Australian Prudential Regulation Framework and the Need for the Framework - Case Study Example

Running Head: Financial Crises Name Course Lecturer Date Australian prudential regulation framework and the need for the framework According to the Australian Prudential Regulation Authority Act 1998, the Australian prudential regulation authority is an independent body that was established and mandated with the responsibility of ensuring there is a good and stable financial system in Australia. To effectively do this it had to promote good conduct while carrying out business, ensure ethical issues are upheld and that consumers are protected from exploitation by financial institutions, Llewellyn (2006). That is why the authority came up with a prudential framework. These are rules, guidelines and standard through which stability in financial institutions is promoted. They help in facilitating proper management of financial services and reduction in risks. The framework facilitates the supervision of the financial institution and thus avoiding any crisis that would arise. This is very important to the Australian economy since most of the population has invested in the financial market. The framework ensures a standard way of carrying out business among the financial institutions that are registered with the authority. This promotes the confidence of the customers. It also facilitates treating customers fairly as the financial institutions regulator guidelines. This facilitates the maintenance of integrity among customers, investors and the service providers. The prudential framework was developed when the authority realized that due to lack of regulation in the financial system there was a lot of dissatisfaction on the services provided and there was no trust on the financial institutions. The framework was also necessitated by the rise in technological changes that needed to be updated for an effective capital market. This was to ensure stability in the financial system. The framework was also developed since there was need for consistency in ensuring consumer protection, upholding business ethics and curbing market failures to enhance a stable market Cooper &Valores (2006). Through the framework there is adequate supervision of the various factors in the financial system. This has facilitated the timely assessment of risk and control of insolvency through proper determination of capital to promote capital adequacy. Prudential framework has also facilitated proper coordination of institution eliminating any form of unhealthy competition. This has been done by dealing with all market externalities and ensuring that effects in one sector are not felt in other sectors. The framework has also provided guidance to customer in making decisions on the ability of the financial institution to be in continued operation thus keeping the promises made to customers and ensuring that the customers are protected from losses. According to, Authority (2011) financial institutions that are mandated with deposit taking apply prudential regulation framework (ASP110, 111 &116). These are banks, building societies and credit unions .They are required to always have extra capital so that incase of losses their activities will continue as they solve the problem leading to losses. This framework enables the financial institutions determine their capital adequacy requirements so that they are able to maintain it always at a minimum risk-based of 8T%. This is in agreement with the Basell 2 requirements for capital adequacy and ensures that the institutions are not rendered bankrupt. The framework also provides a guideline to them on determination of risks as they carry out their activities. They also apply ASP 210 which enable them maintain their liquidity and that the deposit taking financial organizations are not unable to meet their obligations to their clients. This equips them with strategies through which effective liquidity management is achieved. The Australian prudential framework was also designed for life and general insurance companies and depository institutions. This is to protect them in case they have to make some major decisions. For example if it is proven that they have to be liquidated then the framework provides guidelines on the procedure to follow. These regulations also serve to govern the insurance companies so that they serve the shareholders efficiently. They do so by restricting their investments in assets and also providing a framework for providing the actuarial standard in creating the fund. This framework is really helpful in guiding the life insurance company in the management of their assets and liabilities so that they do not become insolvent and are unable to meet their obligations to their clients. They also provide guidelines in case there is need to terminate a policy Byres & Sector (2009). This framework is really important to Australia’s economy, despite the constant changes in the financial systems the regulations provide proper guidelines on how to deal with them thus strengthening the economy. They also enable financial institution to detect the areas that are more prone to risks and dealing with them in advance. Through the framework there is enhanced supervision of the institutions and thus marketers and consumers are assured of proper business