The Changes and Structure of the Australian Financial System and Deregulation of the Financial System - Case Study Example

The Changes and Structure of the Australian Financial System and Deregulation of the Financial System Introduction The debate on the financial system change and reformation have remained multifaceted with debates on the issue now touching on ways in which financial regulation provided authorities with the strategy of managing the monetary side of the economy. Even though this study begins by acknowledging that the course of financial regulation in the country (Australia) was completed about 20 years ago, an understanding of the changes and structure of the financial system is essential in providing a path for future measures that may need to be ratified. Just like Davis (2011) noted, financial deregulation was completed about 20 years ago but a research into these changes and structural adjustments will be essential owing to the fact that changes to the system is continuous especially with regard to laws under which financial sector operates. There is need for vibrant, competitive and dynamic sector and as a result, the argument on such changes will be prudent in ensuring the dynamics, competitiveness and vibrancy. This assignment therefore discusses the changes that resulted to deregulation of the financial system taking consideration of case studies and researches that have informed such changes. Research conducted by Pan (2010) noted that by 1970s the Australia’s Reserve Bank was already taking measures geared towards change. However, these changes were met with fears as some economists thought that such changes could lead to a loss of control when it comes to financial system. It has to be noted that in any case, the power to bring these changes did not rest entirely with the Bank instead, it incorporated different financial controls in legislation and thus the Treasury and the Government were to be convinced about the prudence of the step before any change was to be made or structuring process undertaken on the systems. Before discussing tenet of the changes, this study borrows from Lu and Whidbee (2013) who found that the early moves towards the changes and structure adjustments to the financial systems there were alternative schools of thought that the problem experienced in Australia could be addressed through extending range as well as reach. Studies such as Davis (2011) give an example of this case arguing that there was legislation geared towards extending controls especially to non-bank institutions acting as intermediaries and at the same time coming up due to the controls seen in the banks. However, this study notes that this legislation was not proclaimed, nevertheless, as the intellectual move towards deregulation ultimately took control. To begin with the changes and structural adjustment was the removal in the 1973 of controls regarding rates of interests that banks in operation were required to pay when it comes to wholesome deposits (Yates, 2008). According to Antzoulatos, Thanopoulos and Tsoumas (2008) the structure change was considered as a modest as well as cautious move that was able to allow banking institutions a certain level of control and freedom to compete favourably. As a matter of fact, this was the change that ended up bringing far-reaching repercussions. For instance, research by Lloyd (2008) noted that the change allowed foreign financial institutions to enter the Australian market and the exchange rate being floated. However, other changes that followed the 1973 system adjustment on the interest rates were as followed: Australian financial system ushered in a period where there was removal of interest rates on banks (Lloyd, 2008). The change in the system was designed to necessitate banks to compete favourably and conveniently for deposits as well as loans. While this change managed to fulfill its mandated task, the unintended consequences were witnessed. First, it was seen as a change that reduced the efficiency and effectiveness of the liquidity and reserve rations on financial institutions, specifically, banks (Athanasoglou, Brissimis and Delis, 2008). The reason studies attribute to such consequences was as a result of the fact that banks were now able to deal with a change in the reserve ration by simply re-evaluating their interest rates on deposits so that they can compete aggressively for funds. One point to note is that the funds in question were from foreign capital inflows, since the relatively fixed exchange rate caused the need for Reserve Bank to intervene, thus causing liquidity to the Bank. The Reserve Bank was later tasked with the responsibility of relying on market operations with regard to government securities so as to control liquidity, however, the effectiveness of the proposed change was limited since authorities putting rates of interests on government securities below expectations making it almost impossible to sell the needed amount of securities (Henry, 2011). From the one hand, it can be argued that increase in international capital flows especially after the collapse of the Bretton Woods plans indeed put more pressure on the economy of Australia and in particular, dollar exchange rate. It was for this reason that the change was introduced. Secondly, this was a move that was going to help the authorities to stabilize the rate of exchange. Studies such as Kondeas, Caudill, Gropper & Raymond (2008) have observed that the weakening dollar exchange rates were some of the reasons why the country engaged in large foreign exchange transactions. However, studies have documented that foreign exchange transactions did not really achieve much because it made it difficult for systems to effectively deal with domestic liquidity as well as financial conditions within the country. It was apparent that the change that was introduced (removal of interest rates on banks) was going to bring some problems. In view of this, there was need for Australian financial system structure to be adjusted so that eminent problems could be remedied. The first change was a reformation freeing interest rates touching on securities of the government. Pan (2010) observed that instead of the Australian authorities tasked with the responsibility of setting interest rates, they ensured that securities were given at tender and at the same time, ensuring that Australian market set the interest rate. Specific case to point with regard to this change was a situation where tenders were created for Treasury bonds in 1982 and Treasury notes in 1979. Accordingly, this change brought about the needed effect since it allowed both the government/regime, through primary issue, as well as Reserve Bank, through its operations in different market, to dispose the needed bonds. Davis (2011) differs with Pan (2010) adding that the step taken by the Government and Reserve Bank failed to give the authorities the required monetary control, as it was that there was hardly any success in attaining the monetary targets that were put in place during the period of the changes. Additionally, this was the change that has been argued to have brought about fixed exchange rate which when assessed keenly, remained a weak point when it came to monetary control process, since attempts by the Reserve