The Rationale for the Regulation of Commercial Banks in Australia - Case Study Example

The Rationale for the Regulation of Commercial Banks in Australia Name Course Date Objective The reports seeks to provide sufficient information to the shareholders of the banks on the rationale of Australian banks regulation that was spearheaded by the federal government to ensure international integration such as international financial regulation, minimization of volatility when it comes to global capital markets and how to create best balance competition by providing financial products and services according to consumer preferences. History of Australian Banking Sector These banks have been in existence for a couple of years; the first bank in Australia was established in Sydney in 1817 and was known as Bank of New South Wales, with Edward Smith Hall acting as its secretary and also the cashier. The bank later opened new branches in entire Australia and also Oceania during 19th and 20th century. The banking sector in Australia involves a number of banks that operates under the Banking Act 1959. The Australia banking system is usually liquid, better established and highly competitive. In 1893 Australian banking crisis occurred that resulted from speculative boom in Australian property market. In 1930 the Australian banks also experienced a great financial depression which had a great effect on financial markets and lead to fluctuation in economic condition (Australian Government. 1997,p.575). The major banks in Australia As a matter of fact Australian bank marketing is dominated by four major banks this include Commonwealth Bank of Australia that acquires Bank of Western Australia and also ranked as the first in the Bloomberg Riskless Return Ranking in mid-2013, Westpac Banking Corporation which also acquires St George Bank Limited, Australia and New Zealand Banking Group Limited and National Australia Bank Limited. The banking market comprises of investment banks, regional banks, non- bank financial institution and also foreign banks, The Australian banking system is also liquid, competitive and more so well developed. The banks also consist of customer owned banking institution that is governed by The Customer owned Banking Association that is in charge of 100 credit unions, mutual banks and building societies. The Australian Customer owned banking institution include; CUA with total asset of $9.0billion, Heritage bank with asset of $8.0billion,Newcastle Permanent with asset of $7.5 billion, people’s choice credit Union with asset of $6.1 billion and IMB with total asset of $4.9 billion being the top five leading institutions. However, Heritage bank is currently the largest Australian customer-owned bank. The regulatory bodies governing the Australian banks as recommended by federal government The Napier Royal Commission in 1937 and Reserve Bank of Australia in 1960 ensured that the Australian banking system always adhered to the consumer demand. In 1979 Campbell committee and Federal Treasurer conducted a research due to changes in both domestic and international financial environment this was not to increase the regulation but to assess the levels of bank regulation and government involvement .(De Lucia & Peters 1998,p.3). Change of government in 1983 also had adverse effect in Australian banking system when also the economy of the world was unstable which affected investment and the financial markets globally to control this problem the Australian monetary authorities had to set extra liberal marketing policies while the Commonwealth Government decided to “float” Australian dollar (De Lucia & Peters 2003 , p. 1). The Federal government also recommended that the regulation in the banking and finance sector to be categorized into the Reserve Bank of Australia and the Australian Securities and investments Commission (ASIC) that is established by the Australian Securities and Investment Act 2001 is responsible for consumer protection, regulation of finance companies and investment banks and also it is responsible for market integrity. The Australia’s central bank controls the stability of financial system and also it controls the monetary policy while exchange control is the role played by the Reserve Bank of Australia. The Australian Treasury is a body set to advice the government on how to ensure there is stability in the financial system and also on regulatory matters concerning financial system infrastructure. The Council of Financial Regulators (‘the CFR”) being the another body that helps to promote cooperation and also collaboration among the Australian Treasury, The Prudential Regulation Authority (APRA), The Reserve Bank of Australia (RBA) and The Australian Securities and Investment Commission (ASIC). As a council its objectives is to ensure there is efficiency and also effectiveness by providing collaboration and facilitating forums for discussions in the financial regulation. Banking regulation helps to monitor risk that are from micro and macroeconomic concerns, the regulation may be informal where the government uses