EXPLANATORY STATEMENT

AND

REGULATORY IMPACT STATEMENT

Australian Prudential Regulation Authority Act 1998, section 51

INSTRUMENT FIXING CHARGES TO BE PAID TO APRA

FOR APPLICATIONS FOR AUTHORISATION AS AN ADI, GENERAL INSURER OR LIFE COMPANY

PART 1 - EXPLANATORY STATEMENT

) Instrument to which this explanatory statement relates

1.   This explanatory statement relates to the instrument fixing charges which is made under paragraph 51(1)(b) of the Australian Prudential Regulation Authority Act 1998 (the APRA Act) and which is dated 3 June 2003 (the instrument).

APRA's authority to fix charges

2.      The APRA Act is administered by the Australian Prudential Regulation Authority (APRA). APRA is the prudential regulator of the banking, general insurance, life insurance and superannuation industries.

3.       Subsection 51(1) of the APRA Act provides that APRA may, by written instrument, fix charges to be paid to it by persons in respect of:

(a)      services and facilities which APRA provides to such persons; and

(b)      applications or requests made to APRA under laws of the Commonwealth. (These paragraphs reflect the contents of paragraphs 51(l)(a) and (b).)

) 4. Subsection 51(1) also specifies that an instrument fixing charges may provide for the waiver or refund of the charges.

5.      Subsection 51(2) of the APRA Act provides that a charge fixed under subsection 51(1) must be reasonably related to the costs and expenses incurred or to be incurred in relation to the matters to which the charge relates, and must not be such as to amount to taxation.

Purpose of the instrument

6.      The instrument, made by a delegate of APRA, imposes charges in respect of applications made to APRA for the authorisation or registration (in other words, the licensing) of authorised deposit-taking institutions (AD/s), general insurers and life companies. (ADIs principally comprise banks, building societies and credit unions.)

Background

7.       One of APRA's functions as prudential regulator is the licensing of ADIs, general insurers and life companies. Basically, the Acts under which ADIs, general insurers and life companies

are regulated' prohibit the carrying on of the regulated activity (respectively, banking business, general insurance business and life insurance business) unless it is carried on by a body corporate that is licensed by APRA.2 Each of the Acts confers a wide discretion on APRA regarding whether or not to grant the licence.

8.       A licence is only granted to an entity once, when it first begins to carry on the regulated activity. The licence continues in force until such time as it is revoked by APRA (for example, because the regulated entity is no longer carrying on the regulated business, has become financially unsound, or has breached the relevant legislation).

9.       Licensing is a critically important aspect of prudential regulation. Licensing requirements play a "gatekeeper" role, enabling the prudential regulator (APRA) to keep out of the regulated industry players that are considered to be unsuitable for one reason or another (whether due to lack of capital, lack of technical capability or lack of integrity) and to ensure that entities seeking to be licensed have the requisite capital, administrative and human resources and systems to enable them to be relied on to carry on their financial business in a prudent manner.

10.       Processing and determining a licence application from a prospective new entrant to the regulated industry is a very time-consuming and resource-intensive exercise for APRA. The applicant is required to provide in its licence application a considerable amount of detailed information relating to all aspects of it current and proposed business, including its financial, administrative and human resources, its governance, compliance and risk-management systems, its investment strategy, its outsourcing policy, its business plan, and so on. APRA staff with the relevant technical expertise carefully assess this information. Often they will conduct interviews with the applicant's key personnel and make site visits to the applicant's place of business. They also examine the backgrounds of the directors and senior executives of the applicant to determine whether they meet APRA's "fit and proper person" requirements. They also examine, and in some cases need to fo1mally approve, key professional service providers who are engaged by the applicant (such as approved auditors and approved actuaries). They then advise the relevant APRA delegate whether or not the applicant should be granted a licence. Appropriate conditions are often imposed on the licence.

