Structure of Australian Financial Institutions - Essay Example

?Research report on Australian financial services industry Table of Contents Research report on Australian financial services industry Table of Contents 2 Introduction 3 Structure of Australian Financial Institutions 3 Banking Industry in Australia 5 Legal Framework of Australian Banks 7 Liquidity Management 8 Capital Management 8 Challenges Faced by Australian Banks 11 Conclusions 13 References 14 Introduction Banks and financial institutions have been the institutions that have been impacted most significantly by the global economic recession. The economic recession saw the fall of financial giants like Lehman brother and Bear Sterns. The impact of the crisis was so serve that governments across the world had to introduce financial bailout packages to prevent business organizations from being declared bankrupt. The economic recession spiralled by the subprime crisis has called upon business organizations particularly banks and other financial institutions to ensure better risk management practices. It also calls for financial institutions to increase the level of compliance. These calls for a collective effort on the part of bankers, central bankers as well as policy makers to formulate policies that seek to ensure financial health and stability of these crucial institutions of the economy. The present study would analyse the financial institutions in Australia with regards to their structure and legal framework. Special emphasis would be given to the banking sector in the report that would also analyse the challenges faced by the Australian banks. Structure of Australian Financial Institutions The Australian financial services industry is divided into a total of nine distinct sectors which includes deposit based financial institutions like banks and other credit agencies, non deposit based financial firms, the central bank, asset investing firms like stock trading companies, pension and superannuation fund management companies, auxiliary firms like stock brokers, mortgage securities firms, life insurance, general insurance and finally the insurance broking companies. The financial sector contributes about 18 billion Australian dollars to the nation’s economy which equals almost 8 percent of the total GDP of the nation. The nation has a total of 30000 financial institutions which also provide employment opportunities to a significant share of the population of the nation that is being pegged at 700000 individuals which includes approximately 6.4 percent of the total workforce in Australia (IBSA, 2010, p.4, 6). Figure 1: Assets of the Financial Institutions in Australia (Source: Austrade, 2009, p.13) The figure above shows the total assets of the financial institutions in Australia as of the year 2009. According to the statistics shown in the figure the total assets of the financial institutions of the nation was 4431 billion Australian dollars. The compounded annual growth rate is being pegged at 11.8 percent starting from the year 1994. The financial institutions in Australia have also expanded their reach to across all the major and developing markets across the globe (Austrade, 2009, p.13). In terms of investment based funding assets the current value of the total assets in the nation is 541 billion AUD which is the fourth largest in the world. The figure is expected to grow to about 1979 billion AUD by the year 2015 (Austrade, 2009, p.16). Banking Industry in Australia As per the latest information from the Australian Reserve bank there are about 58 banks in the nation that includes 7 major banks, 7 local banks, 9 foreign banks incorporated in Australia and 35 foreign banks. The total cash and liquid assets including notes, deposits and coins apart from other liquid assets amounted to 3 percent of the total assets of residents in Australia. Trading and investment based securities accounted for 9.3 percent and 6 percent respectively. The loans and advances segment including all forms of loans extended to the retail as well as corporate houses in the nation amount to 62.2 percent. Other investments have a percentage share of 3.4 percent. Assets including fixed, intangible, interest receivables, derivatives and deferred tax based assets were fixed at 7 percent for all the banks in the nation including domestic and foreign banks. The total residential asset base in the entire nation was found to be 2360 Australian dollars (APRA-a, 2009, p.14-20). Figure 2: Capital Adequacy Ratios for Australian Banks (Source: APRA, 2009, p.24) Liabilities for the banks in Australia includes acceptances, deposits that include both corporate as well as domestic and individual segments, Certificate of deposits, tax liabilities, provisions, derivatives, borrowings as well as loans and other hybrid based securities. The total liabilities due to deposits is pegged at 2.4 percent of the total resident based liabilities in the nation. In addition to deposits other liabilities like group based deposits account for 8.2 percent