Regulatory change in Australia and New Zealand following the global financial crisis

Description
The purpose of this study is to explain rationale for regulatory change in Australia and
New Zealand after the global financial crisis.

Journal of Financial Economic Policy
Regulatory change in Australia and New Zealand following the global financial
crisis
Christine Ann Brown Kevin Davis David Mayes
Article information:
To cite this document:
Christine Ann Brown Kevin Davis David Mayes , (2015),"Regulatory change in Australia and New
Zealand following the global financial crisis", J ournal of Financial Economic Policy, Vol. 7 Iss 1 pp. 8 -
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Regulatory change in Australia
and New Zealand following the
global fnancial crisis
Christine Ann Brown
Department of Banking and Finance, Monash University,
Melbourne, Australia
Kevin Davis
Department of Finance, University of Melbourne, Melbourne, Australia
and Australian Centre for Financial Studies, Monash University,
Melbourne, Australia, and
David Mayes
Business School, The University of Auckland, Auckland, New Zealand
Abstract
Purpose – The purpose of this study is to explain rationale for regulatory change in Australia and
New Zealand after the global fnancial crisis.
Design/methodology/approach – Outline regulatory changes and relate to crisis experience and
regulatory shortcomings exposed.
Findings – Regulatory change was driven primarily by need, as capital importing nations, to comply
with emerging global standards, and the different approaches in both nations are also related to
domestic political considerations.
Research limitations/implications – The process of regulatory change in response to the crisis is
ongoing.
Practical implications – A number of areas for further improvement in fnancial regulation are
identifed.
Social implications – Costs of poor regulation and fnancial crises are identifed.
Originality/value – Acomparison of regulatory approaches in two countries dominated by the same
four large banks helps understand the challenges of cross-border fnancial regulation cooperation.
Keywords Banks, Financial markets and institutions, Financial aspects of economic integration,
Regulatory change
Paper type Research paper
1. Experience and lessons from the crisis
Australia and New Zealand escaped the worst of the fnancial crisis, but not without
extraordinary policy actions of our own at various times, and not without a certain legacy of
issues to deal with in our own neighbourhood. (Bollard and Ng, 2012, p. 57).
JEL classifcation – G01, G18, G20, G28
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
JFEP
7,1
8
Received26 November 2014
Revised26 November 2014
Accepted9 December 2014
Journal of Financial Economic
Policy
Vol. 7 No. 1, 2015
pp. 8-28
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-11-2014-0072
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Although Australia and New Zealand (NZ) escaped the worst of the global fnancial
crisis, which began in 2007, the aftereffects have been signifcant and provide useful
case studies for a number of dimensions of regulatory policy.
• First, signifcant differences have emerged in approaches to dealing with the
problem of “too big to fail” (TBTF) perceptions of the four major banks which
dominate both fnancial sectors.
• Second, different approaches to deposit insurance – which both countries had
eschewed before the crisis – and bank resolution arrangements have been
followed.
• Third, both countries have been rapid adopters of the stronger prudential
regulatory requirements of the post-crisis global reform agenda, despite
experiencing few problems within the prudential perimeter.
• Fourth, both countries had signifcant home-grown problems with fnancial frm
failures outside the prudential perimeter, but have followed markedly different
paths in the emphasis placed on market discipline in post-crisis regulatory
approaches in dealing with that sector.
We argue that there are two major factors driving these responses. First, both countries
rely heavily on capital infows, and the freezing of international capital markets, and
consequences for bank funding, was a major source of transmission of the crisis.
Consequently, non-compliance with international standards is not a feasible option, and
speedy adoption of higher standards to limit future exposures was both feasible (given
proftability and strength of the banking sector) and desirable.
Second, domestic political considerations are also relevant – but primarily with
regard to the more domestically oriented aspects of fnancial regulatory policy. Prior to
the crisis, both countries (but particularly NZ) had placed considerable reliance on
market discipline and caveat emptor for the non-prudentially regulated sector. Since
then, the Australian approach has shifted towards the recognition that reliance on
disclosure, fnancial education, and advice is inadequate for fnancial consumer
protection, in contrast to the continuing focus on market discipline in NZ. These
responses are consistent with the ideology of the political parties in power in the
immediate post-crisis period. Australia’s Labor Government (in power frommid-2007 to
late 2012) had a substantially more interventionist philosophy than the NZ National
Government elected in late 2008[1]. This is also relevant to the approaches taken
towards deposit insurance and dealing with TBTF in the prudentially regulated sector.
Of course, regulators and legislators play a role in policy development, and the issue of
appropriate roles and regulatory structure also needs to be taken into account in
appraising the response.
Regardless of the ideological preferences underlying regulatory approaches, the
resulting differences create complications for “Trans-Tasman” home–host cooperation
in regulatory and supervisory approaches to multinational banks. While there is a
long-standing agreement on regulatory cooperation, the (as yet untested) NZ
willingness to countenance failure (involving depositor losses) of the separately
capitalised NZ subsidiaries of Australia’s four major banks creates signifcant
cross-border bank resolution issues. Whether the subsidiarisation requirements
facilitate better host country regulation, better insulate the subsidiary fromproblems of
9
Regulatory
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the foreign parent, improve or reduce managerial oversight of risk-taking relative to a
branch structure or are largely irrelevant due to home country regulator (the Australian
Prudential Regulation Authority [APRA]) supervision at a “Group 3” conglomerate
level, are all relevant issues. Arguably, given the relatively small size of the NZ
subsidiaries, it is unlikely that the Australian parent bank would (for domestic
reputational reasons) allow failure of the subsidiary when the parent was not suffering
problems. But given the caveat emptor approach in NZ, subsidiarisation is unlikely to
prevent runs on a subsidiary if the parent bank was suffering problems. Consequently,
despite the attempts at creating independence of banking sector regulation, there
remains signifcant dependence of the NZ regulators on the supervisory approach of
APRA.
In what follows, we develop these themes by frst outlining relevant fnancial system
characteristics and overviewing the crisis experience, and then providing an overview
of regulatory approaches. We then select a number of key elements of regulatory change
upon which to focus. These include:
• Basel 3 implementation.
