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Über dieses Buch

This Key Code and Handbook examines the corporate governance and accountability of Major Banks, their directors and executives which were the central focus of bank, Supervisor, Regulator and governmental activity and public scrutiny in 2018 and 2019. This book explores this responsibility focus by providing evidence from the Global Financial Crisis and beyond with both APRA and ASIC investigating illegal conduct, misconduct and conduct which was below the level of community expectations. This book discusses how the Royal Commission into misconduct in the banking and financial services industry has already given rise to a detailed Final Report whose recommendations are still being put into effect. Further, this book uses evidence provided by the large number of Prudential Standards issued by APRA and investigations into the conduct of Major Banks by Regulators.

This book explores governance variables – over 1,700 in number and grouped into 159 ‘key groupings’ or separate categories – which are all indexed to 28 governmental, regulatory and supervisory reports and documents to create a governance code and commentary specifically tailored to Australian banks. Each governance variable is modelled on the Stage 1 Relational Approach contained in Enhancing Firm Sustainability Through Governance. Given the huge interest in the governance of banks, Parts 1 and 2 – explaining the Relational Approach - of Stage 1 were recently published in November 2018 and June 2019 in the Australian Journal of Corporate Law.

This book is the largest reference book and handbook in publication worldwide containing the structures, mechanisms, processes and protocols – the checks and balances we call ‘governance variables’ – that deeply addresses and explains banking accountability and regulation in Australia.

Inhaltsverzeichnis

Frontmatter

Governance of Banks in the GFC and Beyond Key Field No 5 (Part 1): Introduction to the Relational Corporate Governance Model, Key Code and Advanced Handbook

Frontmatter

Chapter 1. Aims and Approach to Examining the Governance of Banks in the Global Financial Crisis and Beyond to the Australian Banking Royal Commission Inquiry into Banking Misconduct in Stage 2

The Stage 1 Relational Corporate Governance Approach Model explained how thirty-nine governance mechanisms, structures, processes and protocols called ‘governance variables’ affected ‘agency costs’ and the long-term efficiency and survival or sustainability of the firm. This survival/sustainability was measured by proxies for shareholder wealth or welfare including firm cost of capital, firm value/share price, firm operating performance/profit and the likelihood of earnings manipulation or ‘management’. The Stage 1 Model was not tied to any particular industry and applied to firms generally.The thirty-nine Stage 1 governance variables were extracted from the literature, case studies, governance codes and empirical studies comprising the four original ‘Key Fields’: (1) the application of the theoretical models of the firm to the relational approach; (2) Enron and Hastie corporate collapse literature; (3) international and national governance codes of the US, UK and Australia and (4) empirical/field studies actually undertaken by other commentators and researchers in examining the effectiveness or ability of the governance variables in reducing agency costs, enhancing firm value/share price and operating performance/profit and reducing the likelihood of earnings management/misstatement.This Stage 2 Key Code and Advanced Handbook 2 applies the Relational Model to the Global Financial Crises and the banking and financial services industry in a new Key Field – the ‘Governance of Banks in the GFC and Beyond’ Key Field No. 5. This fifth Key Field examines the behaviour and failures of governance variables relating to banks and financial firms in the GFC of 2008–9 and beyond to the recent Australian Banking Royal Commission Inquiry into banking misconduct. All the bank-specific governance variables – 1749 in number – are modelled or based on, or derived from, seven ‘Key’ or ‘Core’ governance variables from the original thirty-nine variables of Stage 1.This Stage 2 Key Code and Advanced Handbook indexes and examines major reports and pronouncements from the GFC and beyond to propose a uniform approach to governance and supervision for major banks in Australia. An important element is to bring together major reports and pronouncements in Australia to propose a uniform approach for banks, in particular in relation to governance, accountability, remuneration, board characteristics, committees, conduct and other non-financial risks, bank and risk culture and the governance and management of risk.In this Chap. 1, the Key Code and Advanced Handbook introduces the major reports and pronouncements from the GFC and beyond which are indexed and modelled throughout the Key Code. As part of this, the seven ‘Key’ or ‘Core’ governance variables from the original thirty-nine variables of Stage 1 are introduced. Also introduced are the ‘Key Groupings’ of the Stage 2 Bank-Specific Governance Variables for Australian Banks. These Key Groupings are the prefixes or abbreviations – spanning one-hundred and fifty-nine (159) categories – in which the Key Code is classified or divided to represent the functions of the bank at the basic activity level.

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Chapter 2. The Theoretical and Operational Parts of the Stage 1 Relational Approach and Model

In this Chap. 2 of this Stage 2 Key Code and Advanced Handbook the reader/user is introduced to the key components and tables of the Relational Corporate Governance Approach Model for Australian Banks. This comprises an introduction to how the components are combined to predict the relational proximity (relative effect) of ‘governance variables’ on the sustainability of the bank. Next, the reader/user is introduced to the ‘original’ four Key Fields which simulate the ‘real world’ sphere of corporate governance available to the reader in the First Stage of the Relational Corporate Governance Approach Model Project. They are (1) Principal Theories of the Firm; (2) Enron and Hastie Corporate Collapses; (3) Comparative Corporate Governance Codes and (4) Empirical Field Studies of the effectiveness of governance variables in reducing (or increasing) agency costs and enhancing (or reducing) the long-term efficiency and survival/sustainability of the firm/bank measured by firm/bank cost of capital, firm/bank operating performance/profit, firm/bank value/share price and the likelihood of earnings manipulation. Chapter 2 then moves to describe the principal components of the Model – ‘the three relational axes of good governance’, the governance variables and the eight ‘governance factors’.The theoretical ‘weighing mechanism’ of the relational approach and its results are comprised of four components – the three relational axes of good governance, the eight governance factors, the two interrelationship schemes and the relational effect path for each governance variable.The three relational axes of good governance are like a set of scales for weighing the objectives (Axis No. 1), behaviours (Axis No. 2) and positional conflict (Axis No. 3) of the insiders and outsiders (See Sect. 2.2 of this Chap. 2).The eight governance factors are the ‘backbone’ of the relational approach and so are critical to the theoretical components and the operational tables. The governance factors represent the most significant recurring and underpinning firm-specific or firm-level themes or aims of ‘good’ corporate governance represented by the four Stage 1 Key Fields (this Stage 2 adds the fifth Key Field) and thus the 39 original governance variables (Stage 2 has 1699 variables) to which the Fields give rise.The hypothesised or predicted interrelationships between the eight governance factors are set out in the interrelationship schemes. The number of, and manner and direction in which, these factors are affected, switched-on or influenced by the governance variables are depicted in relational effect paths. These paths determine the relative importance or strength – known as the ‘relational proximity rating’ or ‘rprox’ – of those variables in affecting the shareholder wealth measures.

