1203AFE Lecture Notes - Lecture 10: Tier 2 Capital, Scenario Testing, Withholding Tax
30 May 2018
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Week 10 Money, Bank and Finance Lecture Notes
Topic 8: Regulation of Financial Institutions
Reasons for Regulation
• Financial institutions are regulated because they provide goods and services that
the economy needs to function well.
• The environment in which financial institutions operate is characterized by
asymmetric information.
• The social costs of bank failures and the resulting economic problems are high —
banks are heavily regulated.
Bank Failures
• Because the costs of a bank failure is high, regulation has focused on reducing the
risk of this occurrence.
• Banks can fail because of illiquidity or inadequate capital (insolvency).
• Significantly, the failure of one bank undermines confidence in all other banks.
• This confidence may be maintained by the presence of a lender of last resort (via the
central bank, RBA).
• Ensuring that banks have sufficient liquidity in a crisis is of the utmost importance.
• In Australia, the governments and the RBA have, in the past, provided support in a
liquidity crisis.
• Of course, banks are expected to have their own liquidity management strategies as
well.
• The strong prudential supervision of Australian banks has contributed to the stability
of Austalias fiaial sste duig the gloal fiaial crisis.
The Prudential Supervision Framework
• There are three regulatory bodies in Australia:
o The RBA: responsible for systemic stability.
o ASIC: responsible for consumer protection and market integrity.
o APRA: responsible for prudential regulation of ADIs, insurance companies
and superannuation entities.
Legislation
• Five key pieces of legislation are relevant to the operation of financial institutions in
Australia:
o Reserve Bank Act 1959:
▪ Creates the RBA and defines its role, powers and responsibilities.
o Banking Act 1959:
▪ Provide regulatory authority over who can conduct banking business.
▪ Provides APRA with the power to authorize, deny and revoke
authorization.
▪ Requires institutions to provide APRA information.
▪ Gives APRA its powers.
o Financial Sector (Shareholdings) Act 1998:
▪ Controls the ownership of financial sector companies.
o Financial Sector (Collection of Data) Act 2001:
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find more resources at oneclass.com
▪ Further power for the regulatory authorities to compel information
from financial institutions.
▪ Assists with monetary policy and prudential regulation.
o Financial Services Reform Act 2001:
▪ Single licensing regime for financial advisers.
▪ Minimum training standards for financial advisers.
▪ Introduction of standard PDS across financial products.
AP‘As Methodolog
• There are three ke eleets to AP‘As pudetial supeisio faeok:
o 1. Risk assessment and response tools:
▪ Probability & Impact Rating System (PAIRS); and
▪ Supervisory Oversight & Response System (SOARS).
o 2. Industry-wide risk analysis.
o 3. Supervisory action plans.
PAIRS
• PAIRS = Probability and Impact Rating System.
• PAIRS is used to assess the probability that a regulated institution will fail.
• It is a assesset ased o the stegth of a istitutios aageet, otols
and capital base.
• In light of this assessment, PAIRS assess the inherent risk of the institution.
• APRA uses PAIRS to:
o Assess risk.
o Determine the focus of the supervisory effort.
o Determine the level of supervision for each institution.
o Define the reporting obligations of each institution.
o Illustrate to each institution how the level of supervision they receive is
determined.
PAIRS Rating Framework
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find more resources at oneclass.com
Summary of PAIRS Scoring
SOARS
• SOARS is used to determine the supervisory response that APRA should take.
• It combines the PAIRS probability rating with the PAIRS impact rating.
• Refer to the following illustration.
Prudential Regulation in Australia
• Liquidity Requirements
• Capital Adequacy
• Other Prudential and Regulatory Controls
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Week 10 money, bank and finance lecture notes. The prudential supervision framework: there are three regulatory bodies in australia, the rba: responsible for systemic stability, asic: responsible for consumer protection and market integrity, apra: responsible for prudential regulation of adis, insurance companies and superannuation entities. Legislation: five key pieces of legislation are relevant to the operation of financial institutions in. Ap a(cid:859)s methodolog(cid:455: there are three ke(cid:455) ele(cid:373)e(cid:374)ts to ap a(cid:859)s p(cid:396)ude(cid:374)tial supe(cid:396)(cid:448)isio(cid:374) f(cid:396)a(cid:373)e(cid:449)o(cid:396)k, 1. Risk assessment and response tools: probability & impact rating system (pairs); and, supervisory oversight & response system (soars), 2. Pairs: pairs = probability and impact rating system, pairs is used to assess the probability that a regulated institution will fail. It is a(cid:374) assess(cid:373)e(cid:374)t (cid:271)ased o(cid:374) the st(cid:396)e(cid:374)gth of a(cid:374) i(cid:374)stitutio(cid:374)(cid:859)s (cid:373)a(cid:374)age(cid:373)e(cid:374)t, (cid:272)o(cid:374)t(cid:396)ols and capital base. Illustrate to each institution how the level of supervision they receive is determined.