• Deposit insurance/bank resolution and TBTF and international cooperation
issues.
• Determination of the prudential perimeter and the role of market discipline and
fnancial consumer protection.
• Competition and stability considerations.
2. Overview: Financial structure and crisis experience
The AustralianandNZfnancial sectors are inextricablylinkedbythe dominance of the four
major Australian banks – although the dominance is arguably more so in the case of NZ,
where funds management andcapital markets activities have a signifcantlysmaller role[2].
Figure 1 illustrates the comparable size of fnancial institution types prior to the fnancial
crisis. In Australia, the superannuation (pension) fund sector has grown markedly since the
early 1990s (including growth of self-managed superannuation funds, not shown in
Figure 1), and securitisation also grewmarkedly over that time.
With the onset of the crisis, both governments took signifcant actions to prevent
spillovers from the international disruption affecting local fnancial markets and
economies. They also had to deal with some signifcant, largely home-grown, failures
and disruption in the non-prudentially regulated parts of the fnancial sectors. These
refected failures of market discipline and regulatory structures which allowed complex,
opaque business structures and fnancial products to evolve over the preceding years
and to be marketed to poorly informed investors and consumers. Those problems were
more varied and widespread in the more developed Australian fnancial sector, but NZ
experienced a virtual wiping out of its fnance company sector, which commenced in the
middle of the 2000s (Commerce Committee, 2011).
Reasons for the relatively favourable Antipodean experience are well-known and
include:
• Favourable economic conditions.
• Limited involvement of the banking sector in complex products and trading
activities.
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• High levels of bank proftability.
• Strong supervision of banks.
• Rapid government fscal, monetary and regulatory responses to the crisis.
Brown et al. (2011) provide an overview of the experience. Since then, the fnancial
sectors of both countries have experienced relatively limited growth along with
relatively little disruption[3]. Credit growth has been subdued, equity returns have been
modest and interest rates have declined, albeit not to the liquidity trap levels of the
Northern Hemisphere (see Figure 2).
Concerns about government debt and fscal defcits (see Figure 3) perceived by some
to be unsustainable (following surpluses prior to the crisis), and aggravated in the case
of NZ by the fscal consequences of massive earthquakes in February 2011, have
inhibited stimulus measures to boost economic growth – even though both countries
still have quite low debt/gross domestic product (GDP) ratios by current international
standards (29 per cent for Australia and 37 per cent for NZ)[4].
In both countries, however, GDP growth has returned to moderate levels following
the slowdowns induced by the fnancial crisis (Figure 4).
Despite the relatively good performance of both economies and fnancial sectors,
there remain concerns (often expressed by international agencies, e.g. IMF, 2012, 2013a)
about the risk profle and systemic stability of the fnancial sectors of the two countries.
Both have high housing prices by international standards, with bank assets heavily
weighted towards mortgage debt. With bank loan/deposit ratios in excess of unity
(although declining), bank funding (which dominates the provision of debt fnance in the
absence of deep corporate bond markets) remains signifcantly dependent on
international wholesale debt markets, although less so since the crisis, with funding of
persistent current account defcits increasingly occurring through other channels. Both
currencies have been favourites for speculative carry trade strategies, with the relatively
0 500 1,000 1,500 2,000 2,500
Australia - ADIs
Australia - RFCs
Australia - Life Insurance and Superannua?on
Australia - Managed Funds
Australia - General Insurance
Australia - Securi?sa?on Vehicles
NZ - Banks
NZ - Non-bank lending ins?tu?ons
NZ - Funds under management
Notes: For Australia, June 2007: assets (AUD); ADIs (approved deposit-taking
institutions) comprise banks, building societies and credit unions, RFCs are
registered financial corporations, including money market corporations, finance
companies and general financiers. For NZ, December 2007: liabilities
(AUD equivalent)
Source: RBA Bulletin, Table B1; RBNZ (2013c)
Figure 1.
Financial system
size: 2007
11
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large foreign exchange exposure of external debt (held largely by foreigners) making
exchange rates susceptible to changes in market sentiment (whether rationally based in
views about the resources boom outlook or otherwise). The high concentration of the
banking sectors and similar risk profles and exposures of the four major banks also
attract attention, but (unlike in some other countries) there has been little interest in any
regulatory initiatives to change the structure or limit activities of the banking sector.
Regulatory stress tests of the banking sectors have indicated a capacity to deal with
signifcant economic and fnancial shocks.
3. Regulatory structures pre- and post-crisis
Arguably, most activity in the fnancial sectors has been in dealing with the plethora of
new and changed regulation emanating both from international standard setters and
from local responses to the problems in the non-prudentially regulated sector made
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Australia: Cash Rate NZ: Cash Rate
Australia: Credit Growth NZ Credit Growth
Source: RBA Table F1 and D01,http://www.rba.gov.au/statistics/
\tables/index.htmlRBNZ Table hb2 and hc2,http://www.rbnz.govt.
nz/statistics/
Figure 2.
Interest rates and
credit growth
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2002-03 2004-05 2006-07 2008-09 2010-11 2012-13
Australia: Budget Outcome / GDP NZ: Budget Outcome / GDP
Sources: Australian Treasury, NZ Treasury
Figure 3.
Budget outcomes
(% of GDP)
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apparent at the time of the crisis. In Australia, there have been 11 parliamentary
committee inquiries into aspects of the fnancial sector since 2007 (Mulino, 2013),
commencement of a broad-ranging review of the fnancial sector promised by the new
government elected in September 2013 and a raft of regulatory changes impacting upon
the large and growing superannuation sector.
