Australian Banking Industry Analysis - Essay Example

Running Head: Banking Industry Analysis Australian Banking Industry Analysis [Client’s Name] [Affiliation] Introduction The global economic crisis has put serious strain on various economies around the globe. It also introduced a lot of challenges to companies from different industries to survive and remain stable despite huge losses on their part and the imminent financial danger posed by the reality of bankruptcy. The world has seen how financially stable corporations such as AIG, General Motors, Lehman Brothers, and Washington Mutual went bankrupt and require the help of the US government through bailouts in order to pay-off debts and rebound economic activities. Because the global economic recession was unprecedented and the extents of its effects were not totally anticipated, it introduced a lot of strain in various economic industries of different countries, particularly the banking sector. Despite the massive decline in the trade and commerce in the global economy, Australia’s economy has managed to remain strong and resilient. Australia’s economy is one of the largest and the most stable of the world with a $930.8 billion estimated GDP in 2009 (CIA, 2010) at the height of the global economic recession. This stable economic performance fuel the country’s financial sector. Australian banking industry headed by its four largest banks - ANZ, Westpac, Commonwealth Bank, and the National Australia Bank, were able to rake profits (before tax) of $10.9 billion midway of fiscal year 2009 (RBA, 2010). This performance in the banking sector is somewhat counter-intuitive to the performance of other banking sectors in various economies around the globe during the height of the global economic recession. There is a lot of interesting elements from this observation, particularly on the possible reasons why Australian economy, especially its banking sector, was able to remain strong and stolid when all banking sectors around the globe are faltering and are falling over. Any analysis performed on the banking sector of Australia, particularly the economic elements involved in it, needs to discuss the interplay of the international elements resulting to its present economic conditions. This is because Australia’s economy is strongly linked to other economies around the globe and its banking sector operates within the context of its economic performance. This paper will attempt to understand what kept Australia’s banking industry whole during the global economic turmoil, what factors are responsible for its successful resilience to the global recession, and what are the lessons learned from the industry as a result. In order to perform the analysis, the paper will evaluate how the economic and international elements affect and influence the performance of Australia’s banking sector. International Elements Locke and Thelen (1995; p.16) asserts that an economy that is a part of a global network is affected by the global economic scenario and will, in turn, affect the global economy. This is brought by the fact that economies around the globe are opening themselves to massive transnational economic activities ranging from employment opportunities abroad to hedging of funds to money markets that economic dependence develops. The integration of economies increased the economic prosperity experienced by countries as products, services, and labor forces reach bigger markets and serve a wide variety of needs (Mayekawa, 1983; Tilly & Tilly, 1998). This implies that any microeconomic and macroeconomic activity of one country is an interest to other countries for possible opportunities or threats. Hence, when one economy experiences internal issues, there is a very high probability that its economic concerns become the concern of the rest of the global economy. Large economies like that of US and UK have various dependent economies due to the fact that such stable economies attract investors as much as emerging economies do. Funds from various economies around the globe will find its way to promising economies to be used as investments either by direct investments or through financial loans via financial intermediaries such as banks. Thus, it is not unusual to see various economies plummet when the US economy experienced major difficulties during the recent financial crisis. US, UK, Japan and Australia are among the richest economies in the world. The alliances formed between and among economies enable these already-stable economies to grow and develop at a faster rate amidst the risks they faced in the process (Salvatore, 2007). Some of the benefits of such alliances are greater market movement, shared risks, and high profitability; some of the risks include (a) inability to liberate the market, (b) inability to establish free trades, and (c) market de-regularization (Devereux & Genberg, 2007; p.572) which will pull down one economy when any of the interdependent economies experience economic difficulties. Balance of Payments Central to the understanding how one economy will affect the performance of other economies, as was seen in the recent global economic crisis, is the concept of Balance of Payments (BOP). BOP is the record of all the monetary transaction of one economy with other economies around the globe (Sloman, 2004). Monetary transactions recorded in BOP include payments made for imports of goods and services, financial transfers, and financial capitalizations. Emerging economies like that of China, Korea, and Middle Eastern countries pour their BOP surplus to stable countries like UK, Europe, and Australia seeking for higher returns as US dollars and Euro increase the demand for financial assets they dominate, minimize the risk of the traded financial instruments due to the sophistications of these economies, and level out the market imperfections and inadequacies (Devereux & Genberg, 2007; Marx, 1862). As the investments kept on flowing into the more stable economies, the prices of bonds and financial derivatives has increased to substantial levels, forcing financial institutions like banks to offer subprime loans and mortgages. From 2003-2007, large and stable economies like US and UK have BOP deficits (Rogoff, 2007) while emerging economies in Asia and Middle East have generated surplus in BOP (Cooper, 2006). A country with BOP surplus has its currency valued less than it should be, making its products attractive to foreign market. However, countries with BOP surplus may not want to make any serious effort to appreciate its currency because it will hurt