This article by me was first published in Retail Banking Review.
Although Australian financial institutions are not experiencing the solvency crisis of major U.S. and European financial institutions it is important to monitor developments in the USA and Europe. Australia is part of the Group of Twenty (G-20) which will implement international financial regulatory reforms.
In the United States and the United Kingdom, the governments have effectively nationalised banks to help rebuild confidence in their banking systems and revive bank lending.
European Union leaders recently met in Berlin to continue working on the G-20 “action plan”. The guiding principles are “to create a financial system that operates with less leverage, is immune to the set of misaligned incentives at the root of this crisis, where prudential and regulatory oversight is strengthened, and where transparency allows better identification and management of risks”.
The G-20 action plan is designed to implement the report of the Financial Stability Forum with the following objectives:
• Strengthened prudential oversight of capital, liquidity and risk management
• Enhancing transparency and valuation
• Changes in the role and uses of credit ratings
• Strengthening the authorities’ responsiveness to risks
• Robust arrangements for dealing with stress in the financial system
On 2 April there will be a G20 meeting in London to continue international co-ordination on these issues.
USA Financial Stability Plan
The US Treasury Department’s Financial Stability Plan announced on 10 February, 2009 has four elements:
• the “Capital Assistance Program,” which increases the size of a previously announced non-recourse lending facility by the Federal Reserve to potentially reach $1 trillion,
• launches the idea of a public-private investment fund to purchase legacy or toxic assets from financial institutions (the so-called toxic or bad bank), and
• sets aside $50 billion for homeowner assistance. Altogether, the Plan may inject more than $2 trillion into the nation’s financial system, composed of the remaining $350 billion of Troubled Assets Relief Program (“TARP”) funds and support from the Federal Reserve and anticipated private capital investments.
• The Plan imposes a mandatory comprehensive “stress test” on all banking institutions with assets in excess of $100 billion, regardless of whether they seek to participate in the Capital Assistance Program.
UK Asset Protection Scheme
The UK Government has announced the details of the Asset Protection Scheme, which aims to remove continuing uncertainty about the value of banks’ past investments, cleaning up banks’ balance sheets and providing them with greater confidence to rebuild and restructure their operations and increase lending in the economy.
In return for access to the Scheme, banks will be required to pay a fee and enter into legally binding agreements to increase the amount of lending they provide to homeowners and businesses. The Government will report to Parliament annually on the delivery of the agreements.
The UK Credit Guarantee Scheme will be extended beyond its current end date of April this year, so that instead it will run until the end of 2009. To complement this, the Bank of England will continue to provide similar types of liquidity support when the Special Liquidity Scheme expires at the end of this month. The UK Government will provide up to £50bn of guarantees, initially on new mortgage lending and eventually on other assets.
The UK Financial Services Authority has set out the level of capital that individual banks need to keep on their books to allow them to withstand the slowdown and maintain lending. The Government argues that banks should allow their capital to be used to absorb the losses from investments – while not unnecessarily restricting their lending.
Executive remuneration policies
In both the USA and UK, participating banks will have to develop a sustainable long-term remuneration policy which are consistent with sound risk management, and which do not expose them to excessive risk. This will require them to review their executive remuneration policies: in USA there will be a dollar cap but there will not be a cap in the UK.
APRA is planning to issue a discussion paper on principles for executive remuneration in the second quarter of 2009 and, subject to consultation, a final set of principles and guidance in the second half of the year.
The Australian position
APRA Chair John Laker recently told the Senate Standing Committee on Economics:
“APRA is a participant in two working groups set up under the G20 Action Plan, one dealing with provisioning against problem loans and the other with executive remuneration…
APRA participated in the development of the Basel Committee’s revised set of principles for sound liquidity risk management, which are shaping the overhaul of APRA’s prudential framework in this area. The Basel Committee has recently released a set of proposals for enhancing the Basel II Framework, which will also shape any refinements to APRA’s capital adequacy requirements for deposit-taking institutions.
Though not a member of the Basel Committee on Banking Supervision, APRA is also involved in various ways in the Committee’s efforts to improve risk management standards and capital requirements in the global banking system. “
Although Australian financial institutions appear to be in a sound position (APRA says they are prudently managed and well-capitalised and earlier concerns about liquidity and funding have eased), it is likely that for international consistency and confidence, the rules agreed to by the G-20 will inevitably be implemented here.