With the banking sectors of both countries surviving the crisis well, it could be
expected that there would be little change in the structure of supervisory arrangements
applying to banks. That has been the case in Australia where a “twin peaks” model
applies[5], although APRA’s resolution and crisis management powers have been
strengthened by legislation (with further changes under consultation). In contrast,
following signifcant failures in the managed funds and fnancial advice sectors, there
has been substantial criticism of the supervisory performance of the Australian
Securities and Investments Commission (ASIC) (the market conduct regulator), and its
past heavy reliance on disclosure, education and advice as contributors to market
discipline and fnancial consumer protection. While there have been no substantive
changes to the legislative powers of ASIC, it has taken over responsibility of supervision
of trading in fnancial markets fromthe Australian Securities Exchange (ASX) in 2010 –
a change made inevitable by the decision to allow the introduction of a new trading
platform (Chi X) in competition with the ASX. New ASIC Market Integrity rules were
introduced in April 2011. ASIC will also have regulatory responsibility for any fnancial
market infrastructures established for the trading and settlement of over the counter
(OTC) derivatives under legislation passed in December 2012.
The main changes in responsibilities and powers of the Reserve Bank of New
Zealand (RBNZ) have involved assuming prudential regulation responsibilities for
non-bank deposit takers (NBDTs) between 2008 and 2010 (following a Government
Review of Financial Products and Providers in 2006), and prudential and supervisory
responsibility for insurance companies in 2010. Prudential standards for both sectors
have been introduced, but the responsibility for supervision of NBDTs remains in the
hands of independent trustees. Whether enhanced regulation is suffcient to overcome
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NZ Real GDP growth (year on year)
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Sources: ABS 562006; RBNZ table hm5http://www.rbnz.govt.
nz/statistics/
Figure 4.
Real GDP growth
(% p.a.)
13
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the earlier weaknesses of the trustee supervision model exposed by the collapse of this
sector remains to be seen – although the number of surviving institutions is now
relatively small (with some having converted to bank status).
There have been substantive changes in the structure of other agencies responsible
for fnancial sector regulation in NZ. The Financial Markets Authority (FMA) was
created in 2011, replacing the Securities Commission and taking over some previous
responsibilities of the Ministry of Economic Development, and the roles of Government
Actuary and Registrar of Companies. It is responsible for conduct and disclosure
regulation. Responsibility for protection of consumers of fnancial services and products
is divided between the FMA and the Ministry of Consumer Affairs and the Commerce
Commission.
The New Zealand Council of Financial Regulators was established in 2011
comprising the RBNZ, FMA, Treasury and Ministry of Business, Industry and
Employment. Australia’s Council of Financial Regulators (comprising Treasury,
Reserve Bank of Australia (RBA), APRA, ASIC), a non-statutory body with no
regulatory functions, has been in operation since 1998, and is a successor to the Council
of Financial Supervisors, which was established in 1992. The Trans-Tasman Council on
Banking Supervision has existed since 2005, and in 2010, a memorandumof cooperation
for dealing with crisis situations and fnancial distress in a Trans-Tasman banking
group was signed.
4. Basel 3 implementation
In both countries, regulators have proceeded to implement the Basel Accord changes at
a faster pace and with more stringent requirements than set down by the Basel
Committee (see Table I).
4.1 Basel capital reforms
Regulators in both countries have adopted more stringent defnitions of allowable
capital and risk weights than contained in the Basel recommendations and implemented
in many other countries (APRA, 2012a; 2012b; RBNZ, 2014). For example, in a reviewof
NZ, the IMF (2013a) estimated that the conservative approach means capital ratios are
100-200 basis points belowthe fgures which would be obtained if using the approach of
other some other major countries. Similar comments have been made about the
Australian approach.
Regulators in both countries have downplayed the value of a leverage requirement:
“we have not adopted the Basel III leverage ratio as we consider it is a poor measure of
risk for New Zealand banks” (RBNZ, 2013a, p. 8).
Table I.
Introduction of Basel
regulations in the
antipodes
Regulation Australia New Zealand Basel
Basel 2.5 1 January 2012 1 January 2012
Basel 3 minimum 4.5% common equity capital ratio 1 January 2013 1 January 2013 2019
Basel 3 capital conservation buffer 1 January 2016 1 January 2014 2019
Basel 3 liquidity coverage ratio 1 January 2015 1 April 2010 60% in 2015,
full by 2019
Net stable funding ratio 2018 1 April 2010 2018
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While the banks have complainedabout the consequences of higher capital requirements for
their fundingcosts, that effect canbe expectedtobe of lower consequence thanit is for banks
in most other countries. The reason is that both Australia and NZ operate dividend
imputationtaxsystems, whichmeans that dividends paidtoshareholders have attachedtax
creditsrefectingthecompanytaxpaidontheoriginal companyincome. Consequently, there
is no (or less of an) interest tax shield arising fromleverage – with such a shield only arising
from foreign shareholders not being able to use such franking credits, or from payment of
interest inforeignlocations reducingforeign(andthus) total taxpaid. While the signifcantly
reduced relevance of an interest tax shield for the Australian operations is relatively
clear-cut, this is not so for the major NZ banks owned by Australian bank parents. One
consequence of the inability of Australian bank parents to use NZ tax credits received with
dividends from their subsidiaries effectively was their issuance of stapled securities as a
formof regulatory capital. Interest on the loan note issued by the NZsubsidiary (which was
stapled to a preference share instrument issued by the Australian parent) reduced NZ tax
paid.
Notably, APRA has been slow to review its prudential guidelines for securitisation
which did not require “skin in the game” (retention of some exposure), but instead
provide maximumcapital relief for clean sales. APS 120 is presently out of step with the
USA and the European Union. In particular, it does not have a mandated “skin in the
game” requirement, a major component of the reforminitiatives in those jurisdictions. In
addition, the rules dealing with disclosure to investors are not as stringent and the rules
regarding issuer self-assessment and review of assets are far less prescriptive (Brown
and Newman, 2011)[6]. While the RMBS market effectively closed to new issues in the
fve years following the crisis, there were no cases of Australian securitisations
suffering losses due to poor asset quality.
A signifcant number of banks have issued substantial amounts of hybrid securities
with contingent capital features which are required by APRA if they are to be included
as regulatory capital[7]. Those securities have been primarily targeted at retail investors
(including self-managed super funds [SMSFs]), with little wholesale investor interest.