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Chapter 3. Determining the Effects of Governance Variables in the Relational Approach

In this Chap. 3 of this Stage 2 the reader/user is introduced to determining the effects of ‘governance variables’ in the Relational Corporate Governance Approach Model for Australian Banks. The conceptual result of mixing or combining the components in Chap. 2 is that eight ‘governance factors’ are ‘weighed’ in the conceptual ‘scales’ of the ‘three relational axes of good governance’ to obtain or derive the hypothesised or predicted interrelationships between the original thirty-nine governance variables. This is achieved using an additional key component – a diagram called the ‘Shareholder-Primacy Interrelationship Scheme’. Thus, the Interrelationship Scheme gives the relational approach its name of relational corporate governance – each of the thirty-nine governance variables affect each other according to the hypothesised or predicted interrelationships set out in this diagram below. The Shareholder-Primacy Interrelationship Scheme is used to build an hypothesised or predicted ‘relational effect path’ for each governance variable. The Key Code sets out each hypothesised or predicted relational effect path of each governance variable identifying the governance factor affected and the direction of the effect culminating in two operational tables, the ‘Coverage Table’ and the ‘Relational Proximity Table’. The hypothesised or predicted relational proximity rating of each governance variable is akin to the ‘Richter scale’ for earthquakes. Relational proximity does not give the user a dollar value of the effect of the governance variables on each other and the firm’s/bank’s value/share price, operating performance/profit or likelihood of earnings manipulation. Instead, it gives the user a relative measure out of 100 of the importance/strength of the governance variable in affecting those measures.

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Chapter 4. Key Code and Advanced Handbook User Guide

In this Stage 2 Key Code and Advanced Handbook, Chap. 4 introduces a ‘User Guide’ comprising a plain-English guide to using the bank-specific Relational Corporate Governance Approach Model for Australian major banks. This includes how the user determines the relative importance/strength of a governance variable using the Bank Combined Coverage and Relational Proximity Table to determine the ‘coverage’ and ‘relational proximity rating’ of a bank-specific variable. This includes the description of the variable, source, abbreviation and ‘Key Grouping’, the Stage 1 ‘Key’ or ‘Core’ variable upon which the bank-specific governance variable is modelled and the ‘target’ or ‘hypothesised’ coverage/rating. We then describe a ‘mapping’ procedure in four (4) steps for the review of an Australian major bank’s governance, management, control and reporting structures, mechanisms, processes, protocols and lines of responsibility and accountability and bank and risk culture. We present some useful ‘rules of thumb’ to keep in mind relating to the use of the Stage 1 Key/Core variables and their target or hypothesised coverages/ratings in the construction or modelling of the bank-specific variables.

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Chapter 5. Quick-Reference Guide

Chapter 5 of this Stage 2 Key Code and Advanced Handbook comprises a ‘Quick-Reference Guide’ which defines or explains the main terms which recur regularly in the application of the bank-specific Model to Australian major banks. In particular, the reader/user is reminded of the meanings of the principal components, the principal tables and the ratings scale applicable to the governance variables known as ‘coverage’ and ‘relational proximity rating’ or ‘rprox’. In addition, the method for measuring the relative strength of a governance variable is summarised including the effects of positive (+) and negative (−) governance variables on the long-term efficiency and survival/sustainability of a major bank.

Francesco de Zwart

Governance of Banks in the GFC and Beyond Key Field No 5 (Part 2): The Challenge for Relational Governance Variables for Australian Banks

Frontmatter

Chapter 6. Key Questions and Core Failures in Bank Governance

In Chapter 6 of the Key Code and Advanced Handbook we postulate the key questions for the governance and supervision of major banks in the GFC and beyond to the Australian Banking Royal Commission Inquiry into banking misconduct. In the GFC, Sahlman found five related systems which had failed – incentives, control and information technology, accounting, human capital and culture. We then identify the ‘core’ areas of corporate governance failures from the GFC and beyond including the securitisation of mortgage-backed securities. There follows an overview of multiple governance failures in banks – incentives, corporate/bank and risk culture, technology, boards, risk identification, assessment, control/management and reporting, (again) securitised mortgage products, the system of bank regulation and shareholders. We then examine failures identified in commentator studies and governmental and market participant reports – primarily incentives, board structure/composition and processes and risk management. We find that these failures were exacerbated by complex and opaque bank structures, independence being emphasised at the expense of expertise and weaknesses leading to excessive risk-taking where risk management and compensation structures encouraged high risk. We identify excessive reliance on rating agencies and self-regulatory regulation, opaque corporate reporting, complexity, risk and valuation of new derivatives products.

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Chapter 7. Distinguishing Features of Banks for the Relational Approach

Chapter 7 of the Stage 2 Key Code and Advanced Handbook examines the distinguishing feature of banks in the relational approach. We open by examining the similarities and differences with the Enron collapse examined in detail in Stage 1. Then the distinguishing features of banks are examined in detail – the maturity of debt, liquidity, leverage and the interconnectedness of banks. There follows a review of deposit insurance, government bailout and risk-taking including Hopt’s risk-taking and free-riding and the recognition that depositors are stakeholders in banks. Systemic risk is then examined including the EC’s ‘domino effect’ and differing risk preferences for shareholders and depositors. Conflicts of Interest are identified and the perceived weaknesses in governance codes.The chapter concludes with the recognition that specific governance variables for the distinguishing features of banks and specialised bank regulation are needed to introduce the [BankPrudReg] (+) variable for banks – the regulatory, prudential and supervisory regime. Also proposed are bank-specific governance variables for deposit insurance, bailout and the effects of risk-taking, maturity transformation, liquidity and risk management.

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Chapter 8. Maximising the ‘Default Standard’ of Shareholder Value

Chapter 8 of the Stage 2 Key Code and Advanced Handbook for Australian major banks examines the merits of maximising the ‘default standard’ of shareholder value. It asks “should the shareholder wealth-maximisation principle apply to banks and financial firms?” The discussion identifies that the market for corporate control may be weaker for banks than non-banks. We review the shareholder wealth maximisation principle and the short-term share price touching upon agency theory, shareholder primacy and the shareholder-wealth maximization principle. We ask whether the shareholder wealth-maximization principle exacerbated the severity of the financial crisis? We identify that, in the GFC, conservative risk strategies led to better survival outcomes in the crisis and we highlight the short-term danger of the emphasis on quarterly results.

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Chapter 9. Overview of Stage 2 Bank-Specific Key Code and Advanced Handbook for Australian Banks

Chapter 9 of the Key Code and Advanced Handbook for Australian major banks contains an overview of the relational corporate governance approach and Model in Stage 2. Parts 1 and 2 contain an introduction to the bank-specific Stage 2 Key Code and Advanced Handbook chapters. Part 3 identifies the 1749 Stage 2 bank-specific relational corporate governance variables themselves and the 159 Key Groupings in which the variables are indexed and categorised for a ‘deep dive’ review of the governance and supervision of Australian major banks at the activity or function level. Part 4 discusses issues in executive compensation and accountability – incentives, equity and option compensation and the BEAR. In Part 5, we examine boards and committees, independence, expertise and bank and risk culture. Part 6 concludes the Stage 2 Key Code and Advanced Handbook with the governance and management of bank risk, risk appetite and risk culture.

