The recent Royal Commission into the failure of HIH Insurance was not very impressed with the Australian Prudential Regulation Authority. APRA is the regulator of the financial services industry. It was created by Federal legislation.

It has responsibility not only for general insurance companies but also for banks, credit unions, building societies, reinsurance companies, life offices, friendly societies and a large part of the superannuation industry. In total it currently regulates some $1500 billion in assets for 20 million Australians.

The Royal Commission concluded that APRA's performance in supervising HIH had not been good. It had missed many warning signs, had been slow to act and had made misjudgements about some vital matters.

However, the Commission conceded that APRA did not cause or contribute to the collapse of HIH; nor could it have taken steps to prevent the failure of the company. It pointed out that a regulator cannot be expected to provide a guarantee that no company under its supervision will ever fail.

Earlier this year APRA requested another insurance group, Tower Australia Limited, to top-up its surplus assets by $30 million. This top-up was to be in addition to the minimum asset requirements specified under the legislation.

APRA said that it had been monitoring the situation at Tower since November 2002 and that it would continue to watch Tower's reserving levels. It would also carry out detailed investigations into the company's business.

THE DANGER OF PANIC

While the call for more money and the foreshadowed more intense supervision were both most reasonable the public announcement of these moves was not. It could easily have been the kiss of death for the companies.

Such statements by an official regulator could well have precipitated the equivalent of a "run on the bank". This term implies a panic rush by anxious customers to withdraw their money from a financial institution while they still can. Often such action leads to the formation of queues outside its premises.

Panic is sometimes started accidentally - for example, by some ill-chosen words in the media. Rumours may also be propagated by competitors or for malicious reasons. However, at the time the separation of fact from fiction by investors is usually not feasible.

Once an organisation closes its doors - or when a moratorium is imposed by the authorities - it becomes too late to take any useful action. Even if such a development does not lead to a permanent loss of capital for the unfortunate investors caught up in the situation it can result in money becoming frozen and not earning any interest for many years.

Depositors in savings institutions are effectively faced with a one-way option once a run is in progress and have little to gain by remaining loyal.

Announcements in regard to a company's financial problems can easily become a self-fulfilling prophecy: for example, even a highly liquid institution can quickly become illiquid if enough people act on the rumour concerned.

Even sensible commercial steps to deal with the problem - such as attempts to sell assets and/or to raise loan funds in a hurry and in secrecy - may just fuel additional harmful rumours and speculation.

Furthermore, many people feel that denials of problems in such circumstances cannot ever be relied upon, as such denials would invariably be made for obvious commercial reasons, whether justified by the facts of the particular situation or not. This warning applies equally to denials by the organisation concerned, to denials by friendly competitors, to denials by industry associations and even to denials by government spokesmen.

The actions of APRA in going public on the Tower issue, while no doubt well intentioned, have set a most dangerous precedent.

© N E Renton 2003