Lecture 3 Flashcards
What is the reserve bank of australia (RBA) responsible for?
- monetary policy
- systemic stability
- the payments system
What is the Australian prudential regulation authority (APRA) responsible for?
- prudential regulation
- supervision of deposit-taking institutions (including banks)
- insurance
- superannuation
What is the Australian Securities and investments commission (ASIC) responsible for?
- consumer protection
- market integrity (corporations law and FSRS licensing)
What did the Banking Act (1959) introduce?
- Banks must be authorised
- Depositors have priority on assets if a bank becomes insolvent
- Bank mergers require treasurer’s approval
What is the four pillars policy?
- Major 4 banks are not allowed to merge (CBA, ANZ, NAB & Westpac)
What did the financial sector (shareholdings) act 1998 introduce?
- maximum shareholding must be at 15% unless approved by treasurer
Why do banks need to be regulated?
- reduce systemic risk which prevents panic and bank runs due to contagion
- protect consumers and the safety of their deposits
- reduce moral hazard as banks take more risks
What is the relationship between APRA & ADI’s
- APRA can authorise ADI’s to operate
- sets prudential standards and supervisors the operations of ADI’s
- APRA can revoke licences
- if an ADI gets into financial difficulties APRA can resume control of the company
What does prudential regulation refer to?
- requirements or standards designed to limit the risk taking of banks with a view to ensuring the safety of depositors’ funds
What threatens depositors’ funds and the stability of the financial system?
If a bank becomes insolvent
risk of bank insolvency depends on what two things?
- risks impacting on a bank
- amount of bank capital
Regulators enforce what rules to keep the risk of insolvency down?
- limiting bank risks
- requiring banks to hold more capital
what is credit risk?
- the risk to payable earnings and capital that a debtor will fail to meet the terms of any contract with the bank
level of risk depends on:
- credit risk of individual transactions (e.g. credit quality)
- higher levels of portfolio diversification reduces risk
What is APS 220 credit quality?
- banks must have a credit risk management system
What does a credit risk management system include?
- well-structure credit risk grading system
- security valuation policy using net market value where possible
- approved system for setting provisions
- an approach to measuring and reporting on impaired assets
What is an impaired asset?
- items where ultimate collectability of principal and interest is compromised
what are some examples of impaired assets?
- non-accrual items
- restructured items
- other assets acquired through security enforcement
What are non-accrual items?
- payments that > 90days delinquent and security is insufficient to cover the amount due
- provisions must be made and interest and other income earned but not received may not be recognised
What are restructured items?
- facilities rendered non-commercial due to concessional contractual change related to the clients financial difficulties
- to be reclassified to non-accrual if recovery of principal or interest is in doubt or provisions have been struck
What is APS 221 large exposures?
- ADI must have an effective policy for managing large exposures and risk concentrations
Limits apply to who?
- individuals, corporations, governments
- groups of related counterparties
- industry sectors
- countries
- asset classes e.g. commercial property
what is considered a large exposure and whom must the bank reports to?
- exposure of 10% or more of the bank’s capital base
- all large exposures must be reported to APRA
what is aps 222 related entities?
- ADI’s give due consideration to the risks associated with the corporate group of which they are a member
- ADIs cannot take on excessive risk by giving either explicit or implicit guarantees to associated companies
what is aps 210 liquidity?
- this standard aims to ensure all ADIs have sufficient liquidity to meet obligations as they fall due under a wide range of operating circumstances
How do you calculate the liquidity coverage ratio to ensure that the bank is complying with Basel 3?
Stock of high quality liquid assets/total net cash outflows over the next 30 calendar days >= 100%
Who can help ADIS comply with the APS 210 requirements and what do they do to help?
- Reserve bank of australia provides a committed liquidity support facility for a fee
What is APS 222 non-banks?
- to ensure ADIs are not exposed to excessive risk as a result of their associations and dealings with related entities
What is APS 120 securitisation?
- to ensure ADIs adopt prudent practices in managing the risks associated with securitisation
- ensure that sufficient regulatory capital is held against the credit risk
How does APS 120 securitisation help investors?
- banks must inform investors if the bank guarantees the performance of an investment fund or a securitised asset
What is APS 310 Audit & related arrangements for prudential reporting?
- ensures high quality information provided to APRA by banks
- requires bank managements to attest that heir risk management processes are effective and adequate
What is CPS 231 outsourcing?
- outsourcing arrangements must be subject to due diligence, approval and ongoing monitoring
What is CPS 232 business continuity management?
- bank must implement a whole of business approach to business continuity management
What is CPS 240 Risk management of credit card activities?
- banks must implement proper measures to monitor and control credit card risks (falcon)
What is CPS 510 governance?