Francesco de Zwart

Governance of Banks in the GFC and Beyond Key Field No 5 (Part 3): Bank-Specific Coverage and Relational Proximity Rating Results for Australian Banks

Frontmatter

Chapter 10. Existing Stage 1 and New Stage 2 Bank-Specific Relational Corporate Governance Variables for Australian Banks

Table 10.1 of Chap. 10 sets out the ‘Key Groupings’. These are the key Groupings, prefixes or abbreviations of the Stage 1 and new Stage 2 bank-specific governance variables – at the activity or function level – spanning 159 categories for a ‘deep dive’ review of each activity or function. These Groupings were introduced in Chap. 1 .Table 10.2 of Chap. 10 is the ‘Bank Combined Coverage and Relational Proximity Table’. This Table contains the Key Grouping, prefix or abbreviation assigned to the governance variable in an Accountability Statement or Accountability Map required by the BEAR. As noted in Sect. 1.1 of Chap. 1 above, the description of each governance variable introduced in Table 10.2 gives the actual description of the enquiry step required at the ‘nuts and bolts’ bank level.Section references to this Stage 2 Key Code and Advanced Handbook for the analysis of commentators, government, Regulators/Supervisors, major bank and market participant reports and the relational effect path for each existing Stage 1 and new Stage 2 bank-specific governance variable are set out in the right-hand column of Table 10.2. Each governance variable in this Stage 2 has its origin identified from reports, papers and findings in Sect. 1.2 of Chap. 1 .As noted in Sect. 1.1 , Stage 2 is also a Key Code because all its Stage 2 bank-specific governance variables – 1749 in number – are modelled or based on, or derived from, a handful of ‘Key’ or ‘Core’ governance variables from the original thirty-nine variables of Stage 1. Thus Table 10.2 also contains a new feature – a reference to the Stage 1 Key or Core governance variable after which the Stage 2 governance variable is modelled or based.Foreshadowing the ‘relational proximity ratings’ for this Stage 2, the target or hypothesised coverage/rating of each Stage 1 and Stage 2 bank-specific governance variable is set out in the column headed ‘Target/Hypothesised Coverage/Relational Proximity Rating rprox’ of Table 10.2.

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Governance of Banks in the GFC and Beyond Key Field No. 5 (Part 4): Issues in Executive Compensation and Accountability – Incentives, Bonuses, Equity and Option Compensation and the BEAR

Frontmatter

Chapter 11. Approach and Structure of Part 4 Has a Risk-Taking Focus

Chapter 11 introduces Part 4 of the Key Code and Advanced Handbook relating to issues in executive compensation and accountability including incentives, bonuses, equity and option compensation and the BEAR. We begin with an introduction to variable performance-based pay and risk-taking including remuneration committee considerations and a discussion of shareholder value-maximisation, bank risk-taking and bank failures. Section 11.1 contains an introduction to incentives, option-based and equity-based pay and risk-taking by banks including, ‘core’ components of remuneration, aims for examining studies on variable compensation and bank risk-taking, economic justification for equity compensation – ‘buyout’ not ‘reward’ – and the ‘wall street bonus system’ which may be countered by equity compensation. The chapter then reviews compensation governance variables from Stage 1 followed by an examination of variable performance-based pay and deposit insurance which increase moral hazard and risk-taking. We find variable option compensation in combination with limited liability increases risk-taking as does variable pay combined with short-term profit results and reporting.There is then a summary of studies and new governance variables for variable performance-based compensation and bank risk-taking including variable compensation, deposit insurance and government bailout. There follows a new governance variable for compensation in combination with limited liability which increases risk-taking as does the new governance variable for pay in combination with short-term profit results and reporting. In these new bank-specific governance variables for compensation, we find that risk-taking in excess of risk appetite increases the likelihood of bank failure.

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Chapter 12. Government and Market Reform Report Recommendations for Compensation or Remiuneration

Chapter 12 of the Key Code and Advanced Handbook examines government and market reform report recommendations for compensation or remuneration beginning with the recommendations of the Walker Review 2009 including the Compensation/Remuneration Committee and remuneration policy, executives and ‘high end’ employees, an overview of the Walker Review 2009 recommendations and ‘say-on-pay’ shareholder votes. We then examine the OECD Key Findings of 2009, the absence of pay for performance and Moody’s challenges for executive compensation as a forerunner to reviewing the existing compensation variables from Stage 1. These include a summary of the studies and relational effect paths for the [DirCEO$] (+/−), [EqOptIncent] (+), [EqOptEntrch] (−) and [CompCom] (+/−) variables.There follows an examination of the Compensation/Remuneration Committee and high end employees to identify the risk ‘alignment’ effect and risk ‘failure’ effect of equity and options as well as the Compensation/Remuneration Committee variables for risk alignment with shareholders and risk-taking in excess of risk appetite. Here, there is emphasis on the significant [EqOptRiskAlignHighEnd] (+) and [EqOptRiskFailHighEnd] (−) variables.Section 12.6 adds new governance variables for Compensation/Remuneration Committee composition, functions and policies in the ASX Principles and Recommendations, APRA’s Revised Draft CPS 511, the Walker Review 2009, APRA Final Report and the NAB Self-Assessment 2018. There follows the NAB Self-Assessment 2018 responsibilities for the Compensation/Remuneration Committee and governance variables for Compensation/Remuneration Committee functions and policies in the OECD Key Findings 2009 and the OECD 2010 Conclusions and Practices.We examine the IIF Risk-based incentive principles, long-term profitability adjusted for cost of capital, risk-taking and risk appetite, adjustments for the ‘risk time horizon’, adjustments for organization as a whole and firm-wide profit, severance pay and transparency and disclosure. Section 12.16 reviews the IIF examples of risk-adjusted compensation and incentives and Sect. 12.17 reviews the disclosure of bands and elements of compensation for executives and high end employees and anonymous disclosure of pay ‘bands’ for ‘high end’ employees.The Chapter then moves to examine relevant restrictions, delay, lock-up, deferral and clawback of incentive payments with the associated relational effect paths. Relevant principles include that remuneration should not promote excessive risks and principles relating to ‘material risk takers’, deferral, ‘malus/forfeiture’ provisions and ‘clawback’ including the APRA Final Report findings for risk adjustments and variable remuneration. There follows variables for failure to adjust pay bonuses for risks incurred for low level employees, required minimum shareholdings of executive board members, executives and high end employees including vesting arrangements and ‘skin in the game’ shareholdings and ‘retention’ vesting arrangements.We then examine formal codes of conduct for remuneration consultants including use of the code by the Compensation/Remuneration Committee to engage advisers. We conclude with significant variables for incentive payments and bonuses to be calculated by economic profit and not revenue, remuneration design adjustments for the firm’s risk appetite, cost of capital and liquidity risk, adjusting pay benchmarks for risk and remuneration consequences for breaches of company risk appetite limits, internal procedures and legal requirements.