11.       Although resource-intensive and frequently onerous for all concerned, if performed properly the licensing process is likely to pay dividends down the track by helping to ensure that the licensed entity will be up to the job of carrying on its business prudently, thereby minimising the chances of depositors or policyholders suffering loss due to the licensed entity's dishonesty or imprudent behavior.

12.       APRA is principally funded by the annual supervisory levy imposed on regulated entities by the Financial Institutions Supervis01y Levies Collection Act 1998 and the related levy imposition Acts.3 However, section 51 of the APRA Act empowers APRA to impose charges in respect of services or facilities provided by it and in respect of applications made to it under Acts which it administers. Underlying section 51 is the philosophy of "user pays" - that parties who receive special services or benefits from APRA should, where appropriate, have to pay the cost of providing them, rather than leaving them to be funded out of the supervisory levy which is paid by the general body of regulated entities. This reflects the views of the Wallis inquiry into the regulation of the financial system, which recommended that, in the interests of equity and

1 Respectively the Banking Act 1959, the insurance Act 1973 and the Life insurance Act 1995.

2 The provisions empowering APRA to grant licences are respectively section 9 of the Banking Act 1959,

section 12 of the Insurance Act 1973 and section 21 of the Life Insurance Act 1995.

3 The relevant levy imposition Acts include the Authorised Deposit-taking Institutions Supervisory Levy Imposition Act 1998, the General Insurance Superviso1y Levy Imposition Act 1998 and the Life Insurance Supervisory Levy Imposition Act 1998.

efficiency, the costs of prudential regulation should be recouped from the financial industry, saying:4

"The arrangements should involve a mix of direct service fees and annual levies and should distinguish, where possible:

□      services provided at the instigation of individual entities, such as authorisations or registrations, for which per-item cost recovery fees are appropriate; and

□      regulatory activities undertaken at the discretion of the agency and for the general benefit of customers, such as inspections, enforcement and policy development, for which annual industry-wide levies are most appropriate.

Recommendation I 04: Regulatory agencies' charges should reflect their costs

Regulatory agencies' charges should reflect their costs. The regulatory agencies should collect from the financial entities which they regulate enough revenue to fund themselves, but not more. As far as practicable, the regulatory agencies should charge each financial entity for direct services provided, and levy sectors of industry to meet the general costs of their regulation. "

13.      In keeping with that philosophy, APRA has decided to charge entities that apply for a licence to canyon business as an ADI, general insurer or life company the fees fixed by the instrument. The various charging options that were available to APRA and their relative merits are discussed in the Regulatory Impact Statement below.

Description of the charges and how they have been calculated

Description of the charges

14.      The instrument sets a series of fixed fees for licence applications, as follows:

•       application for licensing as an ADI that is a bank or special service provider:

•       application for licensing as an ADI that is a building society or credit union:

•       application for licensing as an ADI that is a specialist credit card institution:

•       application for licensing as a general insurer:

•       application for licensing as a life company (other than a friendly society):

•       application for licensing as a life company that is a friendly society:

) 15. These fees are inclusive of GST.

$68,200

$22,000

$33,000

$68,200

$55,000

$22,000.

16.      The licence fee is payable by the applicant who applies for the licence, and is payable when the application is lodged with APRA.

17.      The licence fee is not refundable if the application is unsuccessful (that is, if APRA decides not to grant the applicant a licence), or if the applicant withdraws the application or decides not to proceed with it (for instance, because APRA has intimated that it intends to refuse a licence or to impose conditions on the licence which the applicant considers unacceptable).

18.      For the avoidance of doubt, it should be noted that the licence fee is payable in respect of every new application, even one that is made after the refusal or withdrawal of an earlier application for which the applicant also paid a licence fee.