of the total residential liabilities. Loans and other securities constitute about 1.2 percent making the monetary value of the total liabilities of all the 58 banks in the nation at 1805.4 Australian dollars (APRA-a, 2009, p.14-20). Legal Framework of Australian Banks The regulatory framework for financial institutions in Australia was introduced in 1998 when a series of reform measures were introduced by the government. In accordance with the recommendations of the Wallis Committee the government of Australia set up a central supervisor named as the Australian Prudential Regulation Authority (APRA) that would act as a central monitoring authority for the banks, insurance and funds for superannuation. In addition to the APRA, the other monitoring authorities in the Australian financial services industry include the Australian Securities and Investments Commission (ASIC) which is responsible for monitoring the activities of the capital markets as well as payment of superannuation and insurance claims. The Reserve Bank is responsible for formulating the monetary and fiscal policies of the nation. The bank ties to maintain a state of stability in the banking sector by ensuring compliance with the banking regulations. The Reserve Bank has also been vested with greater statutory powers which enable it to influence greater control over the monetary system and ensure greater vigilance over the banks and to ensure that the financial institutions ensure greater compliance with the norms. A new payment systems board has also been started under the aegis of the Reserve Bank that has the statutory powers to look after the aspects of payments. The board also has the powers to look into matters governing the elements of risk and competition within the market with regards to the product of the financial service industry. The creation of APRA has reduced the burdens of the Reserve Bank which can entirely devote its strategies towards ensuring compliance and defining the monetary and fiscal policies that largely influences crucial aspects like inflation of the economy (Reserve Bank of Australia, 1998, p.1-2). Liquidity Management Crucial indicators like liquidity of banks are largely regulated and monitored by the APRA. The agency regularly monitors banks to ensure that banks have policies that tend to reduce the risk of liquidity to a certain limit that is acceptable by the regulatory authority so as to entertain all its financial and debt obligations. The PRA also ensures that the compliance regulations are monitored and reviewed with time to meet the challenges of the economy. The regulatory authority also ensures that banks undertake scenario based planning for risk management and also keep a check on the aspects of accountability. The scenario based risk management plans would ensure banks to tide over times of financial and economic crisis situations. The regulatory authority also ensures that banks have a limit on the levels of mismatch in maturity along with periodic monitoring of the actual stock of the different liquid assets of the bank. The compliance norms also state that banks should have a diversified and largely stable funding base with emphasis on greater maintaining strong customer relationships. Sufficient cash holdings must also be maintained that would ensure intraday liquidity (APRA, 1998, p.1-4). Capital Management Australian banks have a strong capital management framework which is supervised by the APRA. The regulatory bodies have ensured that banks follow the framework of the Basel II norms. The regulatory norms state that banks must formulate an ICAAP (Internal Capital Adequacy Assessment Process) that would serve as a template for capital management strategies. This document must be approved by the regulatory authorities who will determine the prudential capital Ratio (PCR) which is the minimal ratio of capital that must be maintained by every single bank across the year. Efficient management would also require keeping a buffer amount that is above the minimal value for this ratio (Barnes, 2008, p. 2). APRA also states that banks must maintain a minimum ratio of 8 percent of the total capital to the risk based weighted assets should be 4 percent of the total tier 1 capital (APRA-b, 1999, p.1-2). Figure 3: The ICAAP Framework in Australian Banks (Source: Barnes, 2008, p. 2) The figure above shows the ICAAP framework for capital management in the Australian banks. The eight step regulatory policy framework ensures that banks have an adequate capital adequacy ratio at all times and also ensure compliance with the Basel II norms. Figure 4: Capital Management Regulatory Framework in Australian Banks (Source: Barnes, 2008, p. 4) In addition to maintenance of capital banks are also required to undertake credit ratings with regards to risk adjustments in the capital requirements and ensure compliance of Basel II norms. Aspects like risk weighted assets as well as deductions in accounting of the total capital are also being monitored by the central regulatory