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Chapter 13. FSB Principles for Sound Compensation Practices (FSBP) and FSB Implementation Standards (FSBIS)

Chapter 13 examines the FSB Principles for Sound Compensation Practices (FSBP) and the FSB Implementation Standards (FSBIS).For the FSBP, FSB principles and standards 1–3 are for effective governance of compensation, FSB principles and standards 4–7 are for effective alignment of compensation with prudent risk-taking and FSB principles and standards 8–9 cover effective oversight and engagement by stakeholders.Moving then to the FSBIS, FSBIS 1 and 2 relate to the Compensation/Remuneration Committee structure and governance while FSBIS 3 covers compensation and capital. FSBIS 4–14 set out governance variables for pay structure and risk alignment. The chapter concludes with FSBIS 15 which governs disclosure.

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Chapter 14. NAB Self-Assessment 2018 Recommendations and Commentary on Remuneration

Chapter 14 of the Stage 2 Key Code and Advanced Handbook for Australian major banks examines the NAB Self-Assessment 2018’s recommendations and commentary on remuneration. This begins with the NAB remuneration framework recommendations for fixed and variable remuneration and the NAB remuneration framework recommendations for consequence management. There follows the NAB board oversight of remuneration practices and the NAB remuneration governance model. The chapter continues by examining NAB’s assessment of risk and conduct within the remuneration framework and concludes with NAB’s application of remuneration consequences.

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Chapter 15. Westpac Review Team 2018 Recommendations and Commentary on Remuneration

Chapter 15 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines the Westpac Review Team 2018 recommendations and commentary on remuneration. This commences with Westpac’s remuneration approach for fixed and variable remuneration. Next, we examine Westpac’s risk gates for short term variable reward, Westpac’s risk adjustments for short term variable reward and Westpac’s navigation and consistency of frameworks and policies.There follows discussion of Westpac’s use of malus provisions, Westpac’s deferral of variable reward and its implementation of the Sedgwick recommendations. The discussion turns to Westpac’s non-remuneration components of consequence management and, to conclude, Westpac’s factors that inform accountability outcomes - accountability frameworks and policies, diffusion of accountability and the BEAR.

Francesco de Zwart

Chapter 16. Shareholder Value Maximisation in Banks and Financial Firms

Chapter 16 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines shareholder value maximisation in banks and financial firms.We begin by examining how traditional governance variables maximise the share price through incentives, governance variables and shareholder wealth-maximisation. We see that incentives tied to the short-term share price for executives and high end employees can lead to risk-taking in excess of risk appetite and increase the likelihood of bank failure. We see that cashing-out equity and options in the GFC reduced executive losses on bank holdings. But, limits on the short-term cashing-out of equity and options by executives and high end employees may help to achieve a level of risk-taking in alignment with shareholders.We then examine shareholder value-maximisation and ownership structure in the case of incentive equity holdings/plans of directors and officers. We find that shareholdings of lower-level management predict bank failure and that owner-control predicts bank failure due to increased risk-taking.The chapter then turns to examine the risk preference of bank management and shareholders which may diverge. Substantial equity ownership is not aligned where holding positions are short-term while long-term stock holding and capping the ratio of variable to fixed compensation may enhance the level of risk-taking in alignment with shareholders. “Inside debt” compensation reduces risk-taking.

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Chapter 17. Additional Compensation/Remuneration Committee Considerations

In Chap. 17 we examine additional Compensation/Remuneration Committee considerations and governance variables. This begins with the Chairperson’s pay and non-executive director pay differentials. We then review ‘enhanced disclosure’ of pay which is not linked to performance and exceptional commencement, termination and pension arrangements – ‘golden hellos’ and ‘golden parachutes.’ We conclude by identifying the disclosure obligation for ‘enhanced benefits’ and their compensation component. Enhanced payouts on termination for executives and high end employees can lead to risk-taking in excess of risk appetite and thus increase the likelihood of bank failure as do enhanced payouts on commencement.

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Chapter 18. Compensation Practices for Misconduct Risk

Chapter 18 examines compensation practices for misconduct risk. There is detailed examination of the Supplementary Guidance to the FSB Principles and Standards on Sound Compensation Practices, the Use of Compensation Tools to Address Misconduct Risk (‘FSBSupp’).FSBSupp 1–4 examine the governance of compensation and misconduct risk. FSBSupp 5–7 provide for the effective alignment of compensation with misconduct risk. In the latter case, compensation is to be adjusted for all risks, measures and tools are provided for adjusting variable compensation for long-term misconduct and compensation policies and procedures are employed to control misconduct.

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Chapter 19. FSRC Final Report Commentary and Recommendations in Relation to Remuneration

Chapter 19 examines the FSRC Final Report commentary and recommendations in relation to remuneration. This begins with the FSRC recommendations and commentary on executive remuneration including, experimentation in the design of remuneration, the proportion of fixed and variable remuneration, the design of variable remuneration and the availability of clawback.There follows the FSRC recommendations and commentary on issues of implementation including, risk-related adjustments to remuneration and the disclosure of consequences. The chapter concludes with ‘front-line’ or ‘customer-facing’ staff remuneration including the Sedgwick Review on governance, culture, remuneration and performance management.

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Chapter 20. The BEAR – Bank Executive Accountability Regime – And APRA’S Non-Financial Risk Accountabilities

Chapter 20 examines the BEAR – Bank Executive Accountability Regime – and APRA’s non-financial risk accountabilities.This begins by reviewing the meanings of the terms ADI and the obligations of accountable persons. We then examine BEAR accountability obligations of an ADI and an accountable person including governance variables for accountability obligations and ‘reasonable steps’. The key personnel obligations of an ADI are reviewed and the corresponding governance variables provided for. We move then to the deferred remuneration obligations of an ADI and governance variables including those for the meaning of variable remuneration, the minimum amount of variable remuneration and the minimum period of deferral. Section 37F governs the notification obligations of an ADI and governance variables for an ‘Accountability Statement’ and an ‘Accountability Map’. The pecuniary penalty for non-compliance with the BEAR is provided for by section 37FC including the meaning of the terms ‘prudential matters’ and ‘resolution’. There follows registration of accountable persons and disqualification of accountable persons.The chapter concludes with APRA’s improvements for non-financial risk accountabilities not being clear, cascaded and enforced (NFRAccFail).

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Chapter 21. APRA Revised Draft Prudential Standard CPS 511 Remuneration

To conclude this Part 4 on remuneration, Chap. 21 examines the APRA revised draft Prudential Standard CPS 511 Remuneration of November 2020.The examination begins with the APRA remuneration framework including the role of the Board in the oversight of the remuneration framework and review of the same. We then examine variable remuneration design, variable remuneration outcomes, variable remuneration of specified roles, deferral and clawback.The chapter concludes with APRA remuneration policy and other requirements of CPS 511.