4 Commonwealth of Australia Final Report of the Financial System Inquiry 18 March 1997 section 12.3 (p 532).

How the charges have been calculated

19.      The fee for each type of licence reflects APRA's costs of processing and determining the licence application.

20.       The costs are based on the amount of APRA staff time directly devoted to processing and determining the average application for a licence of that type, based on the recent experience of APRA's two operational divisions which are responsible for licensing, namely the Specialised Institutions Division and the Diversified Institutions Division. The levels of seni01ity of the staff concerned are determined and the mid-point salary of those levels is used in the calculation. Overhead costs are then added to the salary costs on a weighted average cost basis.

21.       In this manner, APRA 's costs of processing and determining licence applications have been quantified as follows:

•       licensing of an ADI that is a bank or special service provider: $62,000

•       licensing of an ADI that is a building society or credit union: $20,000

•        licensing of an ADI that is a specialist credit card institution: $30,000

) • licensing of a general insurer: $62,000

•        licensing of a life company (other than a friendly society): $50,000

•        licensing of a life company that is a friendly society: $20,000.

GST of ten per cent has been added to each of these amounts to arrive at the GST-inclusive fees that are fixed by the instrument (which are reproduced in paragraph 14 above).

22.       The cost of licensing a regulated entity in a particular category (bank, building society, credit union, and so on) does not va1y significantly with the size of the entity, judged by either its capitalisation or the (anticipated) size of its revenues or deposit or policy liabilities. This is because the same "checklist" of issues is addressed when processing licence applications relating to a particular category of regulated entity, each applicant being vetted with a similar degree of thoroughness.5

23.       The cost of licensing specialist credit card institutions has been estimated rather than being based on actual expe1ience of licensing such entities, because they are a new category of ADIs - the first specialist credit card institutions are expected to be licensed early next financial year. They will cost significantly less to license than a bank, because they will only be licensed to

) engage in the limited business of issuing or acquiring credit cards. This kind of business carries less prudential and systemic risk and hence requires less capital and less complex systems than the deposit-taking and lending business engaged in by banks.

24.       Credit unions generally have a mutual structure under which they are owned collectively by their depositors and under which they do not generate profits for other parties. They offer a limited range of products and services, which are sometimes "niche" products or services that fill a need that is not adequately catered for by the banks. They also normally service a limited geographical area or a limited class of depositors (for example, people who work in a particular industry or profession). In view of these characteristics, the cost of licensing them is considerably less than the cost of licensing banks.

25.       Building societies and friendly societies have similar characteristics to those of credit unions to which reference has just been made. Many building societies, and most friendly societies,

5 As regards the last point, once APRA has begun monitoring a regulated entity it is able to categories it as high risk or low risk and to tailor the intensity of its supervision accordingly. However, APRA is not in a position to make such judgements about an applicant before it has thoroughly checked out the applicant.

have a mutual structure, and they have a relatively limited product range and customer base. Hence, the cost of licensing them is also considerably less than the cost of licensing banks or life companies that are not friendly societies.

26.      Special service providers are ADIs that provide special services such as payment clearing facilities to building societies and credit unions. Although they only provide a narrow range of services, the specialised nature of those services and the systemic importance of special service providers means that the cost of licensing them is likely to be similar to the cost of licensing banks. (No special service providers have been licensed in recent years, hence precise information about the work involved in their licensing is not available.)

Discretion to waive or refund the charges

27.      The instrument gives APRA a limited discretion to waive or refund a licence fee, in whole or in part. The discretion can only be exercised if APRA is satisfied that special circumstances apply which would make it unjust or oppressive to charge the fee, or the full amount of the fee.

)  28. An example of a case where a waiver or refund would be justified is where an applicant applies for the wrong kind of licence by mistake, and withdraws the application before APRA has

done any substantial amount of work conside1ing the application. However, as indicated in paragraph 17 above, the mere fact that the application is unsuccessful, for whatever reason, or that APRA tells the applicant that the application will be unsuccessful, would not justify a waiver or refund, either of the initial licence fee or of the fee payable in respect of any further application that the applicant may subsequently make.

