The Need for the Australian Prudential Regulation Framework - Essay Example

Student’s name Course code+name Professor’s name University name Introduction Sub-prime credit is a general term that refers to loans or borrowings made to people with less than short credit or perfect credit histories. Sub-prime credit includes derivative products as in the securitizations based on the subprime loans as well as the original borrowing. Home loans granted to borrowers and mortgages to borrowers whose creditworthiness is questionable forms the largest portion of the whole market for subprime credit. One of the strongly argued pros of subprime credit is that it gives chance for people who would have been marginalized to obtain loans for homes, automobiles and credit cards (Battellino, 2009). On the other hand, one of the contested cons of subprime credit is based on excessive fees, high interest rates and shorter grace periods. In this aspect Australian Prudential Regulation Authority (APRA) is singled out to help analyze the effects of subprime credit (Davis, 2009). The need for Australian prudential regulation framework Established in 1998, APRA is a prudential regulator of financial services in Australia and a statutory authority. The core roles of APRA are to oversee credit unions, banks, building societies, superannuation industry, insurance and re-insurance companies. In addition, APRA regulates all such financial institutions by strictly ensuring that such institutions remain on watch to their financial promises such that they remain sound financially and meet the obligations to members, depositors and policy holders. In addition, works on the framework that it enforces and develops massive prudential framework of legislation, prudential guidance and prudential standard to enforce prudent behavior by authorized depositor-taking institutions (ADI), superannuation funds and insurance agencies. The main focus in prudential regulation is the quality of the institutions system for measuring, identifying and managing the different types of risks in the business. This is basically to prevent what Viney (2009) terms as, “Financial crises, such as the sub-prime credit crisis, have a significant disruptive impact on the flow of funds in the financial system” (p. 102). To successfully perform this role, APRA enhances public confidence within financial institutions in Australia through a framework that checks on balance in efficiency, financial safety, competitive neutrality, contestability and competition. This framework can only achieve this by; a. Offering advice to the government of Australia on the development of legislation and regulation and what effects the institutions and the financial markets where their operations cover. b. The implementation and development of the vital prudential requirements that the regulated institutions must observe. c. Involving the use of a risk-based approach on the regulated institutions and enforcement measure to make sure that the risk-taking is carried out within acceptable bounds and that the risks are clearly managed and identified. APRA responsibilities cover close to 85 percent of all the available assets in Australia’s financial system. It has the authority to push financial institutions to strictly follow prudential standards such as liquidity, appropriate capitalization and governance so as to intervene if there is a possibility that the interests of policy holders, depositors or the general members are at risk (Kearns, 2009). Moreover, one of the fundamental frameworks of the organization is to enjoy the extensive powers of intervention, investigation and administration (Papademos, 2009). APRA works close with different investigative agencies to ensure that they pursue similar goals by working on similar cases, efficiently managing the evidence generated inevitably in the course of the investigations. As such it has improved APRA’s in managing noncompliance and improved time for processing administrative burdens. The Roles of the Reserve Bank of Australia and 2008 Global Financial Crisis The financial stability review (FSR) published by the Reserve Bank and the International Monetary Fund (IMF) report have considerably given a detailed evolution of the crisis. The Financial crisis of 2008 according to FSR report, points out that it can be viewed through the prism of risk. Risk premia were extremely low for many years leading up to late 2007. This was attributed to a score of factors such as prolonged economic stability in major countries dating back to as early as 1990’s which made most investors become extremely optimistic of the future. Others attributed the risk to the low interest rates that was experienced and prevailed for long in this decade, which compelled investors to look for higher yields in new products. Mismanagement or miss-assessment of risks led to a score of investment decisions being applied which in turn have proved significantly to be excessively costly. This shows how the financial crisis was largely attributed to the wholesale failure of risk management and risk assessment. Godfrey (2008) argues, “We are seeing things that were 25 standard deviation moves, several days in a row” (p. 36). This statement shows that most of the assessment models that were used to manage risks were inferior and overly wrong. This clearly manifested when their results were overridden by short term profit and asymmetric compensation for a major risk taking. Another case of mismanagement occurred in the assumption that the off-balance sheet tools, that were investors low value products, were off the balance sheet. Dislocations in global financial market translated substantially to the local markets. This caused the Australian financial crisis of 2008. As such, there was decline in the local stock market. To curb this there was reduction in tax rates which increased aggregate demand, strengthened