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Governance of Banks in the GFC and Beyond Key Field No. 5 (Part 5): Boards and Committees, Independence, Expertise and Bank and Risk Culture

Frontmatter

Chapter 22. Governance of Banks in the GFC and Beyond Key Field No. 5 (Part 5): Boards and Committees, Independence, Expertise and Bank and Risk Culture

Part 5 of the Key Code and Advanced Handbook begins with this Chap. 22 and explains the approach to boards, committees, independence, expertise and bank and risk culture from the GFC to the Australian Banking Royal Commission Inquiry into banking misconduct.This begins with a summary of the responsibilities of the Board, the ASX board charter for listed entities and ASX appointment of directors. We then move to APRA-regulated institutions, the Head of a group, the use of group policies and functions to be approved and the ‘duty of care’, ‘duty of loyalty’ and oversight of management specifically for risk.Chapter 22 concludes with a review of the [BrdIndMon] (+) variable from Stage 1 – Board Independent: Executive Director Proportion – Monitoring Effect.

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Chapter 23. Board Characteristics for Australian Major Banks

Chapter 23 examines the board characteristics for Australian major banks including board and senior management requirements. This begins with an overview of the governance failings of boards of directors including board of director, executive and management turnover, governance variable failings, the ‘challenge’ step in major risk and strategic issues, the board’s role in risk management and board diversity.For board size, composition and qualification, we look to Turnbull and Pirson and the Walker Review 2009 recommendations including a governance variable for board size and information and task ‘overload’ – the [BankBrdInfoTask] (+/−) variable.We then consider governance variables for non-executive director (NED) induction, training, development programs, ‘dedicated support’ and financial industry awareness and conclude with the time commitment of NEDs.

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Chapter 24. Functioning of the Board and Monitoring and Evaluation of Performance

Chapter 24 of this Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines the functioning of the board and the monitoring and evaluation of its performance. We begin with recommendations and observations by the Walker Review 2009 and APRA.We then construct the [BankNEDTestStrat] (+) variable for challenging and testing strategy by non-executive directors and the [BankNEDTestRisk] (+) variable for challenging and testing risk by NEDs.We continue by listing the sections of the Key Code and Advanced Handbook which consider the time, qualifications, role and annual election of the chairperson and the role of the ‘senior independent director’, the performance evaluation of the board and the evaluation statement of the skills and experience of the board.Chapter 24 concludes with the APRA Final Report failings in board effectiveness, risk management, internal monitoring and decision-making and the APRA Final Report failings in reporting to the board.

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Chapter 25. Diversity

Chapter 25 of this Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks outlines the Stage 2 approach to diversity. It begins with considerations relating to diversity by the EC Green Paper 2010 and the EC Second Green Paper 2011.This continues with the construction of ‘interim’ variables for board diversity. This includes general non-executive director variables for diversity and then gender diversity for non-executive directors.We conclude by examining the ASX diversity policy.

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Chapter 26. Skills, Independence, Competence and ‘Fit and Proper Person’ Tests

In Chapter 26 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks, we examine skills, independence, competence and the ‘fit and proper person’ tests. This begins with the requirements for ASX listed entities including the independence test and the ASX listed entities disclosure and factors of independence.We present the existing governance variables based on the independence ingredient and find that independence may be associated with less bank-specific knowledge. We apply this to bank-specific variables exhibiting a deficiency in banking industry knowledge and competence with a coverage/rating of −4/50.00 rprox. We also find that ‘pro-shareholder boards’ performed worse during the crisis.We turn then to the OECD findings on independence and competence and construct a governance variable based on the OECD recommendations for independence and bank-specific skills, competence and professional qualities with a coverage/rating of +7/87.50 rprox – the [NEDBankSkillsMon] (+) variable. We continue with governance variables based on the OECD recommendations on separation of the CEO and Chairperson roles and governance variables based on the OECD recommendations on the ‘fit and proper person’ test by supervisory authorities.Governance variables are constructed for APRA’s Prudential Standard 520 Fit and Proper including governance variables for fit and proper policy, additional requirements for Head of a group, responsible persons and senior managers. We examine the criteria for fit and proper persons and the process for assessing fit and proper persons. There is a whistleblowing provision for the fit and proper policy. A responsible person who is not fit and proper is not to hold a position including the information to be provided to APRA.We conclude with governance variables based on the OECD recommendations on continuing training.

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Chapter 27. Failures in Risk Modelling and Rating Securitized Products

Chapter 27 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines failures in risk modelling and rating securitized products.This begins with variables for failures in risk models of securitized products – the [NEDRiskModelInfo] (−) variable – including failure to price risk accurately and the consequent reduction in risk management, monitoring and decision-making quality. Similarly, the [EDRiskModelPrice] (−) variable also covers risk modelling of securitized products including the failure to price risk accurately, this time for executive directors.Variables are then constructed based on credit ratings of securitised products for again NEDs and executive directors including conflicts of interest of ratings agencies.We conclude with variables for leverage and off-balance-sheet entities including ‘hidden leverage’ in financial statements and off-balance-sheet entities with the consequent reduction in risk management, monitoring and decision quality and the consequent reduction in the transparency and timing of reporting and internal and external monitoring.

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Chapter 28. Ownership, Governance Structure and Government Bailout

This Chapter 28 examines bank ownership, governance structure and government bailout. We identify that bank size and leverage is related to the probability of bailout.We examine the ‘maturity transformation’ of bank debt and the consequent reliance for banks on a continuous supply of liquidity. Further governance variables are constructed for the level of interconnectedness of banks (high) and its effects on risk-taking and the effects on risk-taking of both the level of systemic risk and increases in bank size.We find that a controlling shareholder is predictive of greater risk and bailout and we examine the relationship between stronger governance, market valuation and performance.We also examine a high level of bank governance and the consequent effects of risk-taking on bank performance (non-crisis periods) and bank value (again, non-crisis periods). We identify that more independent boards with high institutional ownership performed worse in the crisis. We review the existing board independence variables and a new variable for a high level of institutional ownership and its effects on risk-taking. We conclude with an examination of country-level governance.

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Chapter 29. Composition, Independence, Representation, Codes of Conduct and Culture

This Chap. 29 examines board composition, independence, representation, codes of conduct and culture.We begin with board composition, the independence proportion and representation and examine greater challenge, debate and testing.We move to consider a change in board culture and codes of conduct/ethics and conflicts including changing board culture and ‘tone at the top’. We present governance variables for culture and ‘tone at the top’, ‘entrenchment’ of the CEO, codes of conduct and ethics including an ‘ethics, compliance and reputation committee’ and a conflicts of interest policy.There follows the FSB’s Framework for Assessing Risk Culture including the aims of assessing risk culture, the FSB’s elements of a sound risk culture including the FSB’s and NAB’s ‘tone from the top’. We continue with the FSB’s further indicators of a sound risk culture – accountability, effective communication and challenge and incentives.There is then focus on the FSRC findings on governance, remuneration and culture including the FSRC Final Report recommendations and commentary on culture, governance and on the role of the board and concluding that section with the FSRC Final Report recommendations and commentary on priorities.The examination then moves to the NAB Self-Assessment 2018 on financial objectives and prioritisation including strategic planning and performance objectives, the growth fund and annual group budget, trade-offs in decision-making and customer outcomes.Switching to the Westpac Review Team 2018 examination of prioritisation decisions, we examine WBC’s four (4) factors contributing to prioritisation of financial considerations.We conclude with the FSRC Final Report recommendations and commentary on non-financial risks and accountability.