Charges must be reasonably related to the costs and expenses incurred

29. As indicated above, the charges set by the instrument are fixed on a cost recovery basis for the services to which they apply. The charges are based on the average amount of effort involved in the discharge of APRA's statutory licensing responsibilities, and incorporate all the direct costs and appropriate overheads.

Charges must not amount to taxation

)  30. As the charges are reasonably related to the costs incurred by APRA in processing and dete1mining licence applications, the charges do not constitute a tax.

No retrospectivity

31.      The charges are prospective only, in that they are only payable in respect of licence applications that are lodged with APRA on and after the date of gazettal of the instrument.6

6 By virtue of subparagraph 48(l)(b)(iv) of the Acts Interpretation Act 1901.

PART 2 - REGULATORY IMPACT STATEMENT

Identification of issue

32.      The issue is how to fund APRA's costs of processing and determining licence applications lodged by bodies corporate seeking to be licensed as ADIs, general insurers and life companies.

Objective

33.       The objective is to ensure that APRA's processing and determination of licence applications for ADIs, general insurers and life companies is funded in a way that is efficient, that is fair as between regulated entities, that does not have a negative impact on competition and innovation in the financial industry, and that ensures that APRA is able to perform its licensing functions to the standard of quality and thoroughness that is prudentially warranted, without impairing APRA's ability to perform its other regulatory functions.

Identification of options

)

34.       There are only two funding sources available to APRA from which its costs of processing and determining licence applications can be funded:

-       APRA's annual budget, which is funded by the annual supervisory levy paid by all regulated entities; and

-       a specific charge for licensing imposed under subsection 51(1) of the APRA Act.7

35.       The legislation under which the annual supervisory levy is imposed is mentioned in paragraph 12 above. The levy is quantified (in annual Treasurer's determinations made under the levy imposition Acts) as a specified percentage of the value of the regulated entity's assets, subject to maximum and minimum limits. The specified percentage and the specified maximum and minimum levy amounts are different for different categories of regulated entities.

36.       The available options are built around these two available funding sources. The options that are reasonably practicable are considered to be:

Option 1 - Do not charge a licence fee, but fund the licensing from APRA's annual budget.

)

This is the current position - at present APRA does not charge licence fees but funds

its licensing activities from its annual budget.

Option 2 - Charge a licence fee, quantified at the average cost of licensing each category of regulated entity.

That is, charge a fixed licence fee of $X in respect of applications for licensing as a bank, $Yin respect of applications for licensing as a building society or credit union, and so on, where $X is the average cost of dealing with applications for licensing as a

7 A third potential source of funding is afforded by subsection 9A(2) of the APRA Act (which provides that APRA may, with the approval of the Minister, enter into an agreement with a State, Territory or other person under which APRA is, for a fee, to provide prudential regulation or advice services). However, services provided under subsection 9A(2) agreements only constitute a very small proportion of APRA's total activities. Moreover, most of the fee earned under such an agreement would go to cover the cost of providing the service for which the fee was charged, with only the profit component being available to fund APRA's other activities, including licensing. Hence, fees earned under subsection 9A(2) agreements do not represent a significant potential funding source for licensing.

bank and $Y is the average cost of dealing with applications for licensing as a building society or credit union.

Option 3 - Charge a licence fee, quantified as the actual cost of dealing with each individual application.

That is, charge each applicant the actual cost of dealing with their application, on a time and materials basis. This would necessitate recording the amount of staff time actually spent on the application, and possibly also disbursements such as photocopying, faxing, long distance phone calls, courier fees, taxi fares and so on that are expended in the course of dealing with the application (although a variant of this option would be to simply charge a standard mark-up on the staff time to cover disbursements).

Option 4 - Charge a licence fee, quantified either as under option 2 or option 3, but discounted for some or all categories of regulated entity.

