But he said it would be a “tricky question” as to whether APRA would take any action against an individual for a breach of the Banking Executive Accountability Regime, or BEAR.

APRA has been strongly criticised during the royal commission over its lack of enforcement action. It’s taken one group to court in the past 10 years.

Here’s Mr Byers and counsel assisting Michael Hodge discussing the matter.

Mr Hodge: "You've said publicly that APRA will need to be satisfied that a contravention is material before it brings proceedings?"

Mr Byers: "Yes. Well, you don't - I mean, obviously you don't disqualify people lightly and you don't start civil penalty proceedings lightly. So it would be by definition material."

Mr Hodge: "Can you give an example of what would be a material contravention?.. For a bank?"

Mr Byers: "Well, I think the two examples that I often talk about because they're in the public domain, I think the - the issues that were identified by the CBA inquiry report would have asked you to at least think about - would have asked us to think about was there a case to be made for some penalty.

"The other one which is very public case, but some time ago, was the - the NAB FX options episode where it was clear that there were significant failings in governance and oversight in that organisation. And - and questions about - or that could have gone to prudential standing. So they would be two cases that I think are ones that you would be looking, at least asking the question about, whether a penalty was warranted."

Mr Hodge: " In the case of the CBA prudential inquiry, what are the particular matters that would be causing you to, had BEAR been in place, to ask the question is a civil penalty?"

Mr Byers: "Well, I don't think it's a particular matter, I think it's the collective of it."

Mr Byres doesn’t dispute this finding.

“Look, I think that is a fair statement, that there is a - a long journey to go,” he says.

So, Commissioner Hayne wants to know, what’s APRA’S part in this long journey?

Mr Byres nominates three areas where APRA will be working.

One is the issue of accountability within banks.
“The problem of diffused responsibility and no clarity of accountability has been the heart of the problem. No one has had responsibility, no one has actually taken responsibility for issues. Boards have not known how to apply consequences because it's not clear who was responsible for things,” he says, calling for a "strenghtening of accountability".

The second point he makes is that APRA will need to do more work to beef up the audit and compliance function within banks, because regulators can’t be expected to find all the problems.

“It's probably fair to say that the prudential framework, if you look for references to compliance and internal audit, they're fairly cursory and short and will need to think about how we give them more prominence in our assessment of risk management,” he says.

Regulators can't find all this stuff. We can't be the first line of defence.

Wayne Byres

The third area where APRA will need to do more work, Mr Byers says, is around "incentives, and the flipside of incentives: consequences".

"So that would be my quick answer - relatively quick answer to your question, Commissioner."

By June 2017, APRA had a pilot program, which included the regulator giving an independent assessment of an institution's risk culture and involved focus groups, surveys, and observations of banks.

The first pilot review was done mid last year, with results given to the bank in November.

APRA had planned a second pilot, but it was suspended because of the prudential inquiry into CBA.

In late 2017 and early 2018, senior members of the team resigned, and APRA decided to “re-scope” those reviews, and Mr Hodge shows Mr Byres a document on the re-scoping.

We were not seeking to be the definitive culture consultant. It's ultimately for boards to do that work for themselves.

Wayne Byres

“This is an attempt to explain what the refocus is going to be. And it appears as if the refocus is going to be on, rather than assessing - rather than APRA making its own assessment about - of the risk culture, understanding how the entity assesses its risk culture?” Mr Hodge says.

“That was the broad reshaping, yes,” My Byres replies, adding that it’s “nuanced,” and APRA would still be doing a “sense check” of banks’ risk culture.

“So it's not to say that we would just be looking at a process document and saying it's very good. It would still need to have some sort of sense checking against it. But we were not, if - we were not seeking to be the definitive culture consultant. It's ultimately for boards to do that work for themselves.”

Mr Byres agrees it was shifting back to “a less resource intensive way of approaching risk culture.”

Hes said the regulator's experience with pilot programs was that it didn’t have the resources it would need to achieve “anywhere near the coverage that we would need.”

“It's a touchy subject amongst the director community but it means make all reasonable steps you might expect from a director - this is a paraphrasing - to do those things,” Mr Byres says.

Anyhow, Mr Byres explains that APRA has developed a standard that says boards must be satisfied with their organisation’s risk culture, and how it sits with the institution’s risk appetite.

“The board should have regard to what they sense the risk culture to be and if they see there's an inconsistency between those two things, they should task management with action to address that. And that's the essence of where we landed.”