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Chapter 30. NAB Self-Assessment 2018, Westpac Review Team 2018 and Westpac Reassessment on Governance, Accountability and Culture

This Chapter 30 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines the NAB Self-Assessment 2018, Westpac Review Team 2018 and Westpac Reassessment on governance, accountability and culture.This begins with the NAB Self-Assessment 2018 and Westpac Review Team 2018 on the role of the board and senior management including the operation of the board and its committees. There is focus on NAB’s reporting to the board, customer impact and outcomes, second line risk reporting, reporting from third line internal audit, non-financial risk reporting, operational and technology risk, compliance and regulatory matters and NAB’s further variables for non-financial risk reporting. We then switch to the Westpac Review Team 2018 on investment allocations.There follows the NAB board challenge and closure of issues, remuneration and consequence management and the NAB Self-Assessment on senior leadership oversight including Executive Risk Committees, ELT Risk Committees, Customer Experience Board (CXB), Group Risk Return Management Committee (GRRMC), Value Chain Risk Management Committees and the Technology and Operations Risk Management Committee. This section then turns to the NAB operation of the Executive Leadership Team (ELT) and the Group Risk Return Management Committee (GRRMC).The examination then moves to Westpac’s functioning of the Executive Team and Westpac RISKCO including enhancing RISKCO reporting and enhancing Executive Team functions. The Westpac examination concludes with the Westpac Reassessment’s board and executive oversight of non-financial risk including the Westpac board and RISKCO.Chapter 30 concludes with the NAB Self-Assessment of accountability including clarity of accountability, effectiveness of accountability, accountabilities for resolving ‘complex’ issues and NAB accountabilities in performance and remuneration.

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Chapter 31. NAB and Westpac Recommendations and Commentary on Culture

Chapter 31 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks examines the NAB and Westpac recommendations and commentary on culture.This begins with an examination of NAB’s five cultural inhibitors to targeted culture including a discussion of values, behaviours, cultural ‘levers’ and measuring risk culture. NAB’s cultural inhibitor 1 is rigour and discipline. Cultural inhibitor 2 is over-reliance on people for deficiencies in systems and processes. There follows cultural inhibitor 3 – failure of collective intensity or individual resolve to fix complex issues. Cultural inhibitor 4 is failure to listen and learn from customers, regulators and employees and concluding cultural inhibitor 5 is other priorities put before commitment to customers.We then move to Westpac’s findings and commentary on culture of which there are 9 findings examined in this Chapter: vision, values and strategy; management of non-financial risks; caring, relationship-focus and collaboration; collective decision-making and diffused accountability; completeness and organisational complexity; speaking-up and challenge; prioritising, making decisions and saying “no”; conceptualisation and process over outcome; and institutional learning and reflection. We conclude with the Westpac Reassessment findings on risk culture.

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Chapter 32. APRA Information Paper 2019 on Risk Culture

In Chapter 32 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks, we examine the APRA Information Paper 2019 on risk culture.The APRA commentary is that: risk culture is not always well understood and that significant scope for improvement and investment remains; measurement and analysis of culture is still developing; behaviours are overlooked in favour of formal mechanisms; and a lack of a clear view of risk culture.

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Chapter 33. Financial and Bank-Specific Expertise

Chapter 33 examines financial and bank-specific expertise. We find that lack of financial expertise is predictive of bank failure and identify inadequate risk management and internal controls. We construct governance variables in the negative direction for a deficiency in knowledge of risk management processes, measurement and methodology and a deficiency in banking expertise before identifying banking-industry-specific knowledge, skills/competencies and professional qualities.There requires a mix of financial and non-financial industry knowledge for effective challenge and we examine how to determine the balance for effective challenge, testing and debate including composition of the board and relevant expertise and the board selection process.We move to examine the financial industry expertise and independence trade-off and construct a number of governance variables for the number and time commitment of non-executive directors for audit, remuneration and risk committees. We review the non-executive director independence variables from Stage 1 and construct relational effect paths for the NED number and time commitment for the Compensation/Remuneration and Risk Committees.Chapter 33 concludes with development, training and support of non-executives and new non-executive director mentoring by senior executives and the ‘senior independent director’.

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Chapter 34. Role, Responsibilities and Time Commitment for the Chairperson

Chapter 34 examines the role, responsibilities and time commitment for the Chairperson. We begin by reviewing the division in CEO/Chairperson roles from Stage 1 and the OECD recommendations in Stage 2.There follows discussion of agenda items, access to information and promoting alternative views. Moving further into the Chapter, we examine outside meetings for non-executive directors, CEO entrenchment, time commitment for the Chairperson and demarcation of the Chairperson and the CEO.Chapter 34 concludes with the conditions and criteria for the Chairperson and annual election.

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Chapter 35. Size and Composition of the Board

Chapter 35 of the Stage 2 Key Code and Advanced Handbook examines the size and composition of the board.This begins with the proportion of executive and non-executive directors on the board. We then move to some evaluation/review variables – evaluation of the board and board renewal. In particular, we examine the board review of performance for the board and committees and renewal of the board including the ASX board and executive review variables.There follows an evaluation statement of the skills and experience of the board, communication with major shareholders and cooperation of the board and committees including the agenda-setting function.

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Chapter 36. Board Committees

Chapter 36 of this Stage 2 Key Code and Advanced Handbook examines board committees.This begins with the Audit Committee with a review of Audit Committee variables from Stage 1 including a review of the [AudCom] (+) variable relational effect path from Stage 1 with a coverage/rating of +6/75.00 rprox. We then examine the ASX’s safeguarding of the integrity of corporate reports and the APRA Prudential Standard 510 on the Board Audit Committee. There follows the requirements of the BCBS Audit Committee and NAB Self-Assessment 2018.We then move to the APRA shortcomings in the operation of the audit committee, ‘red’ audit reports failings in audit committee practice, APRA audit committee reporting weaknesses and reliance on key individuals and conclude with the Westpac audit committee reporting from group audit.Other committees examined include the Board Risk Committee (BRC), Compensation/Remuneration Committee and other committees including the Nomination and Governance Committee, the Ethics, Compliance and Reputation Committee and NAB’s Customer Outcomes Committee.The examination then turns to consider APRA’s failings in board committees including failings in communication between board committees, failings in the candour of messaging to the board and its committees, over-confidence and lack of benchmarking.There follows APRA’s failings in senior executive leadership giving rise to a Non-Financial Risk Committee (NFRCm) and examining the Executive Committee and Non-Financial Risk Committee. We conclude with APRA’s improvements in non-financial risk management in relation to operational, compliance and conduct risks (NFRMan) and APRA’s observations that acknowledged weaknesses are already known (NFRWeak).