Bank to change monetary situations/conditions were largely offset when delegated to private capital flows. This change came in handy owing to the fact that the financial system was beginning to be insufficient, noting that studies such as Yates (2008) documented that there were wide interest spreads, little or no innovation and a number of creditworthy possible borrowers limited from accessing credit. Change was needed and really fast. According to Lloyd (2008) changes and structural adjustments was needed since the controls were weakening the positions that were held by banks and as a result, affecting their ability to specific needs of their customers. The existing structure banks were constantly losing their cutting edge and market share in the financial system. As a matter of fact, statistics from studies such as Yates (2008) have observed that by mid-1980 shares from Australian banks had dropped by at least 40 percent when compared with about 80 percent in the early 1960s. Therefore to remedy these effects, floating of exchange rates in 1983 was another change that was witnessed on the Australia’s financial systems (Henry, 2011). It has been observed that the authorities within the country were concerned about introducing greater levels of flexibility in the rates of exchange since 1971; however, none of the exchange rate regimes that were introduced over the period provided the needed flexibility to make sure that the domestic monetary policies were not overcome or overwhelmed by foreign capital flows. As a matter of fact, Yates (2008) reported that the float managed to change the process. That is, the float allowed the exchange rate to vary with the forces of demand and supply thus eliminating the need for the Reserve Bank to make clearances on the foreign exchange market. Again, the controls were increasingly becoming obsolete and ineffective the more there were unregulated intermediaries coming up to provide finance. What Australia’s financial systems experienced as a result of these changes was the influence on foreign capital flows on domestic liquidity and at the same time giving the central bank the authority to control domestic financial conditions. Lloyd (2008) argues that the whole process allowed Australian financial systems to implement monetary policy that could allow them to delink from the use of liquidity and reserve rations on financial institutions to the adoption of market segments so as to influence market interest rates deemed as short term and through this process, the interest rates that were charged on all lenders on loans. The consequence of this step was that it brought about policies working more prudently and broadly through the Australian financial system, instead of focusing only on banks which made it more efficient and effective and less distorting when compared with previous systems. The fourth change and adjustment on the financial system was aimed at increasing competition in Australia’s financial sector. The core reform agenda was to allow financial institutions, borrowers and foreign banks to enter the financial systems in Australia, but again, processes for establishment of new domestic banks were further made easy. However, this change was met with a number of concerns from economists to the larger Australian population. From the one hand, Lloyd (2008) noted that it was essential to harness community and public support for processes of financial system reform. In as much as the intellectual climate within the bank (Reserve Bank) as well as other economic policy frameworks and agencies were already making a move to favour the processes of deregulation, wider community and public acceptance of the need for this change was not implemented until after the Government brought a number of inquiry that were conducted by a number of independent experts (Henry, 2011). This change is however, argued to have generated the following measures: Australian banks were now subjected to directives regarding the quantity of loans as well as times there was ethical suasion regarding the industries to which a given loan can be or cannot be made. All transactions in connection to foreign exchange were closely monitored, especially transactions on capital, which were approved individually. For instance, Henry (2011) observed that Australians were not allowed to make any portfolio investments offshore. The reason for ratifying this measure was for the authority to preserve domestic savings that would help domestic investment. Institutions were supposed to specialize in their undertakings. That is, trading banks were supposed to lend to business and not go beyond this scope. On the other hand, savings banks were mandated to lend to households and thirdly, finance companies were allowed to lend properties deemed to be risky property consumer credit and savings. Banks were now subjected to liquidity ration and reserve ratios. To ensure that this policy was implemented, these rations were adopted and used by the authorities to control the what Yates (2008) terms as ‘second-round effects’ on financial institutions’ balance sheets of exogenous flows of different liquidity either from the fiscal policy or balance of payment. Conclusion The study observes that while Australia succeeded in putting measures that harnessed financial systems, the consequence of change are not always predictable in as much as the case of Australia led to the deregulation of its financial systems. For example, Australia experienced a situation where removal of one of set measures put pressure on another control system. While this study as discussed he changes in Australian financial system, a regulated financial system may tend to bring about credit rationing bringing about unsatisfied need for credit in the country. References Antzoulatos, A. A., Thanopoulos, J., & Tsoumas, C. (2008). Financial System Structure and Change-1986-2005 Evidence from the OECD Countries. Journal of Economic Integration, 977-1001. Athanasoglou, P. P., Brissimis, S. N., & Delis, M. D. (2008). Bank-specific, industry-specific and macroeconomic determinants of bank profitability. Journal of international financial Markets, Institutions and Money, 18(2), 121-136. Davis, K. (2011). The Australian financial system in the 2000s: dodging the bullet. The Australian Economy in the 2000s, 313-314. Davis, K. (2011). The Australian financial system in the 2000s: dodging the bullet. The Australian Economy in the 2000s, 313-314. Henry, K. (2011). The Australian banking system-challenges in the post global financial crisis environment. Economic Round-up, (1), 13. Kondeas, A. G., Caudill, S. B., Gropper, D. M., & Raymond, J. E. (2008). Deregulation and productivity changes in banking: evidence from European unification. Applied Financial Economics Letters, 4(3), 193-197. Lloyd, C. (2008). Australian capitalism since 1992: a new regime of accumulation?. Journal of Australian Political Economy, The, (61), 30. Lu, W., & Whidbee, D. A. (2013). Bank structure and failure during the financial crisis. Journal of Financial Economic Policy, 5(3), 281-299. Pan, E. J. (2010). Structural reform of financial regulation. Transnat'l L. & Contemp. Probs., 19, 796. Yates, J. (2008). Australia's housing affordability crisis. Australian Economic Review, 41(2), 200-214. Read More