The Financial System in Australia - Case Study Example

Student Name: Tutor: Title: Banks in Australia Banking Activities’ Risks Course: Introduction Off-balance sheet business activities refer to debt or asset or financing activity that is not captured on the balance sheet of the company. Financial institutions have numerous off-balance sheet assets as well as liabilities. The financial institution has no direct claim to those assets hence they do not record them on its balance sheet. The financial system in Australia has strong features that mitigate the risk of loss of taxpayer’s money which has been backed by a conservative regulatory system as well as bank management that is prudent. Major banks in Australia are well-capitalized both within absolute terms as well as when compared with other global peers on the basis of consistency (Fein, 2011). There is presence of vigorous degree of supervision of domestic systematical vital banks which targets to reduce any moral hazard risk. Since the Global Financial Crisis major banks in Australia have narrowed down on enhancing the quality and quantity of capital, increasing liquidity holdings as well as enhancing the resilience of the funding models. In numerous cases this has happened in anticipation of, as opposed to response to, global regulatory change. The banking sector in Australia is relatively stronger as compared to before the financial crisis. Westpac is an Australian bank as well as a provider of financial services with headquarters at Sydney. It is one of the major four banks in Australia. By assets Westpac is the second largest bank in Australia (Westpac, 2014). This report looks at Westpac in-balance sheet and off-balance sheet business activities while analyzing the risks involved. Westpac off-balance sheet and on-balance sheet Business activities and risks Westpac business comprise of nine business units where it serves about 8.2 million customers. Westpac engages in retailing and business banking activities. This entails transaction accounts, deposit taking, mortgages, credit cards, as well as other lending. Westpac is a big home loan provider and further meets financial needs of business customers who have a turnover of up to $20 million (Panjer, 2006). Superannuation, investment and life and general insurance products are sold through the branch network. Westpac provides banking services for companies as well as individuals. Other business units that Westpac is involved in include Human resources, Group Finance, Group services as well as Group risk. These units are also described as ‘Corporate Core’. Trading activities at Westpac are under the management of Board-approved market risk framework that involves value at risk approved by the board. Westpac holds that the growth in the housing finance market of Australia does not have undue systematic risk in the financial system. There are clear indications that show when systematic risk is present (Bloxham & Kent, 2009). Some of these indications include over-indebtedness for borrowers, the widespread of high-risk loans on non-commercial terms as well as supply-driven concentration of housing assets within the bank balance sheets. Westpac has the belief that growth in housing finance in Australia has been basically demand-driven and is guided by economic fundamentals that are sound. The demand factors as opposed to supply factors form the basis of housing finance growth. Bank mortgage portfolios within Australia are low risk and diversified, and regulatory capital requirements remain conservative. Both rigorous stress-testing together with historical precedent have shown that even dramatic meltdown in house prices will be within loss absorption capabilities of Westpac (Westpac, 2014). Westpac consents that enhanced credit risk modeling capacity is important feature for the financial system. The regulatory capital requirements defined for lending portfolio have to make sure that banks are within the capacity of absorbing losses in the course of severe stress. Value at risk refers to the basic mechanism for controlling and measuring market risk. Market risk on the other hand is managed using value at risk as well as risk limits together with stress testing and scenario analysis. Market risk limits are assigned to business management following business experience as well as strategies, besides regard to concentration risk and market liquidity (Westpac, 2014). All business trades are daily valued at fair value applying independently reviewed or sourced rates. The rates possess independent sources that are limited reviewed every month. The trading activity of the Group Financial Markets represents dealings that entails book running together with distribution activity. The kind of market risk that emanates from these kind of activities entail foreign exchange, interest rates, equity price, commodity, volatility and credit spread risk (Fein, 2011). The trading activity of the Group Treasury involves dealings that encompass the management of foreign exchange, interest rates and credit spread risks traced to the wholesale funding task, foreign exchange repatriations and liquid asset portfolio. Compliance risk refers to not being able to adhere to all provided regulatory and legal requirements and codes of practice in the industry and meeting other ethical standards. The compliance program at Westpac forms part of a wider integrated risk management system and it is propelled by high level standards of practice and principle that are applied to all staff and management (Carr, 2012). Compliance does not refer to only adhering to the letter of the law but further refers to embracing the spirit the spirit of standards of regulatory