Necessity of Australian Prudential Regulation Framework - Case Study Example

Introduction This paper looks at the Australian Prudential Regulation Framework. Secondly, it explores the necessity of this framework. Lastly, it looks at the role of the Reserve Bank of Australia in managing the effects of the Global Financial crisis in early 2008. The Australian Prudential Regulation Framework Australia’s prudential regulation framework, gives the Australian Prudential Regulation Authority (APRA), the authority to oversee the functions of financial institutions to gauge whether such institutions are in need of restructuring, capital investment and or a change in the management. Formed in 1998, APRA is the regulator of the Australian financial service industry. It was brought into existence by the enactment into legislation of the Australian Prudential Regulation Authority Act of 1998. The mandate of APRA canters on supervision of several financial institutions such as: credit unions, reinsurance, general insurance, the superannuation industry, building societies, life insurance and other financial institutes. Above all, the responsibility of the APRA is to ensure that these financial institutions live up to the promises that they make to investors (RBA, 2012; APRA, 2012). APRA is fundamentally concerned with management of risks by investors in financial institutions. Henceforth, the APRA is also concerned with minimising the risks where they are unavoidable (APRA, 2012). Under the Australian Prudential Regulation Authority Act of 1998, on evaluating the status of financial institutions APRA can take either of the following actions. First, it may withdraw licences, replace members of the management or specific service providers, it can also merge a financial institute with another, and restrict business activities until certain concerns are addressed or alternatively run-off the existing businesses all together. Further, the APRA has authority to quarantine assets, appoint an inspector, a judicial manager or a provisional liquidator to shed light into the dealings of the financial institution. In addition, the APRA can also issue directions for sanctions or place the company into receivership also known as liquidation (APRA, 2012). According to APRA (2012), in 2002 the financial oversight authority introduced assessment and supervisory response tools dubbed Probability and Impact Rating Systems (PAIRS) and a set of supervisory oversight and Response Systems (SOARS). The PAIRS are meant to asses actions that the APRA can take in a given situation while SOARS provide crucial information on how supervisory concerns based on PAIRS are determined. Hence, the APRA is tasked with ensuring that financial organisations operate under sound financial status that are reflective of sustainability. ARPA has authority within its jurisdiction to halt the operations of a financial institute that it deems is operating in contradiction of certain stipulations. Also, the ARPA can delegate the administrative responsibilities of a failing financial institute to another that is far better performing. The International Monetary Fund (2006), points out that the ARPA has the powers to initiate court injunctions and generally power to assess the fitness of financial institutions. The central objective of the APRA as earlier mentioned is concerned with risk reduction and it does this by collaborating with financial institutions to develop appropriate solutions to financial challenges facing such institutions (IMF, 2006). The banking Act of 1959 spells out the obligations of the APRA framework in terms of liquidity requirements and capital adequacy. First, on Authorised Deposit taking Institutions (ADIs) are expected to hold capital as a buffer against unforeseen losses due to unpredictable market trends. ADIs include credit unions, banks and financial institutions that are incorporated locally. Moreover, the ADIs are required to operate with a minimum balance of capital adequacy ratio maintained at 8% at both stand alone and consolidated levels. APRA therefore must ensure that ADIs meet these two fundamental requirements in their operations (Australian Government: The Treasury, 2013). The need for Australian prudential framework The need for the Australian prudential framework extends to the fundamental requirement that investors interests are safeguarded and that there is adequate security for their investments. APRA (2012), emphasises that the need for the oversight authority is based on evaluation of ‘risks’. Thus, the need for a body that can examine the vulnerabilities that financial institutions are exposed to can serve to anticipate financial challenges that are eminent and therefore take appropriate measures to counter them. Moreover, this framework is necessary to put to check financial institutions that per-say depict irresponsibility in the manner in which they handle the financial risks that they get caught up in and more importantly to ascertain that these institutions take appropriate measures to avert the effects of such risks. In certain conditions the APRA may take legal action to ensure that there is improvement of the financial status of financial institutions by ensuring that APRAs concerns and consequences there-in are not ignored. Polizatto (1990) point out that the Australian prudential framework incorporates standards that serve to stabilise the financial systems in Australia. The necessity of this stability goes beyond just safe guarding the financial system but in stabilising the economy at large. Furthermore, the standards in this framework are important in evaluating or re-evaluating financial institutions that have failed in the promises they made to their investors or that are near failure. Under the Australian prudential framework, APRA has the mandate to take appropriate measure to re-organise the management of such institutions to secure investors capital or to bar such organizations from further operations by withdrawing licences. Putting