Financial Crises - the Need for Australian Prudential Regulation Framework - Case Study Example

Financial Crises Name: Lecturer: Course name: Course code: Date: Introduction Prudential regulation refers to a financial operational legal framework that has a significant contribution to reducing the financial crises in financial institutions. According to the research studies, there is a lot of evidence showing that absence of these prudential regulations leads to systematic instability and bank failures. While establishing perfect, easy and clearly monitored rules for all the financial transactions, they help the institutions to run effectively and limit the risk occurrence. One of the downfalls of the financial systems, especially the intermediaries and cooperative societies is failure to comply with prudential regulations (Blundell, 2007). For instance, some countries have only one universal banking law that encompasses all the laws and regulations. However, most of the other countries have mandated the supervisory institutions to deal with the operational issues or make routine decisions. a) Australian prudential regulation framework The Australian prudential framework has its roots traced back in 1998 as a result of the financial system inquiry. The inquiry system recommended the reforms in the financial regulations so as to achieve an effective, flexible and competitive system (S, 2010). The framework consists of three agencies each with specific roles. These include: Australian Prudential Regulation Authority (APRA) This is one of the integrated prudential regulators which are answerable to financial institutions like banks, credit unions and building societies. It is also responsible for general insurance, friendly societies and superannuation. APRA is authorized to develop prudential policies that aid in balancing financial safety, competition, efficiency and competitive neutrality. APRA help in regulating financial institutions that take deposits under one license and are under one depositor protection (Blundell-Wignall & P, 2010). This type of regulation empowers the APRA to take correct decisions in favor of the depositors. This includes the power to cancel licenses, make sensible standards or give directions, appoint statutory managers to any authorized deposit-taking institution (ADI). In case of any complexity, APRA has powers to wind-up that institution and dispense the available assets. In case of winding-up of the ADI, the depositors have the first priority to claim assets in agreement with depositor preference provision. In order to promote the interests of depositors, it is required that all the ADIs hold the assets within the country i.e. Australia, at least equivalent to their deposit liabilities within the country. However, these arrangements do not guarantee any depositor’s funds. At the same time, the depositors are not answerable to APRA neither does it have any responsibility on any losses incurred by the financial institutions. In the case of authorized deposit-taking institution, whereby the financial instability of the company, friendly society, general insurer or even the superannuation fund might also have negative effect on the members’ interest and the policy holders, APRA may intercede (R, 2009). On the other hand, the treasurer may impose some duty on the industry so as to compensate the other members who have been affected by the fraud or losses. This only happens in the case of superannuation and in the national interest. Australian Securities and Investments Commission (ASIC) This sets and implements the required standards for financial sector intermediaries, financial market behavior and the sale of financial products e.g. insurance, deposit-taking activities, investments and the superannuation. The aim of these standards is to safeguard the consumers and the market from deception, manipulation and other financial malpractices but more so to encourage confident participation within the financial system. Furthermore, ASIC helps to administer the laws of the corporation aiming to promote fairness and integrity within the financial system. The submission of the ASICs to the call by the senate select committee on financial services and superannuation into the financial services clearly spells measures it took in safeguarding the customer interests (S, 2010). In addition, ASIC assesses and monitors compliance with the credit code practice, code of banking practice, building society code of practice among other practices as partial role of consumer protection. It is mandated to supervise industry-based alternative dispute as well as administering the provisions linked to the consumers of the retirement savings account. Reserve Bank of Australia (RBA) This has the responsibility of financial system stability and the monetary policy. It directly deals with the coercions to financial stability but does not offer protection to bank depositors directly. The RBA maintains its role as a lender of the last resort especially for emergency liquidity aid in the case of financial crisis (Kohn, 2009). However, in some circumstances, the RBA is ready to give direct lending to any financial institution under liquidity constraints. Specifically, the institution should be under the supervision of APRA and should be solvent. The reserve bank of Australia is mandated to promote the efficiency and safety of the entire country’s payment system because it has very strong back-up regulatory powers. Incase RBA, for instance, carries out an assessment and realize that there is need to improve access, safety or efficiency, it designate the whole system under its regulation. It may therefore impose an access strategy on that particular system or formulate standards for safety and efficiency. Finally, the RBA conducts exchange settlement accounts for active participants within the payment systems. b). The need for Australian prudential regulation framework The main aim of the framework is to consider the following issues: i. Assess the entity risks ii. Supervise the outcomes and the responses iii. Ensure quality assurance iv. Need to support infrastructure material Entity risk assessment The main aim of the dynamic entity risk assessment is ensuring that the supervisory judgments are accurately made, robust and timely and the afforded supervisory attention to each financial institution