APRA has issued a warning to financial organisations that are gradually ramping up risk to compensate for below-average profits.
Speaking at Finsia’s The Regulators conference in Melbourne on Friday, APRA chairman Wayne Byres said the low interest rate environment is putting pressure on organisations to increase returns.
System-wide profitability for APRA-regulated organisations was below its 10-year average for the 2015-16 financial year, Mr Byres said.
While Australian institutions aren’t yet faced with negative interest rates, pressure is growing to join the "hunt for yield" by moving up the risk spectrum, he said.
“To date, we have not seen major shifts in asset portfolios designed to bolster returns by accepting materially greater risk,” Mr Byres said.
“That doesn’t mean that risk-seeking isn’t happening at the margins however, and it is at the margins where we need to be most vigilant,” he said.
APRA-regulated organisations are unlikely to “roll the dice” and immediately ramp up risk in their portfolios, Mr Byres said – rather, it is more likely to be a gradual process.
“Like the anecdote about the frog in boiling water, there is a danger no one notices the ever-increasing risk profile until it is too late,” he said.
This situation can be avoided so long as financial institutions have an appropriate "risk culture" in place, Mr Byres said.
“Just as the frog is said to be oblivious of the dangers of the gradually warming water, an organisation with a poor risk culture will be oblivious, if not neglectful, of its gradually rising risk profile,” he said.
“Group risk insurance and mortgage lending standards are two examples that reinforce the need for a strong risk culture at a time when a little more risk might well be a tempting way of dealing with otherwise subdued returns.
“This temptation can be even harder to resist when competitors appear to be doing likewise – even though that is the weakest justification of all.
“Our best protection against becoming boiled frogs will not be regulatory reforms such as those emanating from [the] Basel [Committee], but a strong risk culture within financial institutions that gives appropriate weight to both sides of the risk-return trade-off.”
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