For example, ascertain that the average cost of dealing with applications for licensing

) as a credit union is $20,000 (as under option 2), and then set the licence fee for credit unions at the discounted sum of, say, $10,000. Resort to this option would only be

warranted if and insofar as charging the licence fee at the full cost recovery level constituted a significant barrier to entry for a particular category of regulated entity. The purpose of the discount would be to reduce the fee to a level where it ceased to be a barrier to entry.

Impact identification

37.      Options 2, 3 and 4 will have a direct financial impact on entities applying to be licensed as ADIs, general insurers or life companies, as they will have to pay the licence fees.

38.      Option 1 (which represents the current state of affairs) will not impose any specific financial burden on licence applicants, but it will impose an indirect financial burden on the general body of regulated entities, because they will have to subsidise the cost of licensing applicants through the annual supervisory levy they pay (which will have to be higher than it would be if APRA's costs of licensing were met by licence fees).

)

39.       All the options have a relatively small indirect financial impact on depositors and

policyholders of ADIs, general insurers and life insurers, insofar as regulated entities pass on to them either the licence fee or the higher annual supervisory levy that results from the absence of licence fees. (Depending on market conditions, regulated entities may be forced to absorb some or all of such costs themselves rather than passing them on to their customers.)

40.       Options 2 and 3 could potentially also have an indirect non-monetary impact on consumers if the licence fee acts as a barrier to entry by new ADIs or insurers, especially smaller ones. In that case, the licence fee could result in a diminution of competition and innovation in the banking, general insurance or life insurance sectors. (The discount in option 4 would be designed to minimise or eliminate the possibility of the licence fee acting as a barrier to entry.)

Assessment of costs and benefits

41.       Option 1 (which involves funding APRA's licensing activity out of its annual budget derived from the annual supervisory levy paid by all regulated entities) has several disadvantages.

42.       First, it is lacking in fairness and equity as between licence applicants and other regulated entities. Licence applicants generate significant costs for APRA of dealing with their licence application, and they obtain a valuable commercial benefit if their application is successful, namely the 1ight to carry on business as a financial institution of the relevant kind in a regulated market to which entry is controlled. It is prima facie fair and reasonable that they should bear the costs of their licensing, rather than forcing the general body of regulated entities to subsidise those costs through the supervisory levy.

43.      Second, option 1 can potentially unde1mine the quality and effectiveness of APRA's prudential regulation. This is because it is not designed to provide APRA with sufficient funds to enable it to carry out both its licensing function and its other regulatory responsibilities effectively and to the optimum standard. APRA cannot accurately predict the number and type of licence applications it will receive in a given financial year. If it has to fund licensing from its annual budget, then if it receives more licence applications than it has budgeted for, but receives no matching increase in revenue to fund its processing of them, it will be faced with a choice between:

-       not expending as much staff time and resources on processing the licence applications as is

)  prudently required (which will create increased prudential risk due to inadequate vetting of the applicants); or

-       cutting back on its other regulatory activities and functions such as policy development, setting prudential rules and standards, monitoring regulated entities and enforcement (which will create increased prudential 1isk due to such cutting back).

44.      The charging of licence fees, as advocated under options 2 to 4, overcomes these disadvantages. Charging licence fees gives effect to the user pays philosophy under which those who obtain the benefit of a service are expected to foot the bill. User pays is also fairer to the general body of regulated entities, who no longer have to subsidise the cost of dealing with licence applications. It also eliminates the potential distortions of APRA's regulatory functions referred to in paragraph 43 above - licence fees will enable APRA to devote sufficient time and resources to licensing, without detracting from its ability to carry out its other important regulatory responsibilities.

45.      For these reasons, option 1 should be rejected in favour of one of the other three options which involve the imposition of a licence fee.