Mr Byres agrees this is a different approach to the Netherlands, where the regulator itself forms a view on a bank’s risk culture.

Mr Byres says the Netherlands – which took a lead on the issue of banks’ risk culture after their banks needed to be rescued in the global financial crisis – is an “outlier” in this area.

After referring to Australia’s nearly three decades without a recession, Elliott made the point that ANZ (and its peers) are high and largely fixed-cost businesses. He referred to the technology and branch networks within banks.

Banks were, he said, high-returning businesses, with returns on equity approaching 20 per cent in the early part of that period, and fast-growing.

"The logical strategy to pursue, and that is to grow, is to do more. And so the way you do more is to focus on growing revenue. And so it becomes a derivative of that strategy to continue to do more and at some level it becomes so confined that people become totally fixated on just the revenue achievement.’’

Read the attached story for Mr Bartholomeusz' full analysis.

The head of the embattled banking regulator, Wayne Byres, has told the royal commission it will let its bank supervisory team off the leash after telling them they need to “ratchet up the mongrel”.

Mr Byres, who was giving evidence at the banking royal commission, also said the Australian Prudential Regulatory Authority will also expand its supervisory remit to include regulation of all pay inside the big banks, including for frontline staff, after concluding that poor remuneration structures can lead to poor conduct.

Mr Byres also revealed the Commonwealth Bank and APRA had been at loggerheads over a number of issues during its 2017 culture review of the bank. He admitted that APRA should have acted sooner on CBA’s executive pay structures before the company’s record-making 2016 shareholder strike against its remuneration report, but said it decided to back off after the strike because the bank board was "despondent".

He also revealed he did not know what good remuneration looked like and that APRA lacked expertise on this front.

APRA’s willingness to show more teeth when dealing with conduct inside the big banks came after the interim report from the royal commission questioned the conduct of both APRA and the Australian Securities and Investments Commission in not stamping out wrongdoing in the sector. APRA has only taken court action once in the past 10 years.

Great deal of 'tenacity'

During the hearing, Mr Byres was taken to an executive board paper for APRA from June 2018. It shows APRA discussing what it could learn after its culture review of the Commonwealth Bank in 2016 which was scathing of the bank.

Under the heading of “supervision mongrel”, the paper reads: "Stronger support of supervisory gut feel together with strengthened supervisor tenacity and more frequent use of sanctions can be considered.”

The paper adds: "Supervision mongrel is an attitude rather than a framework issue, senior leadership in APRA would need to set the tone on how this supervision mongrel would operate in practice."

“There were a raft of issues that they were pursuing, and they were at loggerheads with CBA on a number of fronts,” he said.

“So I would never in any way question the tenacity of the supervision team. They were doing a good job.”

Counsel assisting, Michael Hodge, QC, pressed Mr Byres saying the document also showed the problem was not at the supervision level.

“The problem is at the senior leadership level in terms of the tone that is set,” Mr Hodge said.

“It was really important that supervision teams pursued issues aggressively, even when the institution concerned was pushing back quite aggressively."

Changing view on executive pay

Mr Byres also conceded that APRA could have done more on remuneration throughout the sector. APRA has had to rein in the amount of interest-only loans that banks hold after sales ballooned. The royal commission has been exploring the impact that pay structures in the big banks for frontline staff has had on breaches of responsible lending requirements.

The change to APRA’s view on executive pay will have massive implications for the sector with APRA currently only reviewing executive pay through the government-mandated Banking Executive Regulatory Regime, or the BEAR.

Mr Byres said the Financial Stability Board, the international body charged with monitoring the global financial system, had recommended in 2018 an expansion of the supervisory responsibilities of all prudential regulators.

He got off to a rather dry start yesterday, explaining how the Australian Prudential Regulation Authority works. Which, as we pointed out then,  made complete sense given the confusion between what the royal commission thinks the APRA should do, and what APRA thinks it should do.

But as he got going, more fascinating things started to emerge - such as how the banking regulator, which has run just one court action in the past 10 years,  is starting to home in on executive conduct (or misconduct) and expand its oversight of pay structures within the banks.

Mr Byers saved the best for last, telling the commission that following a review of its supervision of the Commonwealth Bank last year, the banking regulator now plans to "ratchet up the mongrel" - pursue issues more aggressively, even if the targets push back.