authorities to ensure a strong and stable financial position of the banks (Barnes, 2008, p. 4). Challenges Faced by Australian Banks Like every economy the Australian economy also faced a crisis during the period of the global economic meltdown. The main issue faced by the Australian banks was that the economy was on an overheating mode with key aspects like inflation reaching all time peak levels. Boom in the housing prices also added to the pressures faced by the nation’s banks. However owning to the fact that subprime loans as well as arrears on home loans had a low value helped the nation to withstand the effects of the global financial meltdown (Battellino, n.d., p.303-305). The Australian economy unlike their counterparts in Europe and US was more resilient towards the impact of the global financial crisis. The reasons for this can be largely be traced to the efficient regulatory framework and strict adherence with the compliance stated by the regulatory authorities. The APRA which is the regulatory authority for banking companies has ensured that banks comply with Basel II norms. The flexible exchange rates adopted by the central banks have also ensured greater financial stability so as to counter the effects of the recessionary phase of the economic business cycle. Reducing the policy rates to seven and half percentage also helped in ensuring a sound fiscal policy which largely helped in countering business and mortgage rates in the banking industry. However over dependence on commodity based trading also poses elements of risk in the long term with trading volumes stated to be on the path of decline following a slowdown in the recovery of European economies and dip in demand of commodities by China. International aspects of risk also include slowing down of the pace of recovery in the European nations. The sovereign debt crisis in Europe could then spill over to the nation with Australian borrowers incurring a higher capital cost. In addition to international aspects national elements of risk also include dip in housing prices that would lead to negative impact on the rates of private consumption. In addition to this the present boom in the domestic mining industry would impact output and scale up the inflation figure in the nation (IMF, 2010, p. 2-13). Conclusions The Australian banking sector through a strict and efficient regulation by the APRA was able to withstand the effects of the global economic meltdown through an efficient regulatory framework. However certain challenges like dependence on commodity trading and other economies poses serious challenges. The economic recovery of European nations also poses areas of challenges for the banking industry as slowdown in recovery can slow down the pace of growth in the banking sector. Challenges also remain for the central bank to maintain this favourable trend in the wake of outlooks and predictions that foresee an increase in inflation rate. It remains to be seen how the banking regulators in the nation are able to formulate an effective fiscal and monetary strategies so as to ensure sustainability of the macroeconomic elements so as to ensure sound and strong financial health of the financial institutions in Australia. References APRA. (1998). Liquidity Management. [Pdf]. Available at: http://www.apra.gov.au/ADI/upload/Liquidity-Management-April-1998.PDF [Accessed on May 21, 2011]. APRA-a. (2009). Banks. [Pdf]. Available at: http://www.apra.gov.au/Insight/upload/Insight_Issue_2_2010_Banks_Sept_2009.pdf [Accessed on May 21, 2011]. APRA-b. (1999). Capital Adequacy of Banks. [Pdf]. Available at: http://www.apra.gov.au/ADI/upload/Capital-Adequacy-of-Banks.pdf. [Accessed on May 21, 2011]. Austrade. (2009). Australia. A Global Financial Services Centre. [Pdf]. Available at: http://www.fex.com.au/media/Austrade.pdf [Accessed on May 21, 2011]. Barnes, C. (2008). Capital Management in Australian and Chinese Banking Systems: Capital Management in Australian Banks. [Pdf]. Available at: http://www.apec.org.au/docs/08_ALA_RT/S6_Barnes.pdf [Accessed on May 21, 2011]. Battellino, R. (No date). High-level policy panel on monetary policy and exchange rate issues: the RBA’S monetary policy challenges during the international financial crisis. [Pdf]. Available at: http://www.bis.org/publ/bppdf/bispap52q.pdf [Accessed on May 21, 2011]. IBSA. (2010). Environment Scan 2010. [Pdf]. Available at: http://www.ibsa.org.au/Portals/ibsa.org.au/docs/Research%20&%20Discussion%20Papers/Sectoral%20report%20-%20Financial%20Services%20Industry%2026%20Feb%2010.pdf [Accessed on May 21, 2011]. IMF. (2010). Australia: 2010 Article IV Consultation—Staff Report; and Public Information Notice on the Executive Board Discussion. [Pdf]. Available at: http://www.imf.org/external/pubs/ft/scr/2010/cr10331.pdf [Accessed on May 21, 2011]. Reserve Bank of Australia. (1998). Australia’s New Financial Regulatory Framework. [Pdf]. Available at: http://www.rba.gov.au/publications/bulletin/1998/jul/pdf/bu-0798-1.pdf [Accessed on May 21, 2011]. Read More