Topic 8 AU Fin Sys & Fin Inst Flashcards
What are the Main Drivers of change in the financial system?
Customer behaviour
Technology
Regulation
Government activities
Name the three different periods of government regulation?
- regulation (1940’s - 1970’s)
- deregulation (1980’s)
- post regulation (1990’s beyond)
Who are the three main regulators of the Australian financial system?
The RBA - responsible for monetary policy, stability and payments system. Set target inflation rates (2-3%) and interest rate target (1.75%)
ASIC - consumer protection, market integrity and corporations law.
APRA - supervises banks, insurance companies, super funds, building/credit unions/building societies.
What are the main drivers of change?
Changing customer needs - increased consumption and preparation for old age by increased asset accumulation
Technology - business and social, ATM’s, EFTPOS, internet bank and brokering. Ability to work 24/7
Changing financial landscape - global competition, takeovers, more sophisticated products and informed customers.
Deregulation - floating exchange rates, restructure of regulatory framework, capital adequacy
What is the structure of Australian banking system?
Major banks - big four - ANZ/CBA/Westpac/NIB (65%)
Regional banks - Adelaide Bank, Bendigo Bank (25%)
Foreign Banks - HSBC (10%)
What are some of the challenges facing the Australian banking system?
Due to deregulation, banks found themselves in an increasingly competitive market free of regulation and control. In the 1980’s banks expanded into corporate lending, which led to an increase in non-performing loans in the 90’s banks had combined losses of $1billion.
They have since rebounded with profits of $6bill but new challenges of competition due to globalisation, rapid technology advances are having to be dealt with.
How have banks responded to new challenges of globalisation and competition and tech changes?
- greater emphasis on sales and service
- greater efficiency
- tighter cost controls (decreased staffing, branch closures)
What is a banks off-balance sheet business?
A transaction not recorded on the balance sheet.
A liability that can only be recorded When the event occurs.
Taking into account a banks assets and liabilities only shows part of the picture.
There are 4 types of activities that do no fall into that category and make up over 4 times the value of A+L:
1) direct credit substitutes - credit or financial guarantee
2) trade & performance items - documentary letter of credit
3) commitments - advance funds, underwriting, unused credit card limits, housing loan approvals that have not been used yet
4) FX- IR and market rate related contracts (derivatives like futures, forwards, options, swaps) and risk exposures
These do not appear on the balance sheet.
Name some features of the GFC credit crisis?
- evolved in the US in 2007
- loan default rates reached high levels
- property values fell significantly
- two factors of low interest rates, loose government policy caused the loan defaults
- questionable lending practices due to the large commissions being paid
- were able to securitise mortgage lending in the international markets, this created a large pool of risk globally.
Step 1. In the GFC - US govt policy - explain?
- the Fed reserve was maintaining expansionary (very low IR) policy for a long time
- they encouraged lenders to provide housing loans to low socio economic groups, dropping standards to increase loan volumes
- honeymoon rates (low repayments) to start with but then they increased
- the increase in housing lending led to a property price boom (high demand)
Step 2. Describe property bubble and debt funded consumption?
- because of property boom this meant homes had a lot equity which they were encouraged to borrow further against.
- this fuelled consumption, non essential items were purchased (cars, pools, holidays, home appliances)
- it was believed that property prices would always continue to rise.
Step 3. Explain market change disturbances (contagion) that spread through collateralised debt obligations and securitisation?
- COD or collateralised debt obligations, and securitisation lead to spread (contagion - can refer to boom or crisis) of the crisis
- banks are required to fund part of their loans with capital. To reduce the amount of capital needed to be held, banks grouped the loans into COD’s and sold them to special purpose vehicles (SPV).
- SPV pays for the mortgage assets by issuing new debt securities (like bonds) to institutional investors.
- the SPV receive mortgage repayments and uses the funds to pay coupon interest payments on the bonds and the principle on maturity.
- because so many defaulted on loans when the honeymoon period was up, plus the property bubble burst (housing prices dropped significantly) the cash flows into the CDO’s fell.
- the value of the underlying assets, property, fell.
- confidence was lost in the financial industry everywhere because the largest holders of the assets were other financial institutions globally. Mostly insurance and super funds.
Step 4. Explain the govt reactions and stimulus package?
The crisis spread quickly across debt and equity markets causing recession over most major economies.
- banks were under stress
- in the US some. Of panties were bailed out and other like Lehman brothers failed.
- governments like Australia initiated stimulus packages including spending on infrastructure ( schools and hospitals) financial support to householders to install insulation batts and cash payments to taxpayers to encourage financial spending.
What is the result of the stimulus packages?
- high public debt that needs to be repaid
– austerity measures (as unsure whether the govt’s could pay back loans) - this included increasing retirement age, reduce govt spending, reduce public servant salaries.
Why did securitisation become so attractive?
- Higher return
- reduced credit exposure
- advantage for banks in that there is no recourse back to them
- increased liquidity for banks
- higher income for banks
