The Global Financial Crisis - Example

Financial Crises Name Date Course Financial Crises Introduction The current financial system involves financial organizations, financial instruments as well as financial markets. This kind of system offers a variety of financial services and products with various risks, returns and liquidity of cash flows so as to support various savings and can then be accessed so as to be invested within the economy. This implies that the financial system plays a key part in growth and development of a country’s economy. This is because it provides an atmosphere for savings (Viney, 2009). This also implies that a crisis in finance has its implications to the country. As noted by Viney (2009), financial crises have a disruptive impact on how funds flow in the financial system. This paper shall outline and explain the Australian prudential regulation framework. It shall also explain the need for this framework and outline how the Reserve Bank of Australia dealt with the 2008 G. In Australia, the financial system is governed by various interrelated components that constitute a regulatory framework. This framework was created in 1998 as a response to recommendations by the Wallis Committee from their Financial System Inquiry. The new structure created one prudential supervisor (The Australian Prudential regulation Authority). This was supposed to be in charge of supervising banks, general and life insurance companies as well as funds from superannuation. Customer protection and market integrity was mandated to the Australian Securities and Investments Commission while monetary policy and maintenance of stability in finance was the responsibility of the Australian Reserve Bank. This also included stabilizing the systems for payment (ABS, 2013). A regulatory framework reduces the impact as well as the probability of failure through particular classes of financial institutions. The various components that constitute the framework include generic requirements that are based on principles for all corporations. In addition, there are other rules that apply to the commercial endeavors and some specific requirements that are meant to address certain problems in the financial system. Every component of this regulatory framework has its unique objectives. A guarantee scheme can be introduced to the regulatory framework so as to act as a safety net and this can be accessed through the understanding of how the scheme will interact with other components of the framework (Australian Government, 2013). The regulatory framework consists of a prudential framework, a consumer protection, a corporate and market regulation and a market discipline. Market discipline forms the foundation of the framework because in the financial system, those who can best assess the quality of a financial promise are those who stand to gain or lose directly from a financial promise. The corporate and market regulation ensures companies operate orderly and ensures that there is timely and adequate exposé of information to the market. On the other hand, consumer protection is tasked with addressing the imbalance of available information to investors who are unsophisticated while the prudential regulation is meant to reduce the probability of failure of entities being regulated. The prudential framework is further comprised of some elements. These include the prudential regulation, prudential supervision, comprehensive intervention and strategies for resolution and the capability to apply for winding up. The prudential regulation is a standard setting that defines the constitution of the minimum acceptable behavior as well as promoting sound practices of risk management. Prudential supervision facilitates timely detection of difficulties in finances in the firms that are regulated and monitors compliance with the prudential regulation. Comprehensive regulation involves handling the regulated firms that are in difficulty while the capability to apply for winding up is meant to allow a regulated company to be closed and its assets distributed before any potential losses are too great to bear. Source: Australian Government, 2013. A justification of the prudential regulation stipulates that tolerance f the community for the insolvency of a financial institution is lower than what may be accepted for firms that operate in other parts of the country’s economy. Having a prudential regulation serves to stabilize the financial system. Some financial institutions have a bigger number of retail customers who cannot make judgments that are sufficiently accurate and informed on the ability of an institution to meet the promises made t its clients whether now or in the future. The repercussions of not being able to meet the promises are considerable. In addition, the financial system is susceptible to other manners of market failure like external effects or contagion effects in which a problem spreads from one institution spreads to other financial institutions. Cases of prevalent contagion and failure in the market should be differentiated from the occasional failure of one firm. In every competitive market, insolvency is a normal occurrence. However, the occurrence in financial institutions raises concern since it is vital to ensure that the failure does not spread to other participants in finance or to avoid undue cost or complexity while trying to resolve the issue. In handling the insolvency of an institution of finance, the prudential framework ensures that there is ability to identify and to handle a troubled institution’s exit before any significant losses are accrued to certain shareholders. However, this is not possible every time and creditors as well as customers of the financial institution may not be paid back in full. The Australian prudential regulation framework was designed around distinct industries. The requirements for institutions that