April 2010 • Equity and commodity markets have recovered remarkably • Can’t quite say the same for credit/funding markets – but they are improving • Still some jitters • US housing data • Central bank in China moving to slow growth • Sovereign issues with Greece • Questions marks over Portugal ....and Spain

5. Economic Environment as at May 2010 • All ords index has fallen from 4833 to a low of 4325 during May • Credit/funding markets remain under pressure as a result of global events – sovereign debt issues • Increased degree of uncertainty remains as to whether the global economy has successfully weathered the impact of the GFC • Not a time for complacency within the financial sector

6. How are CUBS coping? • By and large, CUBS are coping – but the very large majority have issues they are trying to address • We find CUBS at opposite ends of the spectrum • A very small number are doing it relatively comfortably – strong capital, resilient funding base, good margin, reasonable cost ratios etc • Conversely, a small number are really struggling – minimal capital, weak funding base, unprofitable, poor prospects for future etc • The majority fall somewhere in between

7. Critical areas for ADIs – 2008/2009 • Governance • Strategy • Capital • Funding • Warehouses • Impaired assets • Interest rate risk • Margins and profitability

8. Current areas of concern for CUBS • Strategy • Capital • Funding • Margins and profitability • Some observations on credit • Securitisation – implications of APS120

9. Strategy • Strategy remains a significant challenge for CUBS • Strategy is all about balance and execution • A number of CUBS are in a strategic void – with little light at the end of the tunnel • An ADI that does not have a sensible and cogent strategy, relative to the current market environment, then it is simply a matter of “when” rather than “if”

10. Capital • Industry remains strong from a capital perspective – based on average capital ratios • Ongoing and proactive capital management is the key • Stress testing is important – understanding the ability of an ADI to absorb losses is a key focus for APRA • Portfolio analysis a fundamental tool for stress testing

11. Funding/Liquidity • This is arguably the primary challenge for the industry • Enormous competition at the retail level • We are concerned at the funding profile of a number of CUBS – excessive potential for significant volatility due to reliance on large wholesale/semi-wholesale deposits or arrangements with investment advisory groups • Remember – funding/liquidity isn’t just about raising funds • Instances where risk management has not kept pace with increased funding risk profile

12. Margins & Profitability • In past 18 months, this has become one of the most critical areas • The days of relatively easy profitability are long gone • Margin pressure from competition for funding • Cost ratios too high, return on assets too low • While this is an issue for all CUBS, our observations are that the problems in this area are largely proportional to size

13. Credit • By and large, underwriting standards have been one of the areas of strength of the CUBS • Credit exposures that have hurt CUBS have generally been commercial exposures • APRA is concerned with individual exposures in excess of 10% of an ADIs capital base • Currently seeing a number of “unusual” exposures – loans to SMSFs, bridging products, complex commercial exposures? • APRA’s message is for ADIs to stick to what they know!!

14. Securitisation – APS120 Transition • We have seen an inadequate level of attention from CUBS in this area • Transition expires on 30 June • If an ADI did not apply for transition where it should have, then capital implications actually now apply • APRA is concerned we have not seen enough rigor in the self assessment process • We will be reviewing the self-assessments and capital treatment applied by ADIs • Leniency should not be expected by ADIs given the length of the transition period • Capital consequences can be very significant

15. Regulatory developments • APRA a member of Basel Committee from March 2009 • APRA a part of the international reform program • Capital and liquidity review underway following GFC • Significant resource commitment but APRA committed to objective of influencing global standards in such a way to ensure they do not unfairly hinder Australian ADIs

16. APS 310 – Background to changes • Basel 2 changes – standardised and advanced approaches • Revised reporting requirements • Advanced ADIs – greater use of modelling and statistical data to complete forms • “Reasonable assurance” for accounting records • “Limited assurance” for data collections not from accounting records • Financial data is the cornerstone of APRA’s offsite analysis • APRA reviews continue to reveal significant errors

17. APS 310 – APRA experience • Errors in returns continue to be identified • Capital, liquidity and provisioning returns stand out • Lack of a robust control process • Statistical data findings are not always documented in APRA review reports

18. APS 310 – APRA expectations • First wave of reports being submitted and reviewed in conjunction with the APRA Policy area • Requesting management letters in conjunction with required reporting • Liaison with audit firms is continuing • APRA welcomes an open relationship with an ADI’s auditors

19. Questions ?