How the Reserve Bank of Australia Dealt with the Global Financial Crisis of 2008 - Case Study Example

Financial regulation in Australia and how the Reserve Bank of Australia dealt with the Global Financial Crisis of 2008 Financial regulation in Australia and how the Reserve Bank of Australia dealt with the Global Financial Crisis of 2008 Compared to other developed countries, Australia managed to emerge from the global financial crisis of 2008 with minimum disruptions in its financial system. This was as a result of a strong regulatory framework, management practices and supervision carried out by several institutions. In this paper, an outline of the prudential regulatory framework in Australia is presented. Its essence, together with how the Reserve Bank of Australia dealt with the global financial crisis of 2008, is presented. The Australian prudential regulation framework The Australian prudential regulation framework falls under the jurisdiction of the Australian Prudential Regulation Authority (APRA), whose main objective is to establish overall stability in the financial system in Australia. In order to achieve this objective, the institution seeks to attain and maintain a state of equilibrium between the competing demands represented by the following: the need for competitive neutrality in the market, overall financial safety and efficiency within the system (OECD 2010, p. 43). In order to achieve its objectives, the prudential regulation framework depends on a number of tools, processes and systems. The first one entails the use of the key registers in the system. Key industry registers in the Australian prudential regulation framework are used to record the occurrence of any trend or business practice that bears the possibility of causing widespread effect in the entire industry (OECD 2010, p. 46). As such, the industry key registers are able to provide a framework for monitoring the possibility of specific risks in the industry on a short- to medium-term basis. Apart from capturing potential threats to the industry, the key registers are used in the Australian prudential regulation framework as a basis for developing Supervisory Action Plans (Rocha, Brunner, & Hinz, 2008, p. 138). As such, industry groups are able to carry out a comprehensive review of all risks that have occurred or those that have the possibility of occurring in the near future. This is important in the way the framework seeks to enforce capital adequacy and liquidity requirements for institutions in the financial system in Australia. These requirements are applicable to all local institutions that are registered as deposit-taking institutions in the country. The adequacy of capital requirement means that these institutions are obliged to meet a minimum ratio of 8% for risk-based capital adequacy ratio (International Monetary Fund, 2012, p. 28). Secondly, the Australian prudential regulation framework is composed of industry groups. These are forums that comprise representatives from different sectors, industries and professional inclinations. According to Nier (2009, p. 57), industry groups within the Australian prudential regulation framework serve the purpose of providing a forum for building consensus across the entire system on current and emerging issues in the industry. These issues include the overall strategy for maintaining liquidity within the industry and issues to do with risk-based capital requirements for financial institutions. Thirdly, there is the industry analysis team. This is a team of professionals within the regulatory framework that is charged with the duty of carrying out research on current and emerging issues in the system (Nier, 2009, p. 66). The findings of the industry analysis team are passed on to the supervisors and the top management of the APRA, for use in the overall decision making processes. Lastly, the industry risk management framework provides a mechanism by which risks affecting the entire industry are identified and acted upon (International Monetary Fund, 2012, p. 33). By identifying specific macro-prudential risks in the system, the framework enables appropriate responses to the risks to be developed and implemented early enough across all institutions affected or in the risk. This approach ensures that the Australian prudential regulation framework is able to identify and manage emerging risks early enough before they develop to unmanageable levels. The need for this framework There are several ways in which the Australian prudential regulation framework is a necessary arrangement in the Australian financial system. To begin with, it is important to note the Australian prudential regulation framework, as carried out by the APRA, is part of the overall system of financial regulation and safety system in the country (Haines, 2011, p. 239). Together with the functions of the Reserve Bank of Australia, the Council of Financial Regulators and those of the treasury, the Australian prudential regulation framework provides an effective safety net for the entire financial system in Australia (Gorajek & Grant, 2010, p. 46). In addition to this, the necessity of the prudential regulatory framework in the Australian financial system is made evident by the fact that the entire system may not tolerate the effects of insolvency in the country’s financial institutions. As such, the framework provides a means by which the financial institutions that have become insolvent can exit the market before the accrued losses spread to all the stakeholders in the institutions (Gorajek & Grant, 2010, p. 47). Also, the prudential regulatory framework is necessary as a means of protecting the interests of retail clients of financial institutions (Haines, 2011, p. 260). Since the majority of the retail customers are not able to make well informed and accurate judgments about the capacity of the financial institutions to honour their financial obligations, the regulatory and supervisory framework ensures that customers are protected from the effects arising from the failure by financial institutions to honour their