This has led to concerns being expressed by ASIC (2013b), the securities regulator, as to
whether retail investors understand the risk associated with such securities and
consequent pricing.
APRA (2012d) has classifed the four major banks as domestic systemically
important banks (D-SIBs) and subject to additional capital (higher loss absorbency)
requirements. It has also released standards for supervision of conglomerate groups
(Level 3 supervision) to take effect at the start of 2014. The same four banks are deemed
systemically important by the RBNZ[8].
4.2 Basel 3: Liquidity
Both the Australian and NZ authorities have proceeded rapidly with the introduction of
new liquidity requirements, with the RBNZ acting well ahead of the Basel timetable,
having foreshadowed in November 2008 the intention to introduce locally designed
liquidity requirements.
NZ introduced a liquid assets requirement in April 2010 in the formof required holdings
to meet both one-week and one-month mismatch requirements. In doing so, the RBNZ
adopted similar tiering of high-quality liquid assets (HQLA) instruments to the Basel
Liquidity Coverage Ratio (LCR), allowing various forms of private sector securities to be
15
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eligible subject to specifed haircuts. Since its introduction, NZ banks have had an average
mismatchratio (HQLAminus net stress outfowprojections as a ratio to total funding) inthe
order of 5to7per cent. The Core FundingRequirement, requiring65per cent (and70per cent
byJuly2011and75per cent byJanuary2013) of fundingtobe customer deposits andgreater
than one year wholesale deposits was introduced in April 2010.
Australia has committed to implementing the Basel LCR fully by January 2015. In
doing so, it has rejected the Basel option of allowing certain private sector and
multilateral agency securities to count as HQLA 2A and 2B for purposes of partially
meeting the requirement. Consequently, eligible HQLA consists only of government
debt (and cash and deposits at the RBA – with actual bank holdings of the latter being
minimal due to interest rate and system liquidity management arrangements).
This position appears to confuse the potential implications of a general system-wide
and bank-specifc liquidity crisis. In the event of the latter, holdings of high-ranking
private sector securities should be marketable to acquire needed liquidity. In the event of
a system-wide liquidity crisis, the RBA will need to provide liquidity through
repurchase transactions against good private sector collateral. Hence, the rationale for
excluding such securities from eligibility to meet some part of the LCR is unclear.
One consequence of this decision is that there is a shortage of available eligible
securities, with relatively little government debt on issue, and much of it held by foreign
investors. The result has been that the Australian authorities have opted for one of the
alternative liquidity approaches (ALA) permitted by the Basel Committee, specifcally
the committed liquidity facility (CLF) option to apply from the start of 2015. Under this
approach, banks can use amounts accessible through a fee-based CLF with the RBA to
meet the LCR requirement. The RBA has announced a fee of 15 basis points for the
facility, with borrowings under the facility to be priced at the offcial cash rate plus 25
basis points (the same as currently exists for overnight borrowings). The size of the CLF
available to each bank is to be determined by an offcial assessment of an appropriate
share of the estimated total CLF needed, given some forward-looking, longer-term
estimate of aggregate required HQLA, less reasonably available HQLA.
Use of the CLF, should it be needed, involves the provision by the bank of collateral
acceptable to the RBAfor repurchase agreements, and this broadly includes the types of
private sector securities (other than equities) included in the defnition of HQLA2Aand
2B. While there is no requirement to hold such assets prior to use of the CLF, it would
seem likely that bank liquidity management practices would lead to some level of
precautionary holdings to enable access to the CLF should it be needed.
Thus, some induced level of bank demand for such private sector securities can be
expected fromthe CLFarrangements, although not as much as might be expected if they
were eligible for use as HQLA. It can be asked whether use of one of the other ALA
approaches (such as allowing greater use of HQLA2Aor 2Bwith larger haircuts) might
not be simpler and more consistent with other goals of policy, such as encouraging
further development of the domestic corporate bond market. While Basel capital
requirements are separately likely to induce further development of this market,
endowing such securities with enhanced liquidity characteristics through eligibility, as
HQLA would also work in that direction.
Perhaps the one clear beneft from the CLF approach is the fact that banks will be
charged some fee for the “liquidity put” which they have available anyway. Whether
that fee (of 15 basis points) is appropriate is another matter. There is, arguably, no
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unique optimal fee (because the effect of different fee levels is to change the demand for
government debt and thus its relative return), but the maximumfee is constrained by the
practice of the RBA paying the cash rate minus 25 basis points on bank exchange
settlement accounts held with it.
One consequence of the proposed introduction of the new liquidity requirements is
that banks have already adjusted relative pricing of deposits. Carr (2013) illustrates the
substantial wedge that has been driven between rates paid by banks for the “more
stable” term deposits from retail customers and those from other fnancial institutions.
With deposits from SMSFs being treated by APRA as retail deposits, this has the
indirect effect of further inducement for individuals to shift from institutional super
funds to SMSFs.
There is clear evidence (Shi and Tripe, 2012) that the banks in NZ have not merely
responded to the new liquidity rules but have anticipated them and increased the
maturity of their liabilities rather further than is required both in domestic and foreign
funding.
5. Deposit insurance, bank resolution, TBTF and international
cooperation
Prior to October 2008, Australia and NZ were the only The Organisation for Economic
Co-operation and Development (OECD) countries without explicit deposit insurance.
The Australian position was motivated by reliance on depositor preference as a
perceived mechanism for ensuring safety of deposits, while the NZ position refected a
strong commitment to the desirability of market discipline[9].
The market disruption following the Lehman collapse led both governments to
introduce deposit guarantees and make fee-based guarantees available for newissues of
wholesale debt by banks. The debt guarantee facility (used substantially by the four
major banks and others) was terminated on 1 March 2010 in Australia and 30 April 2010
in NZ.
The two countries have followed different paths with regard to deposit insurance.
The New Zealanders initially introduced the Crown Retail Deposit Guarantee available
to banks (and other deposit takers) on an opt-in basis for a fee with a cap of $1 million
(after an initial temporary period with no cap). The scheme was terminated in October
2010 (for banks, but extended until end 2011 for other deposit takers on less favourable
terms) with the authorities reverting to their preferred position of no explicit insurance
and promotion of a “haircut” or bail-in scheme, referred to as Open Bank Resolution
(OBR) (Hoskin and Javier, 2013).