discretion to influence the outcome of the banking system such as maintain state ownership of the bank, bail out insolvent banks and also to decide on bank mergers. Reasons for Australian banks regulation Federal government recommended regulation of Australian banks so to ensure there was security and stability in payment system and also to deal with systemic dangers of bank failures due to global financial crisis in the financial market and it has mostly affected the flow of capital. Banks being a ‘public good’ it has to benefit both the interest of shareholders, customers and the management by controlling and managing all the risks. Capital regulation being controlled by The Australian Prudential Regulation Authority (APRA) that makes rules and also ensures its enforcement that governs capital adequacy; the rules include the application of international capital standards that is termed as Basel 11 that was issued by Basel Committee on Banking Supervision (BCBS) that was introduced in 2008.The Committee introduced Liquidity Coverage Ratio (LCR) that required every bank to have enough high-quality liquid assets (HQLA) such Commonwealth Government securities (CGS) in order to meet the outflows it also helps to manage the risks involved in over-the-counter in the derivatives markets to increase the demand of liquid assets so as to facilitate smooth operation in financial markets. Federal government mandated The Australian Prudential Regulation Authority to categorized cash, semi-government securities, central bank reserves and commonwealth government securities as the highest-quality liquid assets in Australia. The Basel capital standards focus on regulation of capital and also in measurement of risk. Capital regulation is done though the sum of its ‘Tier 1’ and ‘Tier 2’ capital, net of all the specified ‘deduction’. The total net Tier 1 on March 2010 was $131 billion. Tier 1 consists of the ordinary shares retained earnings and also specific type of convertible securities and preference shares in which the bank can allocate losses and it will not experience bankruptcy while Tier 2 consists of senior creditors and the funding sources that are ranked below bank’s depositors it also includes subordinated debt, the total net of Tier 2 by March 2010 was $33 billion in the Australian banking system. The Australian Prudential Regulation Authority ensures that not more than 25% of Tier 1capital is used to allocate losses by the Australian banks. For the purposes of capital adequacy Australian banks uses the technique of quantifying their credit risk that is measured through ‘risk-weighted assets ‘ and Internal Ratings-based approach, operational risk and market risk. Banks are mostly subjected to non-exhaustive regulatory provision such as restriction on branching and new entry, restriction concerning the asset portfolio a bank can hold restriction on pricing that is the interest rates and fees, regulation on ownership linkages in the financial institutions, regulation on reserve requirements that is the Australian central bank should hold certain amount of liabilities and other rules regarding banking sector such as mergers. The Australian Prudential Regulation Authority authorized 185 deposit-taking institutions (‘ADIs’) in April 2010 that comprised of 21 Australian ADIs, 34 foreign ADIs,108 credit unions, 3 non-operating holding companies,11 building societies and 8 others (McCoach & Landy 2009).The rationale of banks regulations ensured effective operation of economic policy and social objective of Australian government. Federal government implemented Minimum capital requirements as a bank regulation, imposed by The Australian Prudential Authority where 8% of risk-weighted assets should be hold as total capital by the local incorporated banks that means at least Tier 1 should be half of the total capital. The banking system was to ensure that the minimum capital requirement was to be set where a Tier 1 capital ratio was to be at 6.0%, common equity Tier 1 capital ratio was to be at 4.5% and the total capital ratio was to be maintained at 8.0%.The banking system of Australia had an aggregate of 11.8% as total capital ratio and an aggregate of 9.4% as Tier 1 capital ratio (Gorajek &Turner 2010). The Australian banking system also recommended regulation relating to the conduct of the business this include confidentiality where the transaction and the customer accounts has to be kept confidential ,privacy also has to be adhered to the banks should not disclose any relevant information regarding their customer as stated in Part 111A of the Privacy Act 1988 (Gorajek & Turner 2010) and also the Australian banks should ensure they are against Anti-money laundering and counter terrorism financing where the Australian banks are supposed to provide designated services and duties such as verifying the identity of their customer, maintaining accurate records and also implementing a compliance program. The banks should provide consumer protection which is provided by The Australian Securities and Investment Commission Act 2001. Recommendation