)

46.       A potential disadvantage of licence fees is that, if they are set at a high level relative to the

financial capacity of prospective new entrants, they could constitute a barrier to their entry, thereby having a deleterious impact on competition and innovation. Option 4 is designed to avoid this. However, option 4 is unnecessary. This is because small entrants are likely to fall into the building society, credit union or friendly society categories, and the costs of licensing these kinds of entities is relatively low at $20,000, and hence the licence fee for them is set at the same amount plus GST (which they are able to reclaim). An impost of $20,000 is unlikely to be a

serious obstacle for any viable building society, credit union or friendly society applicant, even a small one.

47.      The position is similar as regards the relatively small amount of $30,000 payable by specialist credit card institutions.

48.       Banks, general insurers and life companies other than friendly societies will have to pay higher fees of $62,000 and $50,000 respectively. However, by their very nature these businesses require a large amount of capitalisation and infrash11cture, and in the context of such requirements licence fees of these amounts will not act as barriers to entry.

49.      Thus, option 4 should be rejected as unnecessary in the circumstances.

50.      This leaves options 2 and 3 to choose from. Option 3, where the licence fee is tailored individually to reflect the actual cost of handling the particular licence application, may be theoretically superior, but implementing it would be too costly and impractical, because APRA does not have the sophisticated individual client-based cost recording and billing system that would be needed to implement it. It would be too costly to introduce such a system solely in order to enable option 3 to be adopted, especially as the fixed lump sum licence fees under option 2 do reasonably approximate actual cost.

51.      Thus, option 3 should also be rejected.

Consultation

52.       APRA holds annual consultations with financial industry representative organisations as well as the Australian Consumers' Association (which represents the interests of consumers of financial services) concerning the level of the following financial year's supervisory levy. The

) consultations concerning the levy for the 2003-2004 financial year took place in April and May 2003.8 During those consultations APRA advised of its proposal to introduce licence fees (as

well as fees for other elective services).9 APRA has also foreshadowed the introduction of such fees in the course of the consultations with industry currently occurring as part of the wider­ ranging "Review of Financial Sector Levies" which was established by the Minister for Revenue and Assistant Treasurer in October 2002.10

53.      There has been general support from the industry organisations for fees for specific services, including licensing. This is mainly because such fees reduce the supervisory levy and hence the cross-subsidy by the general body of existing regulated entities of services which are only provided to, and which only benefit, individual entities. Indeed, this cross-subsidy effect is magnified in the case of the licensing of new applicants, as they will not yet have made any contribution to APRA through the supervisory levy - and if their application is unsuccessful, they will never make such a contribution.

54.      The licence fees will by definition be payable by entities that are not yet regulated. The interests of such entities are not necessarily adequately represented by industry organisations

) whose membership comprises currently regulated entities. However, potential applicants for licensing do not have their own representative organisation, and are too diffuse and indeterminate

a group to make it practicable for APRA to consult them. APRA is conscious that this is a shortcoming in the consultation process, but it cannot be helped. APRA has (as noted in paragraphs 46 to 49 above) taken into consideration the potential for the licence fee to act as a barrier against new entrants to the industry, concluding however that it will not in fact constitute such a barrier.

8 The industry organisations consulted were: Australian Bankers' Association; National Credit Union Association Inc; Australian Association of Pem1anent Building Societies; International Banks and Securities Association of Australia; Credit Union Services Corporation (Australia) Ltd; Insurance Council of Australia; Australian Friendly Societies Association; Investment and Financial Services Association Ltd; Australian Finance Conference; Retirement Funds Association; and Australian Institute of Superannuation Trustees.

9 Australian Prudential Regulation Authority Discussion Paper/or Consultation with the Financial Sector Industry on Levies for 2003-04 section 9 (p 11).

10 Media release by Senator Helen Coonan, Minister for Revenue and Assistant Treasurer, entitled Review of Financial Sector Levies No Cl 15/02 dated 29 October 2002.

Conclusion and recommended option

55.      For the reasons set out in paragraphs 41 to 51 above, option 2 is the preferable option. That is the option implemented by the instrument.

)

)