Structure and Legal Framework of Australian Financial Institutions - Literature review Example

Table of Contents page Introduction………………………………………………………………………2 Structure of Australian Banks…………………………………………………..3 Total Assets…………………………………………………………………….3 The legal framework of financial institution in Australia…………………….4 APRA…………………………………………………………………………..5 ASIC…………………………………………………………………………...6 RBA……………………………………………………………………………7 Challenges faced by banks in Australia………………………………………..8 Liquidity Challenges…………………………………………………………..9 Cost of competitive terms……………………………………………………..9 Fostering competitive environment…………………………………………...9 Conclusion………………………………………………………………………10 References………………………………………………………………………11 Introduction Australian financial industry comprises of a number of financial institutions namely Authorised Deposit-taking financial institutions, non-authorised deposit taking financial institutions as well as funds and insurers managers (RBA, 2010). The Authorised Deposit taking financial institutions includes banks, building societies and the credit unions. The non authorised deposit taking financial institutions include merchant banks (money market corporations, securities and the finance companies. Funds and insurance managers include general insurance companies, life insurance companies, public unit trusts, cash management trusts, approved and superannuation deposit funds, friendly societies and common funds. (RBA, 2010). Australian banks which form a large segment of authorised deposit-taking financial institutions provides all sectors of the country’s economy with financial insurance and funds management services. Foreign banks confine their activities of deposit taking to wholesale markets. According to the report released by the Australia Reserve Bank in the third quarter of 2010, the banking industry in Australia comprised of 55 banks. Australian non-banking institutions undertaken wholesale operating activities such as lending to, borrowing from government agencies and large corporations (RBA, 2010). Other services provided by the non-banking institutions include capital markets, investment management and foreign exchange services, advisory and corporate financial relations. Additionally, the non-bank institutions also provide offer loans to small-scale business and households. Using unsecured notes and debentures financial companies raise their funds from retail investors and wholesale markets. The focus of this report is to explore the structure of Australia financial institutions, the legal framework of Australian financial institutions and, finally, the challenges faced by Australian Banks. Structure of Australian Banks Total assets According to the Reserve Bank of Australia there were 55 banks in Australia by the end of 2010. The assets of banks in Australia, unlike the stock-based businesses which have traditionally operated in the financial market, comprise mainly of financial assets such as trading securities, liquid and cash assets, investment securities, trading securities, gross advances and loans (RBA, 2010). The report released by the Australian Banking Association in June 2010 indicated that Australian Banks have a total asset of $2.6 trillion. Out of the $2.6 trillion assets, approximately $2.5 trillion are resident assets (assets held by domestic banks in Australia). More than $140 billion are non-resident assets (assets that belong to Australian banks but held by other organizations overseas) (RBA, 2010). More than $70 billion are assets from operations carried out by Australian banks overseas. The graph below shows the trend in growth of assets in Australian Banks. (Source: RBA, 2010) From the graph, it is evident that banks in Australia have continued to record a steady growth in assets. The Reserve Bank of Australia estimated that banks in Australia have recorded an approximate 12% growth in their assets over 10 years (RBA, 2010). However, the growth in bank assets reached a 30% high in 2007 due to the significant shift in demand from customers pertaining to lending and many other services provided by banks in Australia. The growth in bank assets was slowed by the financial crisis that occurred in 2008 with growth in assets reaching a 20% record low by the third quarter of 2008. From 2009 to 2010, the banking industry recorded an annual fall in asset growth with many banks recording negative growth in their assets on annual basis (RBA, 2010). By the end of 2010, the total loss in bank assets was more than $80 billion with the business and commercial loans accounting for 96% of this loss and fall of bank asses in Australia. The graph below shows the type and the amount of assets held by banks in Australia. (Source: RBA, 2010) In terms of individual assets held by different banks, the four leading banks in terms of asset and market capitalization include; the Commonwealth Bank with total market capitalization of $80 billion; Westpack Banking Corporation with a market capitalization of $70 billion; National Australia Bank with a market capitalization of $55 billion and, finally, the Australia and New Zealand Banking Group with a market capitalization of $60 billion (all figures are in terms of Australian dollar) (RBA, 2010). Mutual credit unions, building societies as well as regional and smaller banks are the main competitors to the four banks mentioned