Financial Challenges Faced by Australian Banks - Literature review Example

The Financial Challenges Faced by Australian Banks Name Course Name and Code Instructor’s Name Date Executive summary The Australian financial industry comprises of licensed banks under the Banking Act of 1959 to undertake banking business. According to studies, the competitive region location of Australia provides services for wealth management which is made eminent by its economic resilience as well as strength, the financial market liquidity, depth and size. This has resulted to Australia being able to maintain a very strong banking system one that in more than 100 years has been safe and stable. However, a number of challenges have been reported to threaten the banks in Australia. The challenges faced by these banks include implementing international regulatory reforms, cost as well as stability of funding, pressures of increased competition and structural challenges. Introduction It is evident that the Australian banking industry has for almost 20 years enjoyed a sustained economic growth. As indicated by Merrill and Capgemini in their World Wealth Report of the year 2010, the sustained economic growth has seen Australia become one of the largest wealth markets in the world (Henry, 2010). The industry comprises of licensed banks under the Banking Act of 1959 to undertake banking business. According to studies, the competitive region location of Australia provides services for wealth management which is made eminent by its economic resilience as well as strength, the financial market liquidity, depth and size. In addition, the funds management innovative as well as sophisticated nature, reinforced by the compulsory superannuation income policy (Henry, 2010). As a result, Australia has been able to maintain a very strong banking system one that in more than 100 years has been safe and stable. This is evidenced by the fact that in a long time in history, there has not been any complains of deposit loss in any of the Australian bank (Weerasooria, 2000). However in the near past, it has been noted that the banking industry in Australia has been showing a down war trend due to a number of challenges (Henry, 2010). This report seeks to identify and evaluate the financial challenges that the Australian banks are facing in order to come up with the desired solution to the problem. Liquidity challenge According to studies, the major issue that has been facing the Australian banks has been defining liquid assets (Blees, 2011). Evidently, the assets that can be categorized as liquid are in two types; those limited to cash, commonly referred to as level one asset and those referred to as level two assets (Blees, 2011). These are not in a position to compromise over 40 percent of total stock. In addition, they are limited to particular covered as well as corporate bonds that have been ascertained to be a dependable basis of liquidity even in hard economic times. According to an announcement by the (Apra), Australia Prudential Regulatory Authority, in Australia, the assets that meet the liquidity necessities happen to be the balances which are held with semi government securities, Reserve Bank of Australia as well as Common Wealth Government Securities (Blees, 2011). Worsening the situation is that the level one asset not meeting the requirements is not sufficient enough to address the banks liquidity needs. The estimates by the National Bank of Australia indicated that the supply of semi government securities and the Common Wealth Government securities will peak at 374 US dollars. The Australian bank on the other hand will account for 250 US dollars (Blees, 2011). This would be impossible since there will be lack of the necessary liquid assets in the market (Blees, 2011). This is due to the fact that the design of the Basel III Liquidity does not take into consideration the Australian financial system. In order to solve the issue, the Reserve Bank of Australia aims at introducing a liquidity facility of adequate size to address the shortcomings between the Basel III requirement and the bank liquid assets (Blees, 2011). However, with respect to the new facility, there are a number of issues that require to be put into consideration. They include the costs of using it. The Reserve Bank of Australia aims at ensuring that a uniform fee will apply by all the institutions using the facility. In addition they will make sure that it is designed in a manner that ensures that the banks in Australia have similar incentives in managing the liquidity just as their complements (Blees, 2011). Current account deficit Besides, the Australian banking is facing a problem with funding the current deficit. As evidenced by research, Australian economy is characterized by the fact that the domestic savings are lesser than the domestic investments (Craig, 2011). This gap is what is referred to as current account deficit. In Australia there is a strong link between the Australian banking industry off shore borrowing and current account deficit. This implies that the Australian banks have a responsibility of financing the country’s excessive investment over the domestic savings. This in return has limited economic stimulation (Craig, J., 2011). As a result Australian banks have resulted to international funding to try solving the problem but it has proven hard to get. In the event of property slump, this proved to be harder. Moreover, there was a reverse in carry trade that was as a result of creation of nearly no interest credit by the Reserve banks which were experiencing deflation (Craig, J., 2011). They provided cheap credit that enhanced asset inflation especially in Australian’s real estate and it resulted to unaffordability in housing. Therefore this meant that the high interest rates were no longer attracting capital inflow. This saw the Australian banks unable to provide loans. In addition it became harder and harder for businesses to get credit and the government to get funding for the infrastructure (Craig, J., 2011). Besides it also put the economy at risk due to the high relationship between; the overdependence on international borrowing to cover the current account deficit in Australia, real estate value, the Australian banks as well as non-financial institutions balance sheets and the problem of maintaining capital inflow. These are risks that have led to the interference with the international capital inflow and as a result the failure of the Australian bank due to the fact that one of their biggest assets in the balance sheet had been devalued (Craig, J., 2011). Structural