Banks should face a new kind of regulation: experts

'There are probably religious cults that are less steeped in group think than APRA'

Principles, not new laws, key to effective regulatory regime

By Alex Sampson

More regulation will not solve Australia’s banking sector woes – what we need is a new approach to taking disciplinary action to court, according to leading financial regulatory experts.

Dr Andrew Schmulow, a senior lecturer at the University of Wollongong Faculty of Law and former APRA lawyer, said financial regulators needed to move away from prescriptive laws toward a principles based and outcomes determined regulatory regime.

Dr Schmulow pointed to last year’s failed case where ASIC brought charges against Westpac for irresponsible lending.

After the regulator and Westpac reached an unprecedented A$35 million settlement – celebrated as the biggest fine in Australian history for breaching credit laws – judges refused to approve the agreement because ASIC had failed to illustrate how Westpac had breached lending laws.

The case hinged on the fact Westpac had used the household expenditure measure (HEM) to judge whether customers were suitable for housing loans, despite knowing (as detailed in emails seized by the royal commission) that this was not a reliable or responsible measure.

As the law does not specifically prohibit banks from using the HEM benchmark the settlement was tossed.

“They worked themselves into a furious lather about the use of the word conduct versus the HEM benchmark – which was never going to work,” Dr Schmulow said.

“Our legislature and our regulators have enacted legislation that is almost exclusively rules based. It is highly and deeply prescriptive – a vast doorstop of a piece of legislation and it doesn’t work.

“The financial industry manages to innovate too quickly and argue the technicalities of particular words so that you can never get a conviction.

“By comparison, in a principles based and outcomes determined regulatory regime all ASIC would need to do would be go into court and say to the judge, “thou shalt not engage in reckless lending” is one of the principles we have laid down, and it is observable now that there are 50,000 instances of people who are over-indebted, and we call that a bad outcome.

“The breach of our principle and the presence of a bad outcome activates our jurisdiction. They engaged in reckless lending. The end.

“Then it is up to Westpac to argue that despite a bad outcome they did no wrong because they used the HEM benchmark, and that discharges their responsibility. If they fail to convince the judge of that argument, they lose.”

If the failure to argue the HEM point was not enough, the judges also decided that the proposed penalty of A$35 million was too small for the misconduct Westpac was accused of, and if ASIC could prove their case, the bank should actually pay at least A$100 million.

Regulatory spine - look to the ACCC

Swinburne University corporate governance specialist Helen Bird argues this aspect of the ruling was in ASIC’s favour, now requiring that you “can’t simply come up with a figure out of thin air”.

“In a sense it gave ASIC some spine,” Ms Bird said.

“There is no point settling in a court case unless this is a good deal relative to the wrong that was done and I think it sends a message to a market that you can’t wash away the wrong, it has to be justified by reference to the breaches that took place and the parties that suffered, and that ultimately will favour ASIC to be tougher in the settlement process.”

Ms Bird argued that the regulators needed more money so they could bring key cases to court and create an environment of regulatory fear.

“You can certainly make it very clear that you are not to underestimate the power of the regulator, and the way you do that is by bringing court cases – not a lot necessarily, but strategically,” Ms Bird said.

“From my point of view the regulator that has done that most successfully in the past 20 years has been the ACCC. They have this great capacity to make people fear them. It works at drawing attention and sending the message that this is not behaviour they’re going to put up with.”

Ms Bird said this approach could eat up A$5 million a case, and only A$20 million extra had been allocated to ASIC for enforcement during the royal commission process.

“The settling (before court) behaviour we’ve seen will continue if the government doesn’t stump up funds to bring cases to court,” she said.

Dr Schmulow said the regulators’ seeming lack of interest in pursuing banks for their illegal conduct to date was more about ineptitude than funding or power.

“This reluctance has developed from people who continue to do what they know,” Dr Schmulow said.

“I worked for APRA for a very short period of time. I dare say there are probably religious cults that are less steeped in group think than APRA.

“I was certainly made abundantly aware that I wasn’t doing myself any favours by asking so many questions.”