that apply. Responsibilities Regulatory compliance of the bank continues to increase. The major significant change currently being experienced by the bank is preparation for the progressive commencement of Australian anti-money laundering as well as counter terrorism legislation. Basic responsibility for implementing of compliance requirements resides within the line management who are needed to show that they possess effective processes in place (Tschoegl, 2005). The staff members have compliance in their sphere of activity and influence. Westpac assess the effect of changes within the regulatory environment on a continuous basis. Management unit ensures that the aggregate exposure to risk of interest rate is mitigated within policy guidelines with described constraints that resonate with the ‘risk appetite’ of the bank as well as strategic objectives that are evaluated by the Board Risk Management Committee. Westpac continuously re-evaluates and manages the counterparty credit exposure that comes from derivatives business. Daily simulation of potential future counterparty credit exposure incorporating movements within the market rates is carried out. The current financial system disclosure regime has led to growing costs and sometimes in voluminous documentation which does not improve customer understanding. Westpac holds that disclosure has to be the fundamental foundation entailing consumer protection within the financial system of Australia. Regulation of financial products has to offer effective consumer protection while at the same time permitting consumers to take risk (O'Donovan, 2005). The interest rate risk is managed on the earnings as well as a valuation approach through the Bank the Balance Sheet risk of the bank. Operational risk does not entail the risk of losing money due to normal banking activities like trading, investing or lending. Operational risk includes fraudulent activity like unauthorized lending where a loan officer ignores rules or where by a trader is involved in trading activity way beyond the authorized limits. Market risk refers to the potential for losses as a result of adverse movements in the degree of market factors like interest rates and foreign exchange rates. Trading activities result into market risk. This kind of risk is managed by an overall risk management system that integrates a number of market risk Measurements suck as value at risk (Keating, Quazi, Kriz & Coltman, 2008). Value at risk describes a statistical estimate of the potential loss that can be incurred if the trading positions of the bank were maintained for a defined time period. Value at risk does not refer to the estimate of maximum loss the trading activities can be incurred from an extreme market event. Value at risk measurements are complemented by a series of stress tests that are applied in capturing the probability of extreme events or market shocks (Jeucken, 2004). The market risk framework comprises of applying stop-loss limits on every portfolio, specific options limits, basis point sensitivity boundaries, as well as control of unusual or large trading activity. Credit risk refers to the potential for financial loss whereby a customer or counterparty is unable to meet their financial obligations (Dr. Gattorna, 2012). The Bank has a credit risk system as well as various supporting policies, controls and processes governing the approval, assessment and management of counterparty and customer credit risk. These entail the quantification of loss estimates in case of default, assignment of risks grades as well as credit exposures’ segmentation. Conclusion There are different businesses activities that Westpac bank is involved in that come with different types of risks that have to be managed carefully. On-balance sheet and off-balance activities come with a level of risk that the management has to be aware of in the banking industry. Effective risk management makes Westpac Group to stand out from the competitors and gives the bank a competitive advantage that is required to survive in the competitive business environment. The bank has to strike a balance between optimizing and protecting the balance sheet. Professionals in risk management ensure that the bank does not suffer unexpected loss; they come up with control frameworks and regulatory, compliance and interest rate risks among others. Shrewd risk management frameworks are important in making Westpac to realize its business objectives and serve its customers effectively within and outside Australia. References Bloxham, P. & Kent, C., 2009, Household Indebtedness, The Australian Economic Review, 42 (3): 327-339. Carr, J., 2012, Major Companies of the Far East and Australasia 1992/93: Volume 3: Australia and New Zealand, Springer Science & Business Media, Sydney. Dr. Gattorna, J., 2012, Dynamic Supply Chain Alignment: A New Business Model for Peak Performance in Enterprise Supply Chains Across All Geographies, Gower Publishing, Ltd., New Delhi. Fein, M.L., 2011, Securities Activities of Banks, Aspen Publishers Online, London. Jeucken, M., 2004, Sustainability in Finance: Banking on the Planet, Eburon Uitgeverij B.V., London. Keating, B., Quazi, A., Kriz, A., & Coltman, T. 2008, In pursuit of a sustainable supply-chain: insights from Westpac Banking Corporation, Supply Chain Management: an International Journal 13 (3): 175–79. O'Donovan, J., 2005, Lender Liability, Sweet & Maxwell, Melbourne. Panjer, H.H., 2006, Operational Risk: Modeling Analytics, John Wiley & Sons, New York. Tschoegl, A.E. 2005, Foreign Banks in the Pacific: A Note, Journal of Pacific History. Westpac, 2014, Interim Results Presentation and Investor Discussion Pack, at p. 131. Read More