NZ’s opposition to deposit insurance was heavily reinforced by their experience with
the hastily put together temporary scheme, as it involved a major payout to the creditors
of one large fnance company, South Canterbury Finance, and considerable moral
hazard as the company increased risky lending substantially once it could raise
guaranteed deposits[10].
In contrast, the Australian Government has stated that its Financial Claims Scheme
is a permanent feature of the fnancial landscape. Initially, after a short period of a
blanket deposit guarantee, deposit insurance for amounts up to $1 million per depositor
was provided for no charge. The size of the insurance cap was reduced in February 2012
to the current level of $250,000. The scheme involves a non-risk-based ex post funding
model – although a planned fee of 5 to 10 basis points per annum per dollar of insured
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deposits was fagged in 2013. Although the absence of a fee has been criticised by
international agencies, APRA’s priority in a liquidation process means that most, if not
all, losses would fall upon uninsured depositors and other creditors. In practice, it is
unlikely (judging by past experience) that the authorities would not arrange an exit via
takeover rather than liquidation of smaller institutions, and use of fees to develop a fund
to facilitate such exit mechanisms might, however, be justifed.
For both countries, perceptions of implicit government guarantees for all creditors
constitute a more substantive issue – particularly in the case of the four major banks –
generating potential competitive distortions and moral hazard concerns.
APRA has authority to override shareholder rights, temporarily operate a bank, sell
or transfer assets and liabilities and create a bridge bank or an asset management
company (Financial Stability Board, 2013). It does not have bail-in powers – except
where they are specifed in the prospectus for the liabilities involved (a number of banks
have included bail-in clauses in recent issues of hybrid securities marketed primarily to
retail investors, enabling those securities to qualify as regulatory capital). APRA’s
resolution powers were strengthened in the 2008 and 2010 legislations, and a discussion
paper was released in September 2012 covering further extension of crisis management
powers (Treasury, 2012b). There is some requirement for APRA to take into account
implications of resolution for NZ fnancial stability (refecting the dominant role of the
four major banks in each country).
APRA has implemented trial work with large banks on formulation of recovery but
not, as yet, resolution plans (APRA, 2012c).
NZ has introduced a strikingly different framework for resolving the four large
banks (and others that choose to opt into the scheme), which has been labelled OBR[11].
Rather than seeking a joint solution with Australia or pursuing the ideas advocated by
the USAand the UKfor resolving the parent, NZhas decided to make sure that all banks
are resolvable, irrespective of what other authorities decide they want to do.
This regime has three main characteristics: frst, systemically important banks must
be locally incorporated and separately capitalised, and these subsidiaries must be
capable of operating on their own without support from their parent overnight. This
effectively means that the banking group must be fragmented on national lines. Second,
the main method to be used for resolution is to be a bail-in of the creditors in order of
priority as in an insolvency, i.e. starting with the shareholders, then moving on to the
subordinated debt holders and then on up in seniority until writing down a class of
creditors restores solvency on a conservative valuation of the extent of the losses. Third,
the bank is to be kept operating during the process, in the sense that the resolution will
be performed between the close of business on one day and the reopening on the next
day. Doing this requires a lex specialis, under which a statutory manager (a form of
receiver) can be appointed, who freezes the operations at the close of business, performs
the conservative valuation, writes down the claims, dividing them into frozen and
unfrozen parts, and restarts the operations, all without triggering any closeout clauses
or other interruptions to normal business.
Since, in NZ, there is no deposit insurance and depositors are junior unsecured
creditors, as, unlike Australia, there is no depositor preference, this means that
depositors are highly likely to be written down unless the degree of failure is small. This
imposes a major prepositioning requirement on the banks, as they have to be capable of
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dividing all accounts overnight into their frozen and unfrozen parts, where customers
can access the unfrozen part normally the following morning.
The statutory manager will continue to run the bank until such time as
recapitalisation by the private sector can be organised. Thus, in many ways this will
operate like a bridge bank and will probably require a government guarantee against
further loss. The RBNZ had originally considered a debt for equity swap instead of a
simple write-down of claims, but had rejected this because it would not necessarily
produce suitable new owners.
These changes had been under consideration for some time and the frst steps were
introduced before the global fnancial crisis. The Reserve Bank’s main argument in
favour of this scheme is that the very existence of a credible regime for resolution under
which top management lose their jobs and shareholders are wiped out will encourage
much more prudent risk management of banks in their own self-interest and will
encourage more effcient resolutions, particularly through the private sector, with the
emphasis on an industry solution, followed by bailing in and with bailing out a distant
last (RBNZ, 2012).
Local incorporation entails a fduciary duty to safeguard the interests of NZ-based
depositors rather than simply that of the parent company. Director liability for
disclosure statements is particularly strong, involving the possibility of imprisonment
for up to three years and civil liability for misleading statements. The existence of strict
liability means that the range of defences that can be offered is restricted.
Dominance of the NZ banking sector by subsidiaries of the four major Australian
banks (with a deposit market share of around 80 per cent in 2013) arguably enables the
RBNZ to pursue a somewhat more market-oriented approach to bank regulation and
supervision than the Australian supervisor (APRA) of the parent banks. This is
refected in the RBNZ variant of a three pillars approach based around market
discipline, regulatory discipline and self-discipline – contrasting with the Basel pillars of
capital requirements, supervisory processes and market discipline:
[P]rudential supervision […] in New Zealand is comparatively light-handed. It is not about
completely eliminating risk, but rather aims to ensure that risk is well understood by market
participants, including depositors and policyholders (Fiennes and O’Connor-Close, 2012).
Given the dominant role of the four major banks, one of the main aspects of international
cooperation relevant to the two countries is the Trans-Tasman Council on Banking
Supervision, which was established in 2005 and upgraded in 2010 with the signing of a
memorandum of understanding regarding dealing with responses to distress of a
Trans-Tasman banking group. The memorandum does not lay down any specifc
practices, but rather a set of principles, including ensuring cooperation and
consideration of impacts on fnancial stability in each country.