financial obligations. This is applicable not only for the present financial arrangements but for future obligations as well. Lastly, the possibility of market failures remains a reality in all financial markets. Although the failure of individual companies is an occasional occurrence in all financial markets, the possibility of widespread market failures may trigger a regional or even global financial crisis, as experienced before (Nier 2009, p. 46). Because of this, the prudential regulatory framework plays the key role of monitoring the situation and providing all the information needed to take appropriate action in time. How the Reserve Bank of Australia dealt with the 2008 global financial crisis It is important to note that prior to the global financial crisis of 2008, the financial system of Australia was more or less similar to that in use in other countries in Europe and North America. As such it would have been expected that the country should have suffered similar damage as witnessed in other countries. However, according to Moloney and Hill (2012, p. 234), Australia emerged as one of the countries least affected by the crisis. With strong profitability in the banking sector and an overall positive GDP growth rate, the country had escaped from the effects of the global financial crisis of 2008. In essence, the survival of the country was a result of regulatory and management measures that were taken by the Reserve Bank of Australia prior to and in the course of the crisis. To begin with, the Reserve Bank of Australia sought to unfreeze and restore liquidity to the country’s financial market early during the crisis (Gorajek & Grant 2010, p. 66). Several steps were undertaken to achieve this objective. For instance, private sector securities such as those that are based on mortgages were accepted as collateral for repurchase agreements. Also, following the withdrawal of GE Money from the Australian market, the Reserve Bank of Australia oversaw the formation of a special purpose vehicle that provided finance for local car dealers (Ciro 2013, p. 129). These actions had the overall effect of restoring liquidity in the financial market of the country early enough during the crisis. In the same way that the Reserve Bank of Australia sought to restore liquidity in Australia’s financial market, the bank also sought to restore distressed and troubled financial institutions in the country. By providing debt and equity financing to such institutions, the Reserve Bank of Australia avoided nationalisation of leading financial institutions in the country as it was commonly experienced in other developed countries in Europe and North America. It is also observed that this step had the benefit of insulating the taxpayers from bearing the burden of failure of financial institutions in the country (Haines, 2011, p. 277). Apart from seeking to insulate taxpayers from the effects of failure of financial institutions that resulted from the global financial crisis, the Reserve Bank of Australia dealt with the global financial crisis by use of specific fiscal actions and strategies. For instance, towards the end of 2008, the bank announced a major stimulus package followed by a guarantee scheme for borrowing (Moloney & Hill, 2012, p. 122). These actions had two major effects. The guarantee borrowing scheme enabled the state and territorial governments to access debt financing much easily, thus funding infrastructure projects. On the other hand, the stimulus package, together with major reductions in the interest rate, countered the economic slowdown that had been caused by the crisis. Another way in which the Reserve Bank of Australia dealt with the global financial crisis was by use of regulatory frameworks that sought to prevent further instability in the financial market. For instance, the bank imposed a ban on short-selling on the Australian Securities Exchange from September 2008 (Moloney & Hill, 2012, p. 236). In addition to this regulatory measure, the Reserve Bank of Australia sought to ensure that the remuneration practices in corporate institutions in the country were consistent with the financial risks that companies faced in the economy (Ciro, 2013, p. 133). These regulatory measures ensured that the Australian financial market was insulated from further instability. In conclusion, the global financial crisis of 2008, like similar financial crises, caused disruptions in the financial systems of all countries affected. However, Australia, by virtue of having an effective prudential regulatory framework in place, managed to minimise the effects of the crisis on its financial market. References Ciro, T. (2013). The Global Financial Crisis: Triggers, Responses and Aftermath. Sydney: Ashgate Publishing. Gorajek, A. & Grant, T. (2010). ‘Australian bank capital and the regulatory framework’, Bulletin, September Quarter. Retrieved 6 November 2013, from http://www.rba.gov.au/publications/bulletin/2010/sep/pdf/bu-0910-6.pdf Haines, F. (2011). The Paradox of Regulation: What Regulation can achieve and what it cannot. Cheltenham: Edward Elgar Publications. International Monetary Fund (2012). ‘Australia: Basel core principles for effective banking supervision – detailed assessment for observance’, IMF Country Report, 12(313). Retrieved 6 November 2013, from: http://www.imf.org/external/pubs/ft/scr/2012/cr12313.pdf Moloney, N. & Hill, J., G. (2012), The Regulatory Aftermath of the Global Financial Crisis. London: Cambridge University Press. Nier, E. (2009). ‘Financial Stability Frameworks and the Role of Central Banks: Lessons from the Crisis.’ International Monetary Fund, Working Paper, 09(70). Retrieved 5 November 2013, from: http://books.google.co.ke/books?id=IW8G9oVgs5UC&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=false OECD (2010). OECD Reviews of Regulatory Reform: Australia 2010 Towards a Seamless National Economy. New York: OECD Publishing. Rocha, R., R., Brunner, G. & Hinz, R., P. (2008). Risk-Based Supervision of Pension Funds: Emerging Practices and Challenges. Washington: World Bank Publications. Read More