Structure of Australian Financial Institutions, Market Share and Assets - Coursework Example

Financial Institution Management Name: Instructor: Course: Institution: Date: Financial Institution Management Introduction Over the past several decades, the Australian financial system has developed considerably from being owned by local investors and the government to a more liberalized sector attracting investors from all parts of the globe. In addition to banks, the sector has also expanded to include other institutions such as financial trusts, life insurance corporations, credit unions, and many other institutions (RBA 2006). Correspondingly, the legal framework has also developed, with supervisory and regulatory responsibilities being devolved from the Reserve Bank of Australia (RBA) and the Treasury to other bodies, especially the Australian Prudential regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). These agencies have ensure a sound and stable financial system in the country through enforcing various international and national financial requirements, which have seen the country withstand various economic challenges, including the recent global financial meltdown. This report explores the Australian financial institutions in terms of their structure, the legal framework governing their operations, and some of the challenges they face. Structure of Australian Financial Institutions The structure of the institutions has remained relatively unchanged compared to institutions in other First World countries. However, the industry has seen much development, especially regarding the kind of financial institutions. Today, there are many financial institutions in the country, with the major ones including authorized deposit-taking institutions (ADIs), managed funds, registered financial corporations, and insurance institutions. ADIs, which consist of banks, building societies, and credit unions, remain the leading financial institutions in the country in terms of assets and market share. Market Share and Assets According to Donovan and Gorajek (2011), ADIs enjoyed a market share of about 60 percent of the Australian financial industry by the end of 2010. Over the same period, their assets amounted to over $2.5 trillion, which is because of improved rates of loans to individual borrowers. Australian banks take up the largest share – more than 95 percent – of the ADIs’ assets. The total domestic assets of the major players in the banking sector - National Australia Bank, Commonwealth Bank of Australia, Westpac Banking Corporation, and ANZ Banking Group - amount to about $1.9 trillion, which represent about 75 percent of assets owned by ADIs. In addition, local assets of the remaining smaller banks fall between $40 million and $70 billion, with locally owned and internationally owned ones accounting for 9 percent and 13 percent of ADIs’ portfolio respectively. The market share and asset base of banks have been increasing over the last five years, while that of building societies and credit unions have been slumping. By December 2010, both institutions controlled an insignificant share of the Australian financial market, with their total assets representing less than 5 percent of portfolio owned by ADIs. Majority have asset bases of not more than $1 billion, a situation that has forced most of them to consolidate their assets to keep up with the competitive pressure in the industry. The following table provides a comprehensive overview of total assets owned by the three forms of ADIs, as well as their corresponding market share. Table 1: Assets and market share of Australian ADIs Like the credit unions, the prominence of RFCs in Australian financial market has been declining over the years. Today, Australian RFCs comprises of about 110 finance firms and more than 20 money market firms, which act solely as intermediaries between credit providers and seekers (RBA 2006). They control a market share of not more than 4 percent of the financial industry, with most of them having an asset base of about $100 million and a few, assets worth $20 billion. Compared to banking sector, managed funds sector (composed of public unit trusts, life insurance corporations, and superannuation funds, among other forms of trusts) in Australia enjoys considerable growth from year to year. As at December 2010, they had a market share of about 30 percent, controlling assets worth $1.4 trillion. In this category, the superannuation funds seem the most prominent, representing more than 60 percent of the total funds. Other than the life insurance corporations, insurance firms in the Australian financial industry represent only an insignificant share of 3 percent, which is equivalent to about $133 billion assets. The other major part of the Australian financial institutions, securitization vehicles (composed mainly of residential mortgage-backed securities (RMBS)), has a market share of less than five percent. The recent financial crisis, which had significant impacts of the residential markets across the globe, bears much of the blame for the low market share of the vehicles. The following graph demonstrates the structure, in terms market share, of the aforementioned institutions over the last two decades. Figure 1: Assets of various financial firms over the last 20 years (Source: Donovan & Gorajek 2011, p.30) Ownership Since the Campbell Inquiry that saw massive deregulation of the Australian financial industry, ownership of financial institutions differs from one institution to another, as well as within the different types of institutions. According to RBA (2006), Australian government no longer owns any banking institution, as it offloaded its last shares in the sector in 2001. Instead, out of the 53 banks operating in the country, foreign institutions own 39 and Australians own the rest. All the banks trade on the Australian Stock Exchange (ASX) except one small banking institution, which is owned by a conglomerate of superannuation funds. Like the banks, some building societies trade on the ASX, while others have mutual ownership structure. As opposed to ASX-listed institutions where owners are their shareholders, owners of building societies are both their stockholders and consumers. In comparison to the societies, credit unions are mutually owned institutions in Australia. Banking institutions own majority of RFCs, while ownership structure of managed funds varies from retail funds to self-managed funds. Retail funds include those that offer their share rights to the public, whereas ownership of self-managed ones is limited to a small number of investors. Legal Structure of