6. Prudential perimeters, market discipline and fnancial consumer
protection
“Shadowbanking” is a relatively small part of the fnancial sectors of Australia and NZ,
partly refecting the “universal banking” nature of the major banks. In addition, in
Australia, insurers and institutional superannuation funds are prudentially regulated
by APRA.
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Both Australia and NZ experienced substantial failures of non-bank, non-
prudentially regulated fnancial institutions before, during and after the fnancial crisis.
Many of these failures were home-grown, although such institutions’ prior growth
refected the pre-crisis conditions of excessive risk taking, high leverage, emergence of
complex structures and little regulatory protection of investors outside the prudentially
regulated sector. There was little in the way of systemic effects, although some stock
market disruption was experienced in Australia through failures of frms involved in
securities lending activities.
The responses to these failures have differed signifcantly between the two countries.
In NZ, the problem was the failure of a large part of the fnance company sector
(NBDTs), where private trustees had been assigned the task of supervision, and where
regulatory oversight was minimal. In September 2008, NBDTs were placed under the
prudential regulation of the RBNZ and the introduction of the Crown retail deposit
guarantee scheme in October 2008 (removed in 2011) applied to themand also to banks.
NBDTs are required: to have a credit rating if issuing NZ dollar deposits or debt
securities, a minimumcapital ratio of 8 per cent and related party exposures of no more
than 15 per cent of Tier 1 capital. Refecting the priority given to non-offcial oversight,
independent trustees are still regarded as the appropriate supervisors[12].
The contrast with Australia could not be starker. In Australia, such non-bank
institutions have been kept outside the prudential net and no formal regulatory
requirements (such as minimum capital requirements and related party exposures) are
imposed upon them. Following several failures of non-prudentially regulated fnancial
frms in the mid-2000s, in October 2007, ASIC introduced proposals for new disclosure
requirements for issuers of unlisted and unrated debentures based on an “if not why not”
approach. Since it was extended to a range of other investment vehicles, the “if not why
not” approach involves requiring entities raising funds to disclose in prospectuses and
product disclosure statements whether their business models and fnancial structures in
accord with ASIC-provided benchmarks and if not, why not. Responsible entities (REs)
for mortgage schemes, unlisted property schemes, infrastructure schemes, agribusiness
managed investment schemes and hedge funds and providers of OTC contracts for
difference were subsequently subjected to the “if not why not” approach – with the
benchmarks provided differing across the different types of entities.
Perhaps, indicating recognition that such an approach was not working, and
refecting a number of recent high-profle failures of fnance companies (such as Banksia
in 2012), in February 2013, ASIC (2013a) released proposals, albeit not implemented to
date, to impose minimum capital (8 per cent of risk-weighted assets) and liquidity
requirements (9 per cent of liabilities in HQLA) on debenture issuers. Prudential
supervision of such entities was eschewed with improved powers and responsibilities
for trustees, and auditors required, and a requirement for provision of, a prospectus to
investors holding maturing securities prior to the investments being rolled over[13].
A similar change in approach, away from reliance on disclosure and towards explicit
regulations for REs (managers of collective investments), was announced in June 2013 by
ASIC (2013c). These changes impose specifc requirements on all Australian Financial
Services Licence (AFSL) holders, including market and clearing participants (on ASX or
Chi-X), REs, the managers of retail hedge funds (and other managed investment scheme
[MIS]), investor-directed portfolio services, custodial or depository services, trustee
companies, issuers of margin lending facilities, foreign exchange (FX) dealers, retail OTC
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derivative issuers. They include minimum net tangible assets (capital) requirements and a
liquidity requirement. For REs of managed investment schemes, for example, the net
tangible assets requirement is 0.5 per cent of the value of scheme assets (or a specifed cash
amount or 10 per cent of average revenue if higher) and cash assets must exceed some
proportion (minimumof 50 per cent or $150,000) of the RE’s net tangible assets.
6.1 Consumer/investor protection
Attitudes towards the merits of reliance upon disclosure and fnancial advice arrangements
have also arguablychanged. InAustralia, reliance upondisclosure as a mechanismfor retail
borrowers toassess suitabilityof acredit product has beensupplementedbyaresponsibility
for credit providers to ensure suitability for the customer. Financial advice and fnancial
product sale regulations have been strengthened to improve protection of retail purchasers
of fnancial products. Nevertheless, this is an increasingly problematic area with the
substantial growthof SMSFs, whichare nowaroundone-thirdof the large andgrowingpool
of superannuation savings, and provide a ready target for purveyors of unsuitable fnancial
products. The fnancial crisis and its aftermath exposed considerable problems in the
structure of investor and borrower protection arrangements in both Australia and NZ, and
these have given rise to a signifcant domestically driven agenda of regulatory change in
Australia. Grady (2012) provides an overview. Some part of those changes has involved a
lessened faith in free market outcomes where reliance on education, advice and disclosure
were previously perceived to be a suitable basis for achieving acceptable outcomes.
A key issue in the discussion (ASIC, 2011) has been the culpability of fnancial
advisers and providers of fnance, even though Australia has, since 2001, had a licensing
regime requiring providers of fnancial products and services (which includes advice) to
hold an AFSL and comply with the training and other obligations involved. One
consequence has been, in Australia, a shift in emphasis away from reliance on
disclosure, education and advice as the basis for achieving good outcomes towards
direct intervention in fnancial market contract conditions and imposing greater
responsibility upon fnancial product and service providers for assessing suitability of
their offerings for potential customers.
In Australia, failures of several margin lenders (Opes Prime and Tricom) led to
legislation to include margin lending under the defnition of a fnancial product, and
thus subject to regulation by ASIC (2010), which proposed that non-standard margin
loan arrangements involving transfer of title from the borrower to the lender would
require additional disclosure.