take deposits, general insurance and life insurance companies have been placed under different legislation. Additionally, there is some legislation that applies across all sectors. Such include the Australian Prudential regulation Authority and the legislation that relates to shareholdings in institutions of finance. One underlying principle of the prudential regulation is that regulatory intensity is supposed to vary based on the type of failure that has occurred in the market and the risk involved. The components of the regulatory framework that are most relevant are the liquidity, capital adequacy, the power of intervention by the prudential regulator and the specific rules related to the industry in handling insolvency of institutions of finance. By and large, the role played by the prudential regulatory Authority is to promote prudent behavior among banks, superannuation funds, insurance companies and other institutions of finance. The key aim is to protect interests of depositors, fund members and policy holders. The main focus of the authority is on the quality of the system to identify, measure and manage various risks posed to their business. Therefore, the framework of the regulation is meant to create a balance between financial safety, efficiency, contestability, competition and neutrality in competition. While carrying out the role, the regulatory authority enhances the confidence of the public in the financial institutions in Australia. Achieving this has been made possible through promulgation and formulation of prudential practice and policy that are to be observed by the institutions being regulated. In addition, there are compliance and surveillance programmes that are effective and these involve measures of enforcement that are relevant. These measures have an effect on the laws being administered by the regulatory authority and comply with the standards that are issued under the laws. It has also been achieved through provision of advice to the government on developing regulations and legislation that affect the regulated institutions as well as the financial markets under which they operate in. How the Reserve Bank of Australia dealt with the 2008 Global financial crisis The global financial crisis 2008 called for governments and central banks to respond to the dislocation and weaknesses in the economy by undertaking moves in conducting monetary as well as fiscal policy (Ehler, 2009). The Global Financial Crisis was triggered by the deterioration in the housing market in the USA and the steady rise realized in the delinquencies shown on subprime mortgages. This led to global spillover effects and banks across the world became reluctant to lend money to each other owing to the increase in the risk of counterparty default as well as a lack of transparency (Ehler, 2009). Banks tightened lending standards and this led to a weakened global economy since credit was more expensive. According to Brown and Davis (2009), Australia emerged as one of the least affected by the global financial crisis among the developed economies. In fact, the banking sector in Australia was one of the least affected across the globe. Significant failures were realized by investment companies accompanied by huge investor losses emanating from investment funds and structured products. This prompted concerns on investor protection and the financial market practices. Australia had an approach of regulating the securities and investment markets. This was done based on education, disclosure and advice. The response by the authorities in Australia in involved the Reserve Bank and the government. The two unfroze the financial markets and restored liquidity in the financial market. Earlier on in the crisis, the Reserve Bank increased the range of securities that it would take as collateral for the repurchase agreements so as to include private sector securities like residential mortgage backed securities (RMBS). In addition, there was an extension on the repurchase agreements term to one year. The year 2008 saw the Federal government introduce a RMBS purchase agency in the office of financial management in Australia. The aim was for the restart the frozen RMBS market. In addition, there was a special purpose vehicle called the Ozcar which was established so as to avail finance to car dealers after the two biggest finance providers withdrew from the Australian market (Kearns, 2009). All these were done as part of the strategies to handle the crisis that was experienced in 2008. Conclusion The global financial crisis is triggered by one economy. However, this spreads out to various other economies. The spread occurs when the initially affected economy is among the economies that control the world (a country with a strong position in the world economy). It is vital that governments and financial regulatory authorities devise policies that will help in protecting their economy from the effects of the global financial economy. Such policies would ensure the country is not affected or if affected, will not face adverse effects. Australia was one of the countries that were not adversely affected by the global financial crisis of 2008. List of References Australian Bureau of Statistics, 2013, Financial System: Regulatory Framework. Retrieved on November 2, 2013 from: . Australian Government, 2013, Chapter 3: Australia’s Existing Regulatory Framework. Retrieved on November 2, 2013 from: . Brown, C. & Davis, K 2009, Australia’s Experience in the Global Financial Crisis. University of Melbourne. Australia. Ehler, M 2009, RBA Economics Competition 2009: Policy Responses to the Global Financial Crisis. The University of Queensland. Australia. Kearns, J 2009,“The Australian Money Market in a Global Crisis.” Reserve Bank of Australia Bulletin, June, 15-25. Viney, C 2009, Financial Institutions, Instruments and Markets. McGraw-Hill, Australia. Read More