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Chapter 37. Complexity of Bank Structures, Off-Balance Sheet Entities, Disclosure and Transparency

Chapter 37 of the Stage 2 Key Code and Advanced Handbook examines the complexity of bank structures, off-balance sheet entities, disclosure and transparency.We begin with a discussion of off-balance sheet entities and the relational approach and identify that the separate legal entity principle can affect group-wide risk policy and disclosure. We then move to consider complex and opaque bank structures including the complexity of bank structures and directors’ duties to the entity, boards of parent companies and that complexity makes oversight by non-executive directors problematic.We then construct the [NEDBankStructInfo] (−) variable for non-executive directors recognising that complex and opaque bank, group and entity structures result in a reduction in decision quality and delineation and disclosure of powers, duties and lines of responsibility with a coverage/rating of −4/50.00 rprox.There follows a discussion of complex and opaque bank financial instruments including complexity of financial products and lack of control.Focus then shifts to bank (continuous) disclosure and transparency and structured products including ASX continuous disclosure obligations and ASX information and facilities for security holders.We recognise that information asymmetry extends beyond shareholders and consider principles for transparency and disclosure. For disclosure at the structured-product level, we review deficiencies in the quality of decision-making by non-executive directors and deficiencies in the transparency and timing of reporting and internal and external monitoring. For disclosure at the financial institution level, we recognise risk disclosure, valuation disclosure and liquidity disclosure.

Francesco de Zwart

Governance of Banks in the GFC and Beyond Key Field No 5 (Part 6): The Governance and Management of Bank Risk, Risk Appetite and Risk Culture

Frontmatter

Chapter 38. Introduction to Failings of Risk Management in the Global Financial Crisis and Beyond to the Australian Banking Royal Commission Enquiry into Banking Misconduct

Chapter 38 contains an introduction to the failings of risk management in the GFC and beyond to the Australian Banking Royal Commission Inquiry into banking misconduct including APRA’s Prudential Standard CPS 220 Risk Management. We examine the link between risk management and governance and examine board responsibilities and failings of board oversight in risk management. We construct governance variables based on board responsibilities and principal failings of board oversight in risk management, internal monitoring and decision-quality. There follows our approach to modelling governance variables, governance variables for board responsibilities in CPS 220 Risk Management and additional requirements on the head of a group.Chapter 38 then constructs governance variable for a long list of failings including: failure to identify risks on an organisation-wide basis rather than by business unit or activity; separation and low status of risk managers likely to cause a deficiency or reduction in the flow of information from management to the risk manager on the details of particular risks; failure to escalate problems or ‘red flags’ – deficiencies in the flow of information upward through the bank to senior management and/or the board; failure in information flow on leverage and risks due to over-reliance on regulatory capital ratios and rates of return on equity; failure of information flow on identifying risks; failure of information flow on risks in CDOs and other financial products; failure of information flow to senior management due to ‘silo structures’; failure of information flow due to conducting stress testing with past information; failure to understand and compare bank’s risk position relative to risk appetite; failure of risk model assumptions; failure by board to continuously review internal structure of bank for clear lines of accountability/responsibility, risk culture and flow of information about risks; failure in training employees responsible for distributing risk products; failure in expertise or experience of risk management employees in entire range of risks; failure to monitor changes in risks in real time and to escalate information rapidly upward in the bank; failure to upgrade IT tools for complex and opaque bank structures; failure to devote sufficient management time to management of risks; failure to align corporate strategy, risk appetite and the internal risk management structure; failure to separate risk management and control from profit centres; failure of Chief Risk Officer (CRO) to report directly to board and Board Risk Committee (BRC) in addition to the CEO; and failure in transparency and understandability of material risk factors ranked in order of importance.

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Chapter 39. NAB and ASIC Failures in Issue Identification, Escalation and Resolution

This chapter examines NAB failures in issue identification, escalation and resolution and the ASIC Governance Taskforce 2019 findings on ‘information flows’.We begin with NAB’s failure to escalate problems or ‘red flags’ – in general – giving rise to deficiencies in the flow of information upward through the bank to senior management and/or the board. NAB then identifies a wide range of issues that we convert to governance variables for: operational risk management policy; monitoring and reporting of issues, events and actions; compliance breach assessment and reporting; audit and regulatory issues; the whistleblower program; complaints reporting; significant issues; the customer remediation procedure; management of ‘excessive’ risks; regulatory engagement; breach reporting; voice of the customer in issue management; complex issue management and closure; resolving customer complaints; customer remediation; and regulatory interactions. We conclude with the ASIC Governance Taskforce 2019 findings on ‘information flows’.

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Chapter 40. Risk Culture, Risk Appetite and Risk Appetite Statements

Part 6 of the Stage 2 Key Code and Advanced Handbook examines risk culture, risk appetite and risk appetite statements. This begins with creating a risk culture and ‘risk appetite’ and changing board culture and ‘tone at the top’.We then move to discuss elements of sound risk culture and APRA’s aims for risk culture. There follows APRA’s nine themes inhibiting sound risk culture: widespread complacency; reactivity rather than pre-emption regarding risk; uneven influence of the risk function; not fully ‘walking the talk’ when it comes to risk management; less tendency towards reflection, introspection and learning; collegial, high trust environment leading to some over-confidence and over-collaboration; striving to balance empowerment with challenge, although not well executed; aiming to be a values-led institution, but an over-reliance on good intent; and self-perceived, but incomplete, focus on the customer. The discussion moves to senior management responsibilities for risk culture, risk management and the provision of information including governance variables for senior management responsibilities.We recognise developing a risk appetite is a responsibility of the board and discuss the Risk Appetite Statement (RAS) and Risk Management Strategy (RMS) including APRA’s requirements for the RAS and RMS, governmental and market participant reports on the RAS and the ASIC Governance Taskforce 2019 on the RAS.We conclude with the APRA business plan and policies and procedures.

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Chapter 41. FSB Effective Risk Appetite Framework

Chapter 41 examines the FSB guidance on a risk appetite framework (RAF) in its Principles for An Effective Risk Appetite Framework.This begins with FSB Principles for an effective risk appetite framework (RAF) and the FSB risk appetite statement (RAS). We examine the FSB risk limits and FSB roles and responsibilities for an effective RAF.The Chapter concludes with Westpac’s Board Risk Committee monitoring of risk appetite.

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Chapter 42. The Three Lines of Defence

In Chapter 42 of the Stage 2 Key Code and Advanced Handbook for the governance of Australian major banks we examine the Three Lines of Defence.We begin with Business Units or Line 1 and examine Westpac Line 1 operation, Westpac Line 1 skills, capabilities and stature, the Westpac Reassessment’s Line 1 ownership and capability to manage risk and the Westpac Reassessment’s Building Line 1 risk and control capability.The other two lines comprise the Risk Management and Compliance Function and Internal Audit. We recognise Corporate Defence Management (CDM) as extending the three lines.We move to consider high risk strategies and (improper) delegation of risk oversight, inadequate oversight, risk management and complexity of financial products. Our governance variables for the complexity of financial products include risk modelling deficiency variables and credit rating deficiency variables.The Chapter then constructs variables for: bank-specific variables exhibiting a deficiency in banking industry knowledge and competence; inadequate risk management and internal controls; the failure of information flow on risks in CDOs and other financial products; and the complex and opaque nature of securitized/financial products. The conclusion of the Chapter considers factors contributing to a short-term emphasis and acceptance of increased leverage.