Margin lending was also a component of predatory lending practices arising fromthe
high (and double) leverage strategy which fnancial planning frm Storm Financial
inficted upon clients for whom it was unsuited[14]. This led to the introduction of a
range of new legislative requirements for the fnancial planning/advising industry,
locally referred to as the Future of Financial Advice reforms (Treasury, 2014). These had
three main components, with precise arrangements still being fnalised in mid-2014:
• Arrangements involving fnancial advisers receiving commissions fromfnancial
product providers were prohibited.
• Asset-based fees could only be charged on the net assets under management – not
on the amount fnanced by borrowings.
• Financial advisers were required to have a fduciary duty to their clients.
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As it transpires (and refecting in part compliance costs), the fnancial advising sector is
increasingly becoming structured as groups which are subsidiaries of the major banks
and other fnancial product providers, creating the potential for other forms of indirect
payments from the product providers (the parent entities) to fnancial advisers
recommending their products.
In June 2010, the Government announced the regulations under the National
Consumer Credit Protection Act, which has replaced the state-based UniformConsumer
Credit Code. Under Phase 1, changes include:
• Responsible lending conduct (making it an offence for credit providers to enter
into an “unsuitable credit product” and transferring responsibility for
determining suitability from the borrower to the lender, indirectly having the
potential effect of reversing a growing trend of “no-doc” or “low-doc” loans.
• Extended hardship criteria for relief.
• Predatory lending and exploitative practice prohibitions.
Prohibition of mortgage loan exit fees (other than for fxed-rate mortgages) was
introduced in 2011 as part of the Competitive and Sustainable Banking Sector reforms,
while prohibition of fees (in excess of explicit costs incurred by the bank) for
overdrawing of accounts, and other measures relating to protection of credit card users
have also been implemented. Refecting government concerns about fnancial exclusion
and credit costs for users of payday lenders and other informal credit providers, a
maximum annual credit charge of 48 per cent per annum for small consumer credit
contracts was legislated in September 2012. Increased disclosure for, and protection of,
reverse mortgage borrowers was also contained in that legislation.
The rebalancing of power in consumer credit arrangements also includes fnancial
diffculty/hardship provisions. Financial service providers must stop enforcement
action when a borrower in hardship lodges a notice of dispute with the Financial
Ombudsman Service (FOS). Given time lags in FOS dealing with applications, this
reduces the ability of banks to deal speedily with loans in arrears/default. Bankruptcy
laws have also been changed in recent years, reducing the costs to individuals from
entering bankruptcy, a debt agreement or a personal insolvency agreement.
Comprehensive credit reporting (collection of positive information by credit bureaus)
was legislated in Australia (December 2012) to come into effect fromMarch 2014. While
this facilitates lending decisions, it remains to be seen whether the large banks will
migrate to full participation (provision and use of positive information) or remain as
limited participants only providing and using negative data. It also remains to be seen
how the additional information available will assist given the new responsibilities of
lenders to ensure suitability of credit products for retail borrowers.
Also relevant are the “Stronger Super” reforms, (Treasury, 2013), which included
permitting superannuation funds to provide simple fnancial advice and requirements
that a low-fee default (MySuper) option be provided.
The Superannuation Legislation Amendment (Service Providers and Other
Governance Measures) Act 2013, came into effect June 2013, requiring six monthly
disclosure of holdings on a look through basis (i.e. both direct and indirect holdings via
fund managers), but introduction deferred until June 2014. Australian super funds
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opposed the legislation and lobbied for deferral of introduction due to concerns that
hedge funds will object to implied disclosure of their holdings.
7. Macro-prudential regulation and systemic stability
APRAhas designated the four major banks as D-SIBs and has produced draft policies in
early 2014 (Schwartz, 2013). While there is increased attention being paid to the network
structure of the fnancial sector and implications for systemic stability, there has been no
explicit interest expressed by governments or regulators for initiatives (such as forms of
structural separation of banks) which might affect system stability. In NZ, some such
initiatives were introduced some years ago via requirements for separately capitalised
subsidiaries of international banks operating domestically, and for outsourcing and
information technology arrangements with the Australian parent banks to be
structured such that local operations could continue to operate independently in the
event of the parent encountering trouble. In Australia, the ability for banks (and other
prudentially regulated institutions) to operate within a non-operating holding company
framework has existed for some years. While several groups have adopted such a
structure (Macquarie, Suncorp), none of the four majors has proceeded down that path.
Whether the structural separation of activities achieved under such a framework would
reduce risk spillovers between the various activities of the group is an open question.
The Australian regulators are proceeding cautiously with regard to the introduction
of CCP requirements, recognising the potential for benefts of such multilateral clearing
for some derivatives to be reduced by a reduction in bilateral clearing economies across
a wide range of derivatives.
The NZ authorities have proceeded down the road of introducing new instruments
for system stability reasons. From 1 October, 2013, banks are restricted to having no
more than 10 per cent of new housing loans with loan to valuation ratios of over 80 per
cent (Wheeler, 2013). Other macro-prudential tools noted in a May 2013 memorandumof
understanding between the RBNZ and the Minister of Finance (requiring the RBNZ to
consult, but being able to make independent decisions) include changes to the core
funding ratio, countercyclical capital buffers and adjustments to sectoral capital
requirements (RBNZ, 2013d). The countercyclical capital buffer was expected to be
available as a macro-prudential tool by 1 January 2014 (RBNZ, 2013c), but has not yet
been used. The additional Basel conservation capital buffer, however, began to come
into operation in 2013.
8. Conclusion
The Australasian fnancial systems were not as heavily challenged by the fnancial
crisis as those of the Northern Hemisphere, and stress tests conducted subsequently
suggest that they remain able to cope with shocks of the type underpinning the fnancial
crisis. But the reliance on capital infows and speed of transmission of the crisis have led
to regulators in both countries, with notable exceptions in some areas, being quick to
comply with the global regulatory agenda aimed at mitigating the impact of similar
shocks in the future. Both countries, for example, have moved in advance of the
requirements of Basel III to improve capital and liquidity buffers, although the
regulators appear wedded to reliance on the opaque risk-weighted measures, rather than
giving more emphasis to a leverage ratio limit. But escaping the last crisis should be no
cause for complacency as to whether there are other potential weaknesses in the
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fnancial structures which have not yet been exposed. There are two main areas of
relevance in this regard.