environment. This has also facilitated working together with the Australian Reserve Bank How the Reserve Bank of Australia dealt with the 2008 Global Financial Crisis Australian financial institutions remained healthy though out the 2008 global financial crisis. Their deposits were guaranteed. Nevertheless, the demand for currency increased abnormally quickly in the late 2008 resulting in additional banknotes on issue by the end of the year. The surge in currency demand did not have any destabilizing effect on the banking system, indeed the bank deposits rose during the period. The reserve bank of Australia came up with policy measures control the same. First it maintained a conservative position on capital adequacy, introducing credit assessments by third party originators and higher capital charges for non conforming loans as (Bloxham & Kent, 2009) states. These measures ensured that the problems related with providing mortgages to less credit worthy consumers could not easily be transferred to other investors, such as happened in the sub-prime mortgage market in the US during the global financial crisis. Second, Eslake (2009) explain that the reserve bank considerably reduced interest rates to encourage demand. The cash rate mark dropped from seven percent in September 2008 to less than four percent in first quarter of 2009. The direction also acted to help small businesses and protect the jobs of more than five million workers who work in these businesses. In addition, Smaghi (2009) explains that the reserve bank gave a form of unconventional financial policies which resembled quantitative easing. These involved an expansion of the central bank’s balance sheet. However, the intention was not on the amount of reserves but somewhat the composition of securities and loans on the asset side. The credit easing approach focused on easing credit conditions by inspiring more active trade in some assets and through a process of investment substitution as Murray (2009) states. The ensuing improvement in credit conditions and reduction in credit spread had a stimulatory effect on aggregate demand. Moreover, the reserve bank advised the Australian government to deliver a series of stimulus packages, and consequently the government issued $42 billion nation building plan which focused on the direct investment in infrastructure. The bank argued that the move would provide a boost in output once the plan was implemented and improve the productive capacity of the economy in the long run. The plan also included incentives to support cash bonuses and housing construction to individuals. Furthermore, the reserve bank introduced a new regulation which aimed at preventing creation of further instability. The bank announced a ban on short selling on the Australian securities exchange (ASX) in September of 2008 to all stocks until 19th November and to financial stocks until 25th may 2009. Tougher regulation of margin lending was foreshadowed as a result of the announcement by the bank. Notably, as Peters et al (2011) confirms, the reserve bank provided debt and or equity funding to distressed banks. This prevented nationalization, bailouts and forced mergers with unhealthy institutions. The bank also did unfreeze and restore liquidity in the financial markets. It expanded the range of securities it would accept as collateral for repurchase agreements to as well include the private sector securities, this made the repurchase period being extended to more one year. Conclusions The global financial crisis made regulatory authorities to review and strengthen financial policies. The Australian Prudential Regulation Authority strengthened its frameworks to ensure prudent financial systems. This was considered paramount in avoidance of financial crises in future. Though the financial institutions in Australia were the least affected by the financial crises of 2008, the reserve bank put up strong measures to prevent collapse of the institutions. This ensured financial viability during the crises. With such policies, the financial systems are stable to withstand harsh trading terms as the global financial crisis. References Authority, A. P. R. (2011) Implementing Basel III capital reforms in Australia APRA, 20(20III), 20capital_disc Bloxham P, C Kent & M Robson (2009) Asset prices, credit growth, monetary and other policies: reserve bank of Australia, Canberra. Cooper, J & de Valores Mobiliários, C (2006) the integration of financial regulatory authorities–the Australian experience Speech to Comissão de Valores Mobiliários, 4-5 Eslake, S (2009) ‘the global financial crisis of 2007-2009: An Australian perspective’ Economic Papers. Llewellyn, D. T. (2006, June) Institutional structure of financial regulation and supervision: The basic issues In a World Bank seminar “Aligning Supervisory Structures with Country Needs,” Washington DC (pp. 6-7 Murray, J (2009) when the unconventional becomes to conventional monetary policy in extraordinary times speech to global interdependence center Pennsylvania Peters, G Canadell, J. G., & Raupach, M. R. (2011) Rapid growth in CO2 emissions after the 2008-2009 global financial crises Nature Climate Change, 2(1), 2-4. Smaghi, L (2009) conventional and unconventional monetary policy speech at international Center for Monetary and Banking Studies, Geneva Read More