investment and promoted household income (Sherry, 2009). The Reserve Bank as a mitigating system responded by increasing the demand for cash by financial institutions. Using the exchange settlements (ES) balances, the Reserve Banks increased the cash supply in the system to avert the crisis (Papademos, 2009). This caused an upward pressure on the cash rate beyond the target set by the Reserve Bank in their preset monetary decision. The Reserve Bank in an effort to reduce pressure on the money market increased the maturities of the market operations. The main aim here was to ease liquidity in the money market. In addition to this, a deposit facility was also introduced which essentially is an exchange settlement balance at a longer maturity. Before 2008, there was little Australian corporate bond issuance but in the few weeks of 2008, there was a significant positive change on this. In Australia, the financial institutions are responsible for the issuance of private sector bonds. These affected the development in the global credit market. In the early 2008, the Reserve Bank grabbed the opportunity by adopting a conservative strategy to get ahead of the funding program. In February 2008, the markets issued the corporate bonds in the offshore markets (Australian Government, 2008). In 2007, the issuance of residential mortgage-backed securities (RMBS) has been very minimal. This has been a direct effect of overhang of supply in the secondary market. To overturn this, the Australian government through the Australian Office of Financial Management (AOFM), has undertaken a program to purchase new RMBS issue which has significantly averted the financial crisis. The financial crisis also substantially affected the asset-backed commercial paper (ABCP) market. Initially, it had been funded offshore which was greatly impaired. In subsequent periods, ABCP’s appetite for investors diminished hence decline in the stock outstanding (Brown etal, 2008). As a result, the Reserve Bank increased the collateral pool eligible in the market operations. In addition to this, the reduction in cash rate as portrayed in the statement on monetary policy has been a relative strength of the Australian financial market and Australian financial institutions (Smaghi, 2009). This implies that the vital monetary transmission process has not been flawed, in contrast to many other countries like United States. Foreign exchange swap market has in many occasions been dysfunctional, particularly during the crisis period where there was global shortage of US dollars outside US markets (Kohn, 2009). American banks became unwilling to lend to European banks; a problem that spread into other several foreign exchange swap market, Australia being one of the markets. As an aversion strategy, the US Federal Reserve signed a swap agreement with Reserve Bank of Australia (RBA) to help distribute the dollars in such markets. This as result improved the market. Moving out beyond the short term money market, global financial crisis has significantly impacted on the bond market. As the crisis continued, there was a process of re-intermediation such that corporate who used to borrow in the financial markets turned to the banks. As a result, there was increase in the intermediated business credit in Australia. Conclusion In conclusion, the financial market disruption since mid-2007 impacted immensely on the Australian economy and Australian financial market. The degree to which local markets in Australia have been disrupted is considerably less compared to other countries .This is because of the less counter-play risk aversion in Australia markets, since the Australian financial institutions had less exposure to the securities that compromised the balance sheets of financial institutions in other countries. In Australia there have been significant signs of improvement in the money market. There has been noticeable fall in the spreads and are now below the crisis period. Furthermore the banks have considerably been able to reduce supply of exchange settlement (ES) balances. The demand for longer maturities has also declined to significant levels. In addition the deposits outstanding have also been reduced to marginally low levels. References Australian Government, 2008, “Guarantee Scheme for Large Deposits and Wholesale Funding”, viewed 4 August 2009. Battellino, R., 2009 “Global Monetary Developments”, Address to 2009 Securities & Derivatives Industry Association Conference 28 May, Sydney. Brown, C and K. Davis. (2008) “The Sub-Prime Crisis Down Under”, Journal of Applied Finance, Spring/Summer, 16-28. Davis, K. (2009) "Infrastructure Trust Financial Management", JASSA: The Finsia Journal of Applied Finance, March 2009, 43-47. Godfrey, M,. 2008, “US Fiscal Stimulus Package Agreed”, Tax-News.com, 28 January, Washington. Kearns, J. (2009) “The Australian Money Market in a Global Crisis.” Reserve Bank of Australia Bulletin, June, 15-25. Kohn, D., 2009, “Policies to bring us out of the Financial crisis and recession”, Speech at The Forum on Great Decisions in the Economics Crisis 3 April, Ohio. Kohn, D., 2009, “Monetary Policy in the Financial Crisis”, Speech at the Conference in Honor of Dewey Daane 18 April, Tennessee Murray, J., 2009, “When the unconventional becomes to conventional- monetary policy in extraordinary times”, Speech to Global Interdependence Center 19 May, Pennsylvania. Papademos, L., 2009, “Monetary policy and the ‘Great Crisis’: Lessons and Challenges”, Speech at the 37th Economics Conference 14 May, Vienna Sherry, N, 2009, “The Road to Recovery - Australia, the global financial crisis and the International path to economic recovery”, Address to The Australian American Leadership Conversation 13 July, New York Smaghi, L., 2009, “Conventional and Unconventional Monetary Policy”, Speech at International Center for Monetary and Banking Studies 28 April, Geneva. Read More