a stop to such financial institutions’ operations ensures that no further loses are incurred by stakeholders which is the fundamental objective of APRA (APRA, 2012; Australian Government: The Treasury, 2013). This framework is therefore useful in averting market failures by ensuring that promises made to investors are fulfilled or at the very least minimised. Hence in the face of financial crises such as imminent insolvency APRA provides feasible framework with which financial institutions can exit the market causing minimal damages in terms of the financial losses incurred. In addition, the Australian prudential framework provides APRA the mandate to financial institutions that are deemed of sound financial status. APRA categorises such institutes as ones with foreseeable circumstances in the sense that they have robust governance and control frameworks to forecast a strong capital position. This categorisation serves important in informing potential investors as well as those currently investing in the financial institutions that the risks in the company are generally limited (APRA, 2012). The Reserve Bank of Australia and the Global Financial Crisis of 2008 The global financial crisis of 2008 was one that saw various economies around the world tumble due to the financial implications that befell different economies. Australia was not an exception and as per the Gold Coast Bulletin report dated November 24th, 2011. The RBA’s response to the global financial crisis was to develop policies that would avert a repeat of the 2008 global financial downturn. In this strategy the RBA developed the Base III reforms which are a basically a set of regulations that are aimed at defining international banking standards. The set of legislation focuses centrally on ensuring that the central bank of Australia provides a framework of guaranteeing that commercial banks have adequate financial security in times of financial crisis such as the one experienced in 2008. The concern of the implementation of the Basel III regulations is to increase liquidity in terms of assets possessed by financial institutions such as commercial banks. In this way, during a financial downturn the financial institutes can then dispose the liquid assets for money in desperate times when faced with difficult financial situations. Government bonds are such liquidity assets that financial institutions are encouraged to buy and sell off during financial crises such as the global financial crises of 2008. The Basel III framework also includes the provision that the RBA and the APRA would allow banks to use other high-quality liquid assets in securing their capital base (The Gold Coast Bulletin, 2011). The RBA adopted a tight monetary stance after the global financial crisis experienced in 2008. Soon after, there were marginal results as by March of 2008 a rise of 3.25% in the cash rate was realised. Later the projected growth of the Australian economy along with growth of economies of trade partner states expanded as forecasted by the year 2010. Hence, the move by the RBA to tighten monetary policy served to catapult the economy back recovery. To further improve on the economic stability, the RBA made a bold move in reducing rates on interests by 1% percentage point to 6% from 7.25% (Cusbert & Rohling, 2013; RBA, 2013; Thangaraj & Chan, 2012) this ensured increase in investments across the country that in turn had a great impact in sustaining economic development. Conclusion The Australian prudential framework is necessary in ensuring the security of investors interests in financial institutions. This framework is generally concerned with minimising risks that investors may incur when placing their capital in a financial institution. Furthermore, it provides mandate to APRA such that it oversees the activities of financial institutions to ascertain that they are operating under specific stipulations to ensure economic stability especially in times of financial crises (APRA, 2012; The Gold Coast Bulletin, 2011; The Australian Government: The Treasury, 2013). The Reserve bank of Australia has also put in place several measures that are aimed at prevention of loss incurred during financial crises such as the global financial crisis that was experienced in 2008 (Queensland Economic Review, 2009; The Gold Coast Bulletin, 2011). More importantly, drawing from lessons from the 2008 financial crisis legislation has been enacted to ensure that financial institutions especially commercial banks secure capital in the event of a recurrence of a financial crisis such as the global financial crisis of 2008. References Australian Government: The Treasury (2013). Appendix 3.1: Australia’s Prudential Framework. Retrieved on July 9 2013 Australian Prudential Regulation Authority (2012). Supervisory Oversight and Response System. {Online} www.apra.gov.au/CrossIndustry/.../SOARS-062012-External-version.pdf.‎ Cusbert, T. & Rohling, T. (2013). Currency Demand during the Global Financial Crisis: Evidence from Australia. Research Discussion Paper 2013-01. Retrieved on July 9 International Economic Conditions and Financial Markets (Oct 2009: 5) [online]. Queensland Economic Review. Retrieved on July 9 ISSN: 1038-3182. International Monetary Fund (IMF) (2006). Australia: Financial Sector Assessment Program Detailed Assessment of Observance of Standards and Codes (EPub). Washington DC: IMF. The Gold Coast Bulletin. (2011, Nov 24). RBA's liquidity facility set to help banks stay afloat. Retrieved July 9 2013 from Reserve Bank of Australia (RBA) (2012). Australia's Financial Regulatory Framework. Retrieved on July 9 2013< http://www.rba.gov.au/publications/annual- reports/cfr/1999/aus-fin-reg-frmwk.html> Reserve Bank of Australia (RBA) (2013). About the RBA. Retrieved on July 9 2013 Thangaraj, R. K. & Chan, T. K (2012). “The effects of the global financial crisis on the Australian building construction supply chain.” Australasian Journal of Construction Economics and Building, 12 (3):16-30. Read More