the export sector and hence their economic stability. In order to lower its BOP surplus without jeopardizing its economic stability through its export sector, the country can use monetary and fiscal policies to transform this surplus into domestic activity (Devereux & Genberg, 2007). However, this approach is inflationary as domestic price of goods and services can increase rapidly. Countries with BOP deficits and those that require the BOP surplus of other countries to further its economic activity has placed their investment on housing markets. By December 2009, the Australian BOP increased by 19% to $17.45 billion with a $12.4 billion increase to its net international investment position (ABS, 2010). In 2004, the Australian economy experienced a slowdown as housing construction slowed (Duncan & Elliot, 2004; 322) which signals the start of something bigger. The Credit Crunch Central to the economic recession is the credit crunch resulting to a massive decline in performance of two of the biggest industries in any economy, the housing and the financial industries (Bernanke, 2009). The credit crunch that occurred is a result of the interplay of various economic factors, particularly the increase in interest rates as the economy experience prosperity. This was earlier theorized by the economist Henry Minsky who argued that as the economy experience positive growth and sees a promise for a better economic situation, a speculative euphoria begins to take form (Minsky, 1974; p.5). Because people generally foresee a positive economic growth in the near future, the decision to invest almost comes faster than to save. Individuals and companies alike form strategies that would allow them to invest their funds in the hopes of better returns. These potential investors then turn to banks and other financial institutions for funding through loans. As the economy performs well, interest rates increase. In the same manner, inflation almost always comes with the increase in interest rates which results to the inability of the creditors to pay for their loans and debts. When the investors could no longer pay their debts, it is the banks and other financial institutions that take the hardest blow. The inability of the consumers and investors to afford to purchase existing assets in the market due to ‘overinflated’ prices led to a price collapse which eventually developed into a major financial crisis (Salvatore, 2007). Assets were foreclosed by banks and banks were forced to sell these assets at lower prices in order to entice the market to buy it. However, the market’s vulnerability to the credit crunch left it with no savings or liquid cash to sustain long- and short-term investments. The inability of banks and financial institutions to sell assets at significantly lower prices to the market results to a massive liquidity crisis or the lack of cash of a business required to pay its short-term debts and day-to-day operations (Roubini, 2007). This is the scenario experienced by the global banking industry and the financial market industry. Economic Element The economic element is closely linked to Australia’s banking sector for obvious reasons. Australia’s economy is no less vulnerable than the rest of the world. According to Eslaske (2008), Australia’s economy is vulnerable to the global economic recession at three major points – the price of commodity, overseas borrowing, and consumer confidence. One of the major characteristics of the stable Australian economy is the ever increasing demand for commodities. As the demand for basic commodities increases, the price of commodities shoots up. The increase in the price of commodities threatens inflation growth in the long run. Secondly, the increase in the interest rates of foreign debts increased economic pressures on Australia which has indirect consequence to the banking sector. Because of the global economic turmoil, the confidence of consumers of retail and institutional banking has significantly dwindled forcing the banking sector to readjust its focus. In the last two decades, the Australian economic structure has been thoroughly modified to resist global economic inflation, so to speak. The Australian banking industry was regulated in 1981 following the Campbell Inquiry which introduced the removal of interest-rate ceilings, the switch to policy-based rates interest rates (from monetary targets), the entry of foreign banks in Australian economy, and the implementation of capital adequacy requirements as the basis of prudential oversight of financial institutions (Felmingham, 2003). In 1997, the banking industry of Australia received another deregulation after the Wallis Inquiry which establishes new regulations on three aspects of the banking industry - the establishment of new regulators, the economic consideration of mergers and acquisitions and important recommendations regarding electronic commerce (Tyree, 2003). The leniency of the Australian economy after the numerous deregulations increased its economic activities. Australia was transformed from a highly protected, inward-looking regulated marketplace to an internationally competitive and export-oriented market. Australia has introduced Goods and Services Tax (GST), reduced income tax rates, privatized government-owned monopolies, reformed the existing taxation system in 1980s, and liberalized access for foreign banks among many other (Felmingham, 2003). As the Australian economy became more exposed to the risks presented by a global economy, the Australian fiscal and monetary policies impose stringent restrictions to Australian banks as well as foreign banks operating in Australia in terms of capitalization as they become subject to robust and comprehensive prudential standards. According to RBA (2010), the main concern of the Australian economy in the next ten years does not revolve mainly on the stability of the banking industry as it keeps surveillance of four major factors – foreign debts, employment, housing price stability, and the global economy. Although the foreign debts owed by Australia are significantly high, and is growing at a rapid rate as was discussed previously, the money owed were used in different forms of government investments and expenditures that are none too close to risky investments on real estate. Australian Banking Industry Of the 58 authorized banks operating in Australia as of August 2009, 44 of which are foreign-owned. The four major Australian banks are characterized by large capital bases, strong business franchise, wide geographic presence, and sound asset and