above. The legal framework of Australian financial institutions The regulation framework that characterise the banking industry in Australia is detailed and extensive. The legal framework is split between the Australia Investment and Securities Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) (APRA, 2010). APRA (Australian Prudential Regulation Authority) The latter (APRA) is bestowed with the responsibility prudential supervision and licensing of Authorised Deposit Institutions (ADI) such as banks, credit unions and building institutions (RPA, 2010). APRA also issues guidelines on capital adequacy for different banks across Australia. Banks are therefore required to give periodic reports to APRA. The objective of APRA is to promote stability in financial institutions such as banks by regulating the manner in which banks and other financial institutions undertake prudent management of risks in order to reduce or minimize the financial losses that might be incurred from deposits, superannuation fund members and policy holders (RPA, 2010). Thus, APRA helps in the identification of potential weaknesses that arise in the banking industry which might result into potential losses (RPA, 2010). A risk-based platform is therefore followed by APRA where a closer supervision is enhanced for institutions facing higher or greater risks. After obtaining a licence from APRA, banks are subject to continuous supervision from APRA in order to ensure that prudent risk management requirements are met. APRA also identifies the banks that fail to follow the laid down prudential risk management approaches and subjects such banks to firm regulations according to the laws that govern the operations in the banking industry (RPA, 2010). APRA utilizes two main tools for its supervisory activities which include off-site analysis and on-site analysis. The supervisory approach used by APRA is risk-based, forward looking, in line and consistent with best practices used in the international banking industries, and it is also consultative (RPA, 2010). The main aspect of the approach used by APRA is that management and the board of directors of regulated entities must maintain financial soundness in banks as well as being responsible for risk management activities to minimize losses to the investors and depositors. In this respect, APRA identifies risk taken by different banks as well as ensuring that the identified risks taken by banks are measured, monitored, managed and assessed adequately in a way that banks can be able to withstand any form of losses. Among the main supervisory interventions undertaken by APRA include requirement imposition on the supervised institution (RPA, 2010). This is done through the legal force. Other inventions include making necessary suggestions and recommendations on the critical areas the supervised institutions must take into consideration in order to avoid potential losses. ASIC (Australia Securities and Investment Commission) ASIC regulates the financial services in the financial institutions in Australia. The main objective of ASIC is to enhance the wellbeing and the reputation of financial markets in Australia by ensuring that the financial markets are transparent and fair (ASIC, 2010). This is made possible through the collaboration of informed and confident consumers and investors. The activities of ASIC are guided by the Corporations Act 2001 which entails facilitation, maintenance, and improvement of entities and financial system performances (ASIC, 2010). Specifically, ASIC promotes the informed and confident participation by consumers and investors in the banking industry (ASIC, 2010). It also administers laws that regulate activities in the banking sector by ensuring minimal requirements are instituted in the banking sector; gives effect and enforces the law; processes, receives and stores information quickly and efficiently as given by the banks; and makes the information required by banks available within the shortest time possible to ensure that effective decisions are made in the banking sector (ASIC, 2010). In order to ensure transparent and fair operations in the banking sector, ASIC supervises the amount of competition and procedures used in the financial markets by different players in order to ensure that unhealthy competition does not impact negatively on the players in the banking sector (ASIC, 2010). As a regulator, ASIC regulates businesses that engage in credit activities such as credit unions, banks, and finance and mortgage brokers (ASIC, 2010). The commission ensures that all issues licenses meet the required standards particularly the responsibilities of the banks to the consumers as spelt out in National Consumer Credit Protection Act 2009 (ASIC, 2010). The commission operates under the regulatory, facilitative and enforcements powers under the Corporation Act 2001 (ASIC, 2010). In summary, ASIC enhances consumer regulation and protection activities as well as ensuring integrity in the market which includes regulation of finance companies and investment banks. Reserve Bank of Australia (RBA). RBA is the central depository organization in Australia. The bank is bestowed with the responsibility of conducting monetary policies, working towards enhancement and maintaining a strong financial system in the country and particularly in the banking