the Institutions The Council of Financial Regulators, which is composed of three main regulatory agencies, carries out supervision and regulation of financial institutions in Australia. The agencies include the RBA, the ASIC, and the APRA, all of which execute their specific responsibilities collaboratively. RBA’s main responsibility involves regulating the institutions to ensure financial stability in the country. To achieve this, it monitors and moderates risks in the Australian financial structure, oversees the security of the payment structure, and advises other regulatory agencies and government on financial issues affecting the structure, among others (RBA 2011). The principal responsibility of ASIC regards regulating financial markets to ensure accountability and transparency as stipulated in the Corporations Act and Financial Services Reform Act 2001. The scope of its regulatory and supervisory work entails ensuring comprehensive and prompt disclosure of financial market data, regulating and supervising activities of market players, and providing guidelines and standards for the market. Of the three agencies, APRA remains the most important regulator of all financial institutions in Australia, with the main responsibility being to ensure prudency in terms of capital adequacy and liquidity in the banking sector. According to Gorajek and Turner (2010), APRA monitors and regulates banks’ capital sufficiency according to Basel II standards set out by the Basel Committee on Banking Supervision (BCBS). As per the standards, APRA mandates banks to maintain at least a risk-weighted capital ratio of 4% (referred to as tier 1 capital) and 8% (for total capital). This regulation applies to all ADIs, both small and large. APRA also requires banks to individually satisfy a predefined tier I and total asset ratios above the minimum stipulated in the Basel II rules, which is often in range of 10 to 20 percent. In regard to supervision and regulation of liquidity of banking institutions, APRA requires banks to adhere to qualitative and quantitative provisions as stipulated in Australian Prudential Standard (APS) 210 (APRA 2009). Qualitative provisions require banks to observe various liquidity risk management practices to ensure that they maintain assets of exceptional quality, which can be easily traded or used as collaterals in private stock markets. The agency’s approach on quantitative requires differs between small and large banking institutions. It requires smaller banks to preserve a minimum liquidity holdings (MLH) requirement of about 9 percent of financial obligations in liquid assets. It mandates large institutions to carry out frequent scenario analysis to evaluate their liquidity under varying market situations. Besides, the agency mandates them to integrate APRA-stipulated scenarios of name crisis (ability of an institution to meet its liabilities under favorable market conditions for one month) and going concern (ability to meet obligations for not less than five days under unfavorable conditions) in their analysis. Challenges faced by Australian Banks Compared to banks in other countries, Australian banking industry seems to have escaped the effects of the recent financial crisis. The industry did not experience any significant impacts, with the majority of the banks registering profits during the crisis. According to Ellis (2009), the banks were able to withstand shocks associated with risk because they were not heavily involved in overseas operations compared to their counterparts in other developed nations. Instead, the concentrated much on domestic operations, borrowing funds and providing their financial services to local consumers. Moreover, APRA’s early measures in the housing and mortgage industries cushioned the banks against the effects of the crisis. For instance, the financial regulatory agency increased capital provisions of particular mortgage products, which were believed to be more vulnerable to the crisis. However, the industry experienced some minimal impacts emanating from the financial markets. As Debelle (2009) notes, reduced public confidence in the stock markets due to the crisis led to a decrease in the stock prices of most of the Australian banks. This affected mainly internationally owned banks and a few Australian-owned ones, which had issued their shares on offshore markets. Following the fall of the Lehman Brothers, offshore investors lost confidence over the financial markets and offloaded their stocks to Australian Local Markets. As the crisis had saw a slight fall of the Australian dollar in respect to the US dollar, such offloading meant that the banks experienced some foreign exchange risks. The ongoing European sovereign debt crisis is also putting some pressure on the Australian banking sector. Investors and consumers are losing confidence, which has started to impact on the sector, with some banks registering decline in the stock prices and sales volume. Recommendations Although the Australian Financial system has been able to withstand the recent global financial meltdown, the minimal impacts that appeared in the system towards the end of the crisis indicate that it could have given in if the crisis went on. Thus, more regulatory requirements need to be implemented, especially with respect to capital adequacy and liquidity of banking institutions, to avert downturn of the local economy. The Basel III set of standards may be an effective option to enhance the framework. APRA needs to include requirements of liquidity risk management and insolvency provided by these standards immediately, but not in the beginning of 2013 as it argues. This may provide the solution to prevent a secondary economic turmoil in the country’s financial sector from the unfolding European sovereign debt crisis. References Australian Prudential Regulation Authority (APRA) 2009, ‘APRA’s prudential approach to ADI liquidity risk,’ Discussion Paper, 11 September. Debelle, G 2009, Some effects of the global financial crisis on Australian financial markets, RBA, 19 August 2011, Donovan, B, & Gorajek, A 2011, ‘Developments in the structure of the Australian financial system,’ RBA Bulletin, June, pp. 29-40. Ellis, L 2009, The global financial crisis: causes, consequences, and countermeasures, RBA, viewed 19 August 2011, Gorajek, A & Turner, G 2010, ‘Australian bank capital and the regulatory framework’, RBA Bulletin, September, pp. 43-50. Reserve bank of Australia (RBA) 2006, ‘The structure of the Australian financial system,’ Financial Stability Review, March, pp. 49-51. RBA 2011, About financial stability, RBA, viewed 19 August 2011, Read More