is very appropriate. The assessments are on the risk analysis and are completed on the supervised financial institution. Furthermore, the risk assessments are centered to allocation of APRA of supervisory resources as well as the implementation of the risk based supervision (Freedman, 2009). The major roles of the entity risk assessment are: i. To suggest the most appropriate supervisory action ii. To assess the effects of possible consequences of failing to meet the promises iii. To predict the possibility of supervised financial institution not meeting the set thresholds. In essence, the supervisory action plan considers the significance of the main risks/issues as well as the prominence of the regulated entity. The supervisory oversight and response system (SOARS) drives the supervisory actions of the APRA. At some level, the SOARS aids in allocating resources to areas which are susceptible to high risks. Supervision of outcomes and responses One of the crucial factors in the implementation of the outcome-focused regime is the setting of the suitable supervisory plan that takes into consideration the fundamental risks. The framework is designed in such a manner that it focuses on the significance of the supervisory responses and actions. These actions consist of the ongoing supervision of the supervised financial institution and particular issues (R, 2009). The supervision responses and outcomes range from the normal review cycle to escalated supervisory stance which may require an extra supervisory oversight or institutional restructure. The framework, however, demands the supervisory team to identify and assess the extent of the risk before taking any action to ensure that the supervised institution’s risks are exposed at a reasonable level. Supervisors therefore should demonstrate supervisory action plan activities are appropriate and adequate to the profile of the financial risk institution as well as the required supervisory outcomes Quality assurance within the Framework The adoption of the outcome-focused method towards the supervision is the central motive to maximizing the quality of prudential assessments. Implanting a risk-based, principled-based and outcome-based mindset helps to improve the consistency and the quality of the prudential assessment and the action plans (Freedman, 2009). Improvement of the consistency and the quality use of the framework occur in four levels: internal audit, supervision framework team, APRA management and the independent review. Need to support infrastructure material The main principles for both material and infrastructure support are: i. Flexibility ii. Efficiency iii. Effectiveness Some of the fundamental support components of the framework are: procedures, applications reference materials and the guidance. Whereas these are not the only concern areas, it looks into data analysis, data and information capture and resource management. Furthermore, the supervisory system aims at reducing inefficiencies relating to data and information capture as well as the administrative workload at the same time maintaining the flexibility of the supervisors. c). How the Reserve Bank of Australia dealt with the 2008 Global Financial Crisis The fact remains that most of the countries went into financial crisis in 2008 due to world hurricane financial crisis that rendered most governments into bad debts as well as high budget deficits. Among these countries was Australia. Depending on the country’s plans, each country had its own way of handling. For instance, Australia hit the crisis in a very rude financial health: free from debt, growing very strongly with a number of assets thus running extra budgets. Because of these firm foundations alongside the conducive terms of trade that sustained Australia to survive the crisis (Blundell, 2007). Just before the financial crisis, the reserve bank director drew the attention of the public on the financial position of the country in case of any crisis. Before long, the country was struck by financial crisis. As the disaster moved into liquidity stage, the effects also on Australia increased (Blundell-Wignall & P, 2010). Financial institutions that depended mostly on financing found it difficult to cope up with debts. Most of those institutions had purposely relied on off-shore markets so as to fund the Australia’s steady growth lending habits. By the end of 2007, the country’s debt had accumulated above $500 billion of which part of it is raised by the banks (Freedman, 2009). Regardless of clean balance sheets, the Australian financial institutions were forced to pay equivalent high margins on their borrowed money that the investors demanded from the US and European banks. Money markets were equally affected, thus escalating the interest rates. The reserve banks, just like any other central bank around the world responded to the crisis by adding extra cash into the financial system. Even with local and global financial turmoil, the reserve banks maintained their concern on inflation by raising the rates up to four times in the credit crisis. In response to recover their rising funding costs, other financial institutions increased mortgage rates above the reserve banks (S, 2010). Despite the financial challenges that faced the financial institutions in Australia, the alarm even spread outside the financial market. This brought a lot of fears especial in credit unions and banks. With this fear, the government quickly changed its plans by giving retail deposits for three years through reserve banks as opposed to previous plans of guaranteeing sums of money not exceeding $20, 000. At the same time, it guaranteed bank schemes in order to encourage banks to compete for funding with the government guaranteed banks. This was done through reserve banks (Blundell, 2007). References Blundell, W. (2007). Dealing with Financial Crisis and thinking about the Exit. OECD Financial Market Trends , 78-91. Blundell-Wignall, A., & P, E. A. (2010). The Subprime Crisis and Regulatory Reform,Reserve Bank of Australia. Sydney: Cambridge University Press. Freedman, G. (2009). The Case for Global Fiscal Stimulus. Sydney: Cengage. Kohn, D. (2009). Monetary Policy in the Financial Crisis. NY: Macmillan. R, B. (2009). Global Monetary Developments. Tenessee. S, B. (2010). Austalian Corporates’ Sources and Uses of Funds. RBA Bulletin , 1-12. Read More