Unlike bank boards, APRA can ignore the shareholders’ views and direct the institutions it regulates to include non-financial metrics – like conduct and compliance risks – as set pieces of their remuneration schemes.

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If there’s one compelling conclusion that can be drawn from the past several years it is that there are very severe financial consequences – for institutions, executives and shareholders as well as customers – of bank misconduct and compliance failures.

In fact it isn’t only the direct financial costs of the banks’ conduct and compliance breaches that weigh on the sector.

The reputational and brand damage and the external responses to the revelations of their behaviour – the major bank tax, the calling of the royal commission, the searing insights into their misconduct the hearings provided and the multitude of recommendations – have destabilised the institutions, done lasting damage to the value of their franchises and caused them to be more intrusively regulated.

APRA is a prudential regulator which has previously focused on trying to ensure the stability of the financial system and the individual stability of the institutions within it.

While it has issued guidance and standards on executive remuneration structures, it has looked at incentives almost exclusively through the lens of financial stability and soundness and largely ignored the relationship between variable remuneration and misconduct and compliance failures even as that relationship has become the subject of increasing attention offshore.

APRA has been reviewing its approach to remuneration.

When the review started in 2017 it was largely focused on financial risks. It has, however, been evolving, with APRA chairman, Wayne Byers, telling the commission that the regulator was in the process of changing its prudential standards and guidance to deal expressly with the potential of poorly-designed and implemented schemes to increase the risk of misconduct.

Hayne, quite properly, says prudential regulation and supervision of remuneration arrangements should have, as one of its aims, the reduction of misconduct by financial institutions. Recent history might suggest that the dominant emphasis on relatively short term shareholder returns in executive incentive arrangements has actively encouraged misconduct.

The APRA-commissioned panel that inquired into CBA’s failings concluded that the bank’s financial success and the strength of its record on financial risks had made it complacent and dulled its senses when it came to non-financial risks. There was a lack of oversight on emerging non-financial risks at board level and little ‘’sting’’ within the remuneration framework for senior management when those risks materialised.

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An APRA survey of remuneration practices in large financial institutions last year concluded that, in most instances, the metrics in the scorecards were tied to financial performance but Hayne, while recognising that there is no optimal system of executive remuneration, was adamant that ‘’financial metrics must not determine remuneration.’’

‘’Risks of all kinds, including reputation risk, compliance risk and conduct risk, must be taken into account in both designing and implementing the remuneration system,’’ he said.

As a matter of urgency, he wants APRA’s prudential standards to expressly require institutions to design their remuneration schemes to encourage sound management of non-financial risks and to reduce the risk of misconduct.

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He also wants APRA to gather more information about the way remuneration schemes are being applied in practice and whether they actually to promote the management of non-financial risks and do reduce the risk of misconduct.

If what gets measured is done then it even more the case that what gets measured and rewarded gets done.

If senior executives know that they will only get all, or indeed any, of their variable remuneration if they can individually successfully tick off the non-financial risks in their areas of accountability they’ll make sure those boxes are ticked.

There will be some shareholders, mainly institutional, who will resent the notion that anything other than near term shareholder returns should determine executive rewards.

If APRA limits financial metrics and insists on a reasonable level of input from non-financial measures – and even the use of non-financial measures as gateways before any long term incentives are awarded – neither the institutions nor their shareholders will have any choice but to accept its rulings.