- institutions managed in a sound and prudent manner by a competent board of directors
What is CPS 520 fit and proper?
- management and directors need to have appropriate skills, experience and knowledge and act with honest and integrity
What is APS 610 - prudential requirements for providers of purchased payment facilities?
- requirements for ADIs approved to issue purchase payment facilities (e.g. paypal) but not banking licenses
What is APS 910 Financial claims scheme?
- sets out the minimum requirements should an ADI need to be prepared under the financial claims scheme
What is bank compliance?
- banks must follow APRA’s requirements
What are compliance costs?
- costs that a bank must pay as a result of these regulations
e. g. staff and admin services needed to develop and monitor systems and to compile data as required
e. g. cost of implement risk management systems that the bank would not use it not required to do so
How does APRA monitor that banks are complying with the requirements
- regularly collects information and statistics about bank risks and analyses this information
What will APRA do if it believes a bank is taking too much risk?
- instruct the bank to improve its risk management systems and procedures
How does APRA manage non-compliance?
- issue a formal direction
- transfer the powers of the bank board to a statutory management
(administrator may continue to operate the bank or restructure the bank or wind up)
What systems to APRA use to ensure ADIs are complying with regulations
- Probability and impact rating system (PAIRS)
- Supervisory oversight and response system (SOARS)
What does the PAIRS system do?
- analyses the data and constructs internal ratings
What does PAIRS estimate?
- probability of insolvency/failure of the institution
- impact of the insolvency on the Australian financial system
What is the equation to the probability of insolvency
- inherent risk (default risk, balance sheet risk, market risk, insurance risk, operational risk, liquidity risk)
- MINUS management and control (high quality management and control mitigates risk)
- MINUS capital support ( current levels of capital, and earnings and access to additional capital)
How doe the PAIRS system determine the impact of insolvency?
- depends primarily on the institutions Australian resident total assets
- larger banks is expected to have a greater impact o the australian financial system
What is the index for probability of failure (insolvency)
1 (lowest risk) to 256 (highest risk)
What is the index for impact?
Banks total assets
- $50mil or less, index = 0.25
- more than $50mil, index = assets/200
What is the supervisory attention index (SIA)
overall index = square root of the probability index x impact index
(NOTE!! APRA expects most banks to have an SIA of 4 or less)
What is the supervisory response used by APRA?
- PAIRS to analyse the level of risk for each ADI
- Then uses SOARS to decide what type of regulatory supervision to apply
What are the SOARS 4 supervision stances?
- Normal
- Oversight
- Mandated improvement
- Restructure
What is the Normal stance?
- entity is not expected to fail
- typical supervision activities such as prudential reviews and analysis of data submitted
What is the Oversight stance?
- entity is not expected to fail but there is some concern
- typical supervision activities include:
- more frequent prudential reviews and collection of data
- communication with auditors
- request for revised business plans
- expressing concern to bank management and poss oversea regulators
What is the mandated improvement stance?
- entity is not expected to fail immediately but serious long term concerns requiring urgent action
- typical supervision activities include:
- remedy plans and monitoring performance
- revised business plans
- increasing capital requirements
- issuing directions
- enforceable undertakings (refraining from risk business choices)
- external sources to report to APRA
What is the Restructure stance?
- apra has lost confidence in the entity
- the entity needs new capital, management or owners to minimise the losses to depositors
- typical supervision activities include:
- withdraw license
- replace persons/ service providers
- merge entities
- quarantine assets
- appoint a provisional liquidator
- issue directors or sanctions
- wind up (liquidation/receivership)
What are the probability rating based on the banks probability index that SOARS uses when beginning to assess an ADI?
- Low
- Lower/Medium,
- Upper/Medium
- High
- Extreme
What are the impact ratings based on the bank’s impact index that SOARS uses when beginning to assess an ADI
- Low
- Medium
- High
- Extreme
What is a bank run?
- depositors lose confidence in the banking system and withdraw all their funds
What is the financial claims scheme?
- the gov’t will fund APRA to pay the first $250k of one’s deposits within a short time of an ADI failing
- the failed ADI will then be liquidated and the ooh’t gets repaid from the proceeds
Advantages of deposit insurance
- large uninsured depositors are encouraged to monitor the risks of banks rather than assuming implicit insurance
- encourages competition (smaller banks have the same safety as big banks)
- stops bank runs and supports the stability of the financial system
disadvantages of deposit insurance
- moral hazard problem - less incentive for depositors to monitor the risk taking of banks
- less market discipline and banks may take more risk
- under politcal pressure to help the whole bank (including uninsured depositors)
- limits financial innovation since deposits are protected there is less benefit from developing alternative forms of savings and investments