of federal government on the Instruments for bank regulation The Federal government recommended the Australia banks to implement these instruments in their regulation; capital adequacy requirement, deposit insurance and lender of the last resort; Lender of the last resort Lender of the last resort applies where the Australian Central banks provide assistance to other commercial banks when they are facing financial problems such as emergency liquidity assistance, but it is not applicable to insolvent banks and when the lender of last resort provide assistance to the insolvent banks it will result to macroeconomic consequences that are severe to the economy. Deposit insurance Deposit insurance is the guarantee that incase of bankruptcy the entire depositor’s debt will be honored by the bank irrespective of the insurance scheme whether the fee structure is risk-related fee or flat fee versus variable and also whether the degree of coverage is full versus partial coverage it will have to pay. Deposit insurance thus it reduces the incentive of going to a bank in the event of financial problems and also it reduces possibility of contagion that may arise in the banking system. Deposit insurance has made all banks to be equally attractive even though it has also made the depositors have little incentive to diversify their asset portfolio held in banks. Capital adequacy requirements Capital adequacy requirements was recommended by federal government as regulation that is mostly applicable in the Australian banks and securities firms (Scott 2005,p.76) the banks were supposed to maintain a minimum level of required capital to ran its normal operation, it has some challenges such as it is difficult when it comes to design it in a sufficiently sophisticated method, it may also increase contagion risk thus failing to promote liquidity in the market and lastly it also causes delay in the pace of innovation in the banking system. The rationale in Australian banking system has ensured the bank is providing universal services apart from traditional deposit taking. The universal services include mortgages services, credit cards for paying bills for the depositors, life insurance, consumer loans and financial consulting such as asset management and management of investment funds. The Australian regulatory system also introduced Financial accounting rules and regulations that emerged from Corporations Act 2001 (2001), where the banks were to produce financial statements this was to ensure there was accountability in their operating systems so that to present banks legitimate image as they aim their objective on issues of governance and profit making. Challenges of banks regulation as recommended by federal government Australian bank regulation despite helping to eradicate financial crisis it has some drawbacks and challenges such as the risk of bank runs, banks operate with liabilities that are liquid and are also redeemable on demand, when all the depositors demand their deposits at the same time their bank may not be in the position meeting all those obligations even though the bank can obtain refinancing from financial markets (Valentine etal.2012). Systemic dangers of bank failure is also another risk factor, this will affect the clients and the economy at large since the bank is observed as a “public good” because it aims at serving all their customers and at the same time to generate revenue to the government. The banks will also experience problems in the payment system since there will be restriction in all their transactions, instability in payment system in more severe than instability in deposits that tends to cause disruption in aggregate economic activities. Conclusion The rationale of banks regulation in Australia has experience problems in the payment system since there have been restriction in all their transactions, instability in payment system in more severe than instability in deposits that tends to cause disruption in aggregate economic activities while as in the other hand it has yield sufficient returns in stabilization of Australian economic condition. It also ensured that banks and other financial institutions achieved their set objectives where banks were to hold sufficient liquid assets so as to manage inherent risk by using the short-term liabilities in funding long-term assets for instance the loans, and the other financial institution such as the derivatives markets had enough liquid assets as collateral to cater for hedging and trading activities. The Australia’s financial system is now considered to be stable and resilient because of its prudent economic management and the strong supervision from the financial regulators. References APRA (Australian Prudential Regulation Authority) (2011), ‘Implementing Basel III Liquidity Reforms in Australia’, APRA Discussion Paper, 16 November Australia, Australian Securities Commission, & Reserve Bank Of Australia. (1991). Prudential regulation in Australia: recent developments. Canberra, Australian Government Pub. Service. 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