industry and finally issuing currencies both domestic and foreign as required and dictated by the financial market (RBA, 2010). The reserve bank of Australia was established in 1960 in order to oversee the financial activities in the country. In the banking industry, RBA sets the lending interests rates that other banks should follow when advancing credit to the consumers. RBA utilizes tools of monetary policies such as interests’ rates and cash ratio to regulate the activities of the banks in the country (RBA, 2010). For example, during the periods of high inflation, RBA raises the rate of interests in order to discourage borrowing and lower the amount of money supply in the economy. Other banks are required to adjust their lending rates as per the regulated RBA lending rates. RBA also supervises the capital and bank liquidity by maintaining a given proportion of deposits from different banks. This deposit is used as a risk mitigation measure during hard economic times when RBA releases the deposits to different banks to enhance their operations (RBA, 2010). Challenges faced by Australian Banks Liquidity challenges According to Lee (2011), one of the main challenges faced by the Australian banks is the liquidity challenge. Citing from the review of the Financial Stability Board (FSB) the author noted that even though, Australian Banks emerged stronger from the global financial crisis that saw many banks collapse in other regional and international market, Australian banks still grapple with a wide range of financial challenges such as implementation of Base III and I requirements of capital accord (Lee, 2011). Liquidity challenges have resulted into wholesale borrowing particularly seeking funds from external markets. This has been fuelled by insufficient bases of onshore deposits maintained by the Australian banks. The reduction in liquidity in many Australian banks has also been fuelled by the increase in credit facilities thus pushing the local banks to undertake wholesale funding. Increase in credit facilities has been necessitated by the economic stress occurring in the Eurozone where a majority of investors from the European market are rushing to Australian banks for credit facilities (Lee, 2011). Cost of competitive terms In his speech on “Challenges in the Post Global Financial Crisis Environment” in 2010, the Australian Secretary Treasurer, Mr. Henry Ken identified other challenges facing the Australian banks as including the following; cost competitive terms for raising funds in the offshore markets characterised by increased volatility. This is particularly the case due to the economic stress that has engulfed the Eurozone (Lee, 2011). In this regard, Australian banks which are still shielded from the Eurozone economic stress are finding it difficult to raise funds because funding institutions in the European market are unwilling to advance credit. The sovereign debt crisis in the Eurozone has also impacted negatively on the security market in Australia making it further difficult for the Australian banks to raise funds (Henry, 2010). Fostering competitive environment Additionally, the other challenge facing the Australian banks include the problems in fostering a competitive environment for banking consumers. This is particularly the case at the level of retail banking. The financial crisis in the Eurozone is pushing numerous depositors into the Australian banking industry making it difficult for an effective competitive environment to be established in the banking industry (Henry, 2010). Australian banks are also facing the challenge of international regulatory response implementation advocated by the G20s. The objective of the response is to implement effective mechanisms and regulation in the banking sector globally in order to avoid a repeat of the mistakes that gave rise to the global financial crisis. In conclusion, Australian banking industry is considered as one of the strongest banking industries sin the world. This is because the banking sector in the country weathered the economic recession’s storm and emerged stronger as compared to many other banking sectors regionally and globally. However, liquidity problems fuelled by the economic stress in Europe and ineffective mechanism for the implementation of the international regulatory response are some of the challenges facing the Australian banks. References APRA. 2010. The APRA Supervision Blueprint. http://www.apra.gov.au/AboutAPRA/Documents/APRA-Supervision-Blueprint-FINAL-08Jan2010.pdf ASIC. 2011. Australian Securities and Investment Commission. Available from http://www.asic.gov.au/asic/asic.nsf/byheadline/Our+role?openDocument Australian Banker Association Inc. 2010. Assets in the banking sector. Available from http://www.bankers.asn.au/Assets/default.aspx Henry, K. 2010. The Australian Banking System: Challenges in the Post-Global Financial Crisis Environment. http://www.treasury.gov.au/documents/1921/HTML/docshell.asp?URL=ken_henry_speech.htm Lee, J. 2011. Australian banks still face liquidity challenges, FSB peer review finds. AsiaRisk News. Available from http://www.risk.net/asia-risk/news/2116065/australian-banks-liquidity-challenges-fsb-peer-review Reserve Bank of Australia (RBA). 2010. Main types of financial institutions. Available from http://www.rba.gov.au/fin-stability/fin-inst/index.html Read More