profitability quality (Avkiran, 2007). The domestic banks have S&P ratings of AA to BBB The banking sector as a whole satisfies a diverse product and service portfolio which include corporate finance, retail banking, derivatives, project finance, electronic banking, leasing, property and construction finance, securitization, syndicated loans, trade finance, treasury products, and structured finance. The Australian banking industry appears to be less affected by the global economic crisis that plagues the banking industries of America, Europe and other countries. From the discussion above, two main reasons are derived to explain why the banking sector of Australia is resilient to the pressures exerted by the economic crisis. First, Australia’s banking industry is protected by its fiscal and monetary policies that refrain banks and financial institutions from performing very risky investment activities. Second, despite massive reliance on foreign debts to fuel its business activities, the country’s banking industry’s main focus is consumer lending. It was through increased capital spending of the government and the boom of commodity price that the Australian economy was able to remain safe (Neal, 2004). When the global economic meltdown began to take shape, the Australian government institute regulated spending to offset the effects of low economic performance. Sometime in 2004 when the economy experience a slight pull of the adverse effects of the housing market, the government with the collaboration of its banking industry imposed stricter lending rules for properties and real estate (Duncan & Elliot, 2004). This move was to prevent further degradation of the economic performance of the housing market, particularly to safeguard other industries from the adverse effects of relentless lending and significant increases of the interest rates in mortgages. Australia’s economic standing stems from the commitment of the Australian government to practice high-standard macroeconomic policy settings which include (a) an acceptance of wise and strategic fiscal policy where the government aims to achieve fiscal balance during the economic cycle and (b) the conduct of monetary policy to the Reserve bank of Australia (RBA, 2010). Fiscal policy in this context pertains to the limitations set by the government on the minimum capitalization of banks operating in Australia; monetary policies on the other hand refers to the volume of money released by the Reserve Bank of Australia in the form of government expense in order to divert the negative effects of the global economic meltdown from affecting the Australian economy. As was discussed, the robust prudential standards imposed on banks’ capitals discourage banks and financial institutions from taking too risky investments. Because Australian banks are not exposed to such risky undertaking, or has too little exposures to them, it did not flop by the time the global banking industry suffered from major losses. According to the Financial Stability Review of the Reserve Bank of Australia (2010), the country’s banking sector was able to reduce the impact of the global economic recession through stable income streams and through mild losses from securities and bank loans. Unlike the banking industries of US and UK that ride with the wave of the housing boom, Australian banks, after learning its lesson earlier in 2004, focused its efforts on consumer banking, enticing consumers to deposit and borrow funds from the banks. Since the banking industry with the support of the Australian government imposed stringent rules on bank loans and since the industry retained its focus on consumer banking and deliberately avoiding the risks in housing industry, the banking industry of Australia experience stable growth and development. Clearly, the positive effects of the strategic moves done by the Australian banking industry prior the global economic meltdown became beneficial for the country as a whole. Moreover, the precautions made by the Australian government to avoid unnecessary involvement in highly volatile investments saved its banking industry from serious trouble. Because of the lesser impact from these two profitability indicators, the industry has continued to be very profitable despite massive economic instability facing the global economy. In fact, the banking sector of Australia was able to report a 28% growth of net interest income from domestic operations alone in the 12-month period within the release of the report (RBA, 2010). Conclusion The discussions above were able to satisfy the preliminary questions posed by this paper. What kept Australia’s banking industry whole and intact during the global economic turmoil? The risk-careful structure adopted by the Australian government in the 80s to safeguard the international growth and expansion of the Australian market as well as the lessons learned from the 2004 struggle with its own housing industry proved to be a strong foundation for the Australian economy during the height of the global economic crisis. This explains why the international economic scenario was not fully felt in the Australian economy. Another important factor that was considered to explain why the international element did not affect Australia’s banking industry is the absence of strong drive to invest BOP surplus from China and emerging economies in the housing market, as what other economic superpowers did. What are the lessons learned from the growth of Australia’s banking industry amidst global economic turmoil? The answer to this is safety banking. When the global economy experience Minsky’s speculative euphoria, banks and financial institutions around the globe made decisions that are counter-intuitive, all of which are geared towards the maximization of profits and optimization of investment returns. American banks began pouring their money, including their capitals, on the real estate industry in the hopes that their investments would yield positive returns in the long run. As was discussed, this particular strategy rebounded when the economy snapped and consumers can no longer pay for their mortgages or purchase new assets. Because Australian banking industry stick to the basics of its operations by focusing on the consumer banking, it experienced slow but consistent growth during the toughest economic periods in the global banking industry. References AusAID. (2010). Global Recession. Retrieved online from http://www.ausaid.gov.au/makediff/gec.cfm Australian Bureau of Statistics. (2010). 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