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Chapter 43. Board Risk Committee (BRC)

Chapter 43 of the Stage 2 Key Code and Advanced Handbook examines the Board Risk Committee (BRC) beginning with the requirements for ASX listed entities and APRA’s Prudential Standard CPS 510 Governance.We review the non-executive director number, time commitment and number of meetings for the BRC and review the Walker Review 2009 variables for establishment of the BRC.Section 2 reviews the nature of risks and responsibilities monitored by the BRC including ‘fundamental prudential risks’ and other risks.There follows the responsibilities of the BRC proposed by Walker Review 2009, BCBS Guidelines 2015, NAB Self-Assessment 2018, Westpac Review Team 2018 and the ASIC Governance Taskforce 2019. We recognise the ASIC Governance Taskforce 2019 discussion on the “Emerging Issue: Implications of changing BRC membership and attendance patterns” and “full board attendance at BRC meetings”.We conclude with APRA’s failings in operation, reporting and reliance on key individuals of the BRC and Westpac reporting to the BRC.

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Chapter 44. Board Risk Committee Composition

In Chap. 44 we examine the composition of the Board Risk Committee.This begins with the independence, status and reporting lines of the CRO. By way of summary, we construct governance variables for the establishment, independence, status and reporting lines of the CRO: establishment and independence of the CRO; status of the CRO; reporting lines of the CRO; and access of the CRO. We conclude our examination of the CRO with the role and responsibilities of the CRO.There follows discussion of the role and contribution of non-executive directors on the BRC. Continuing, we examine the BRC and risk appetite and weightings for incentives and economic assessments, “stress” testing and metrics including authoritative financial stability assessments and stress, scenario and fail testing. We move on to external advisers to the BRC and the BRC and significant mergers, acquisitions and disposals.A separate BRC Report is examined with two disclosure variables.We conclude with the APRA requirement that there should be no constraints on persons providing information to APRA.

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Chapter 45. The Risk Management Function

Chapter 45 of the Stage 2 Key Code and Advanced Handbook examines the risk management function beginning with APRA’s requirements for the second line of defence risk management function.There follows other functions and responsibilities of the second line of defence including second line of defence variables, risk identification variables and monitoring variables. We then examine the Westpac second line of defence monitoring variables, second line of defence skills, capabilities and stature and the Westpac Reassessment on second line frameworks, controls and standards. We continue with APRA’s failings in operational and compliance risk policies, frameworks and management, the Westpac common risk and control language, Westpac’s process to regularly review, assess and test controls and Westpac’s identification of new, emerging and heightened risks. We conclude this section of the Chapter with risk reporting of the second line risk management function.Section 45.2 examines the Enterprise Risk Management (ERM) framework and shortcomings in ERM practice. Section 45.3 reviews resources for risk management.Section 45.4 then moves to examine risk identification, monitoring and control with an introduction to internal controls. Section 45.5 is an introduction to communication of risk including principles for identification, escalation/communication and disclosure of risk: at customer level; at the first-line of defence business unit level; at the second line of defence risk management function level; at whistleblower level; and at the board level reporting to shareholders and the external market/stakeholders. Section 45.6 examines escalation of risk information upwards through ‘red flags’ including reporting lines of the CRO.There follows discussion of the failure of ‘red flags’ as a failure in board’s oversight of risk management, failure by senior management to escalate ‘red flags’ or information upwards to the board and failure by the second-line risk management function to escalate ‘red flags’ or information upwards to the board including communication in corporate hierarchies with unitary boards. The latter includes two steps – the second-line ‘red flag’ functions and second-line principles for communication of risk.Section 45.10 reviews the APRA and Westpac Review Team 2018 identification of failures to escalate ‘red flags’ from staff including APRA issue identification, escalation and resolution and Westpac issues and incidents identified by Westpac employees.Section 45.11 examines APRA and the Westpac Review Team 2018 identification of failures to escalate ‘red flags’ from customers including: Westpac customer complaints; Westpac identification of systemic customer complaints; Westpac customer complaint reporting; Westpac escalation of customer complaints; and Westpac identification of vulnerable customers. In Sect. 45.12 we review APRA and the Westpac Review Team 2018 identification of failures to escalate ‘red flags’ from regulators and whistleblowers.Section 45.13 reviews the APRA identification of failures in financial objectives and prioritisation.There follows in Sect. 45.14 a discussion of compliance as part of the second line of defence including the effectiveness of the compliance function.Chapter 45 concludes in 45.15 with APRA’s identification of failings in accountability and responsibility including: the approach to governance variables for failings in accountability and responsibility; the governance variables themselves for failings in accountability and responsibility; and APRA’s recommendations for accountability.

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Chapter 46. The Internal Audit Function

The internal audit function is identified in this Chap. 46 as a subject for a proposed future Key Field.

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Chapter 47. Governance Variables for Remediation Activities

Chapter 47 of the Stage 2 relational approach Key Code and Advanced Handbook examines governance variables for remediation activities.It contains commentary from APRA on remediation attributes including success factors for remediation and additional successful remediation recommendations.

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Chapter 48. Governance Variables for APRA on Risk Management and Compliance

Chapter 48 of Part 6 of the Stage 2 relational approach Key Code and Advanced Handbook examines governance variables for APRA on risk management and compliance.This examines APRA’s risk management framework (RMF), material risks, APRA’s review of the risk management function and APRA’s risk management declaration and notification requirements.

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Chapter 49. NAB’S Risk Management Framework (RMF) and ASX Enviromental and Social Risks

The penultimate Chap. 49 of the Stage 2 Key Code and Advanced Handbook examines NAB’s risk management framework (RMF) and the ASX’s environmental and social risks.In the case of NAB’s RMF we begin with NAB first line risk and control ownership. There follows a number of NAB second line risk management variables: second line risk reporting; second line compliance function; second line conduct risk; and second line operational risk. The Chapter concludes with the ASX Environmental and Social Risks.

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Chapter 50. Governance Variables for the Westpac Review Team 2018 and the Westpac Reassessment on Risk Management and Compliance

The concluding Chapter of Part 6, Chap. 50, examines governance variables for the Westpac Review Team 2018 and the Westpac Reassessment on risk management and compliance.This begins with an examination of Westpac Review Team 2018 on non-financial risk appetite, conduct risk management and reputation risk management.There follows the Westpac Review Team 2018 on divisional approaches to manage risk and compliance and embedding group-wide policies.Part 6 concludes with the Westpac Reassessment “CORE” Remediation Program including: Pillar 1 – Direction and Tone set by Board and Group Executive; Pillar 2 – Clear Risk Boundaries for Decision-making; and Pillar 3 – Accountable and Empowered People.

Francesco de Zwart

Backmatter

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