challenge Another challenge being faced by the Australian banks include the structural challenges (Cooper, 2006). Such problems are for instance the capacity of the banking system to acquire funding on the terms of cost competitive in an environment which has continued instability in the offshore markets especially in Europe as well as the subdued retrieval in the domestic securitization market as a result of the severe instability during the global financial crisis (Cooper, 2006). During the global financial crisis, the Australian government offered support to the banks through the introduction of Guarantee Scheme for wholesale funding as well as large deposits. The guarantees offered the banks an opportunity to access funds on competitive funds continually during the hard times (Cooper, 2006). Despite the fact that the environment seemed stable, there lay the challenge facing the banking system in rolling over on cost competitive terms at approximately 130 billion US dollars in guaranteed debt during the period 2011 to 2014. According to the government, building societies as well as the credit unions ought to offer their help in the funding to back the banking sector robustness over the medium to long term (Cooper, 2006). International regulatory response Moreover there is the challenge of implementing the international regulatory response to global financial crisis for the G20’s (Henry, 2010). The aim of this response is to enhance the world wide banking sector by employing the lessons learnt from the global financial crisis. For the Australian banks, the challenge is on how they could implement the regulatory reforms of the G20’s while taking into consideration their unique situations as well as avoiding the unfruitful effects of the credit flows on the economy (Henry, 2010). Furthermore, for the Australian banks, there is the challenge of promoting a competitive banking environment for their banking services customers especially in the environment that has become so concentrated due to the crisis (Henry, 2010). To explain these, the example of cost of funding is used. It is b evident that since 2008, the competition for deposits have deepened and as a result there has been a remarkable rise in the deposit rates relative to the market benchmarks (Henry, 2010). Apparently, the competition is most notable in term deposit and it has taken place despite the high concentrations of the post crisis in the banking sector. According to the estimates by the Reserve Bank Australia, the main bank’s average cost on new deposit is less than the cash rate. This is due to the fact that it is approximately 150 bases less than the cash rate as compared to before the global financial crisis (Henry, 2010). Evidently, the results of this have seen the net savers for instance the self-funded retirees enjoying the benefits from the increase in return deposits. The increased deposit interest rates have resulted to the increased pressures on the lending rates relative to the cash rates (Henry, 2010). In addition the bank funding has also become very expensive. According to studies it has found that wholesale funding represented approximately 40 % of the major banks funding and around 30 % of the second tier banks (Henry, 2010). This saw the spread for the major banks in Australia relative to the government risk free benchmarks in both offshore as well as onshore markets accelerate from about 50 bases in the year 2006 to 2008 to around 280 bases in the global financial crisis. Since then they have depreciated to approximately 120 bases slightly above the global financial crisis level and this has greatly affected the Australian banks (Henry, 2010). The biggest challenge for the banks was therefore on how to reconsider the reprising issue in a permanent way (Henry, 2010). Net interest margin Another example of the effects of these developments lies in the net interest margin. It is apparent that when there is an increase in competition, there is a substantial fall in the in the net interest margins (Henry, 2010) (Henry, 2010). In the year, 1980, the net interest margins of the main banks in Australia depreciated to below 6 % and approximately 2¼ % in the year 2008. The net interest margin downward pressure is one of the economy wide benefits of the Australian financial system deregulation which included the elimination of the regulated interest rate on the housing rates (Henry, 2010). The fall in the net interest margins was as a result of the competitive pressures as well as new bank entrants to the industry (Henry, 2010). Conclusion It is apparent that the Australian banking system has long developed from the global financial crisis to be strong. However, the bank is facing a number of challenges as discussed in the essay to include; the challenge of implementing the international regulatory response to global financial crisis for the G20’s. The main challenge here has been found to be on how they could implement the regulatory reforms of the G20’s while taking into consideration their unique situations as well as avoiding the unfruitful effects of the credit flows on the economy. In addition, the challenge of promoting a competitive banking environment for their banking services customers especially in the environment that has become so concentrated due to the crisis has also been noted. Moreover, highlighted in the report are also the structural challenges that have led to the instability of the banks in Australia. In conclusion, these challenges need to be addressed in order to ensure a stable as well as safe environment which is of paramount to the economic growth of the country and the stability of the banks in Australia. References Blees, W. 2011. Australian banks still face many liquidity challenges. Accessed on October 30, 2011, http://www.risk.net/asia-risk/feature/2070295/australian-banks-liquidity-challenges Cooper, J.., 2006. The integration of financial regulatory authorities – the Australian experience, 30th Anniversary Conference. Rio de Janeiro, Brazil Craig, J. 2011. Defending Australia from the Financial Crisis. Accessed on October 30, 2011, http://cpds.apana.org.au/Teams/Articles/Fortress.htm Henry, K. 2010. The Australian Banking System - Challenges in the Post Global Financial Crisis Environment. Accessed on October 30, 2011, http://www.treasury.gov.au/documents/1921/HTML/docshell.asp?URL=ken_henry_speech.htm Hoflich, P. 2011. Banks at Risk: Global Best Practices in an Age of Turbulence. New York: John Wiley and Sons. Weerasooria, W. S. 2000. Banking law and the financial system in Australia. London: Butterworths, Read More