First, while the authorities in both countries have sought to extend regulatory
coverage across the whole of the fnancial system in the light of international
recommendations and recognition of existing weaknesses, the regimes still rely on
disclosure and market discipline to a greater extent than in many OECD countries. The
regulatory response in each country, in part, refects their respective political landscape,
but the tendency for light touch regulation is particularly strong in NZ. Both countries
score poorly on international league tables for protection of investors in managed funds.
This may not have systemic stability implications, given the currently small size of
unregulated shadowbanking in both countries, but determining appropriate levels and
mechanisms of protection for individuals in their dealings with the fnancial sector is an
ongoing agenda issue. The signifcant growth of SMSFs in Australia raises particular
problems in this regard.
Second, while there has been concern, on competition grounds, about having
fnancial systems dominated by a small number of banking groups operating across
virtually all parts of the system, there has been relatively limited attention paid to the
implications for fnancial stability. In particular Trans-Tasman home–host cooperation
in approaches to supervision of multinational banks is compromised by the different
regulatory approaches in the two countries. There has also been little discussion of
whether there is merit in interventions to “ring fence”, circumscribe activities of, or
structurally separate, banks on fnancial stability grounds. Whether attempting to
“reshape” the fnancial system, rather than simply accepting and regulating the existing
(and evolving) structure is a debate yet to be had.
More generally, the massive ongoing growth in superannuation in Australia (and to
a lesser extent in NZ) is reshaping the structure of the fnancial systemtowards a larger
role for managed funds and capital markets relative to traditional intermediation. With
similar forces arising from the global regulatory agenda, there are new risks likely to
emerge and yet to be identifed fromthe changed interdependencies within the fnancial
system.
While Australia has joined the deposit insurance “club” (although its depositor and
deposit insurer priority structure involves signifcant design differences not always
appreciated), NZ is becoming more isolated on the topic of deposit insurance. The
combination of this with OBR and no depositor preference has the potential for
considerable fnancial instability in the event of any serious threat to the main four
banks. Following Australia and the rest of the OECD in providing explicit insurance
would be a low-cost means of extending public confdence and would help offset the rise
in the cost of capital that RBNZ expects OBR to cause.
Notes
1. Also relevant is the much larger relative size of household savings outside of the banking
sector in Australia, and thus the potential for problems to emerge in this area.
2. In mid-2007 (before the crisis), the ratio of stock market capitalisation to annual GDP was
around 35 per cent for NZ compared to around 150 per cent for Australia, or about
one-twentieth the size (both countries saw a halving of stock prices in the subsequent year).
Both countries had little government debt on issue, and little use of domestic bond markets by
corporates, although Australia had a large kangaroo bond market.
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3. Davis (2013) and Maddock and Monckton (2013) provide an overview of post-crisis
developments in the Australian fnancial system and economy.
4. This is gross debt/GDP (IMF, 2013b).
5. APRAis the prudential regulator of banks, insurance and superannuation, while ASIC is the
market conduct and fnancial consumer protection agency. The RBA is responsible for
payments system regulation and monetary policy.
6. The RBA is currently implementing a requirement for disclosure of loan-level data in RMBS
to be publicly available if those securities are to be eligible for repos at the RBA, and a new
draft prudential standard for securitisation which requires “skin in the game” was released in
2014.
7. One consequence of the contingency requirements was that it would cause the affected
securities to be treated as equity for tax purposes rather than debt (with interest deductible for
tax purposes at the company level) necessitating legislation to prevent this tax consequence
(Treasury, 2012b).
8. This is stated in the Governor’s introduction to the frst Financial Stability Report, published
by the RBNZ in October (RBNZ, 2004, p. 3).
9. This is refected in the announcement by the NZ Finance Minister in 2011 regarding the
termination of the deposit guarantee. “The Government does not favour compulsory deposit
insurance. This is diffcult to price and blunts incentives for both fnancial institutions and
depositors to monitor and manage risks properly” (English, 2011).
10. This experience was the subject of a critical review by the auditor general (Controller and
Auditor-General, NZ, 2011).
11. See APRA (2012c) and Hoskin and Woolford (2011) for an overview.
12. RBNZ (2013b) reviewed the effectiveness of the NBDT regime.
13. On 19 April 2013, APRA (2013) published recommendations on how fnance companies and
debenture issuers might be better distinguished from banks, including proposals to restrict
use of the words “deposit” and “at-call”, and to impose a minimum maturity of 31 days on
debentures.
14. Clients, mainly retirees, were induced to re-mortgage their homes to free up cash which could
then be used as equity for margin loans fnancing a share portfolio.
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archives/2012/papers/updated/22.pdf (accessed 6 August 2014).
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onsultationsandReviews/Consultations/2012/APRA (accessed 31 August 2014).
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Further reading
Australian Prudential Regulation Authority (APRA) (2013), “APRAreleases consultation package on
banking exemption orders and section 66 guidelines”, 19 April, APRA, Sydney, available at:
www.apra.gov.au/MediaReleases/Pages/13_09.aspx (accessed 31 August 2014).
Australian Prudential Regulation Authority (APRA) and Reserve Bank of Australia (RBA) (2012),
“Macroprudential analysis and policy in the Australian Financial Stability Framework”,
APRA and RBA, Sydney, available at: www.apra.gov.au/AboutAPRA/Publications/
Documents/2012-09-map-aus-fsf.pdf (accessed 6 August 2014).
Treasury (2012a), “Discussion paper on debt equity rules: treatment of tier 2 capital instruments
under Basel III capital reforms”, 16 July, The Treasury, Canberra, available at: www.trea-
sury. gov. au/ Consul t at i onsandRevi ews/ Consul t at i ons/ 2012/ Debt - Equi t y-
Rules-Treatment-of-Tier-2-Capital-Instruments (accessed 31 August 2014).
Corresponding author
Kevin Davis can be contacted at: [email protected]
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: [email protected]
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