Reserve Bank of Australia Annual Report – 1994 Financial System Surveillance
The Reserve Bank has a general responsibility to promote a sound financial system, as well as more specific responsibilities for prudential supervision of banks and protecting the interests of bank depositors. The specific responsibilities do not extend to non-banks.
Banks and other financial institutions continued to consolidate in 1993/94, with most reporting higher profits and stronger balance sheets, including increased capital ratios. Economic recovery has brought not only revenue growth, with housing finance in particular at buoyant levels, but also lower bad debts. Bad and doubtful debt expenses are now approaching historical “norms” for many banking groups, although some further falls are expected. As in other sectors, profits have benefited from increased productivity, including through reductions in staff numbers. Their health much improved, financial institutions are now well-placed to support business investment and other sources of growth in the economy.
The quality of the banks' loan books has improved sharply. The stock of banks' non-performing loans fell by $10 billion during 1993/94 to $13 billion; this is less than half the peak reached in March 1992 and the lowest level since the statistics were first collected in June 1990. As a proportion of banks' total assets, non-performing loans have declined from their peak of almost 6 per cent in March 1992 to 2.3 per cent in June 1994. Stronger economic growth and property markets have helped banks to clear some problem loans. Banks' specific provisions, as a proportion of the reduced level of non-performing loans, rose to 45 per cent in June 1994, compared with 35 per cent a year earlier.
The Australian banking system has remained well-capitalised, both by international standards and relative to the Bank's minimum supervisory requirements. Banks in Australia must maintain minimum risk-weighted capital ratios of 8 per cent, although some banks are required to meet higher capital requirements, reflecting special features in their make-up. All banks continue to have capital well in excess of the Bank's minimum requirements. At 30 June 1994, the average risk-weighted capital ratio of Australian banks was almost 12 per cent, up from 11 per cent a year earlier. Retained earnings provided most of the boost to banks' capital during the year, in contrast to the previous two years when it came mainly from capital raisings. Risk-weighted assets fell by around 3 per cent in 1993/94, reflecting reductions in some banks' offshore operations and other changes in balance sheet composition. The projected pick-up in business lending could cause banks' capital ratios to edge down from their current high levels.
|
Tier 1 capital |
Total capital |
|
|---|---|---|
| US – 50 largest banks (1) | 8.8 | 13.0 |
| Australia – 4 major banks (2) | 8.2 | 11.8 |
| UK – 4 major banks (3) | 6.0 | 10.5 |
| Canada – 6 major banks (1) | 6.7 | 10.0 |
| Japan – 11 city banks (4) | 5.0 | 9.7 |
|
* Risk-weighted ratios drawn from published data calculated in accordance with national
regulatory requirements (1) March 1994 (2) June 1994 – estimate (3) December 1993 (4) September 1993 |
||
Supervision Objectives
The Bank is required to encourage sound prudential practices by all banks operating in Australia. Banks account for close to half the assets of all financial institutions in Australia (60 per cent when their funds management and other non-bank subsidiaries are included), and strong banks help to make for a strong economy.
Over the past decade, the financial system has been transformed by the forces of deregulation, technological change, innovation and internationalisation. As banking has evolved and become more complex, supervisory arrangements also have had to evolve, often in ways which involve more, not less, supervision. Certainly the need for effective communication and co-operation has grown, both between the Reserve Bank and the banks, and between the Bank and other financial supervisors, domestically and internationally.
It is not the Bank's role to seek to prevent risk-taking by banks. Instead, the objective is to see that banks remain adequately capitalised, and that they identify properly and manage prudently the risks which are inherent in their business. Following deregulation, and in response to other changes in the financial system, prudential guidelines have been established for banks' capital adequacy, liquidity management, large credit exposures, associations with non-bank institutions, and involvement in funds management and securitisation. Developed in consultation with banks, these guidelines provide broad parameters within which banks have considerable flexibility to conduct their business. The Bank's approach emphasises that the prime responsibility for the prudent management and ongoing viability of a bank rests with the management and board of directors of that bank. The Bank is careful not to erode the benefits of deregulation, through heavy-handed prudential regulation or intervention which could unnecessarily stifle innovation and competition.
Should a bank face serious difficulties, the Bank's role is to protect the interests of depositors and, more broadly, to limit the spread of problems to other parts of the financial system. In the event of a locally-incorporated bank being wound up, the assets of that bank in Australia become available to meet its deposit liabilities in Australia, in priority to all other liabilities of the bank. In the case of a foreign bank branch, the assets of the bank in Australia become available to meet the bank's liabilities in Australia ahead of its other liabilities.
Comprehensive public disclosure of a financial institution's activities can be a valuable ally of the bank supervisor. Public scrutiny is an important discipline on the management of financial institutions. Levels of disclosure by those Australian banks which are listed on the stock exchange have improved dramatically in recent years and now approach global best practice. Despite its value, however, the Bank does not believe that, as supervisor, it should rely exclusively or primarily on public disclosure. Even where comprehensive information is disclosed, it seems unreasonable to expect bank depositors to digest the detailed financial statements of banks and come to a decision about their viability. Improved disclosure arrangements are seen as complementary to, rather than a substitute for, the Bank's direct supervisory role.
Not all central banks perform a supervisory role. The separation of the supervision and monetary policy functions which occurs in some countries is usually supported on the grounds that such separation reduces the potential for conflicts to arise between supervisory and monetary policy objectives – such a conflict might arise, for example, if a central bank were to compromise its pursuit of low inflation because it thought tighter monetary policies could cause major difficulties for the banks it supervised.
It is easy to overstate this potential for conflicts and, in the Bank's experience, it has not been a problem. Indeed, experience suggests that sound monetary policy and a strong banking system go hand in hand. Monetary policy is not conducted in isolation but in an environment which presumes an intimate knowledge of the workings of the banking system. Central banks also need the information collected by bank supervisors to perform their responsibilities in “lender-of-last-resort” and crisis management situations. For these reasons, most central banks, whether or not they have formal supervisory responsibilities, maintain a close interest in the banking system, sometimes duplicating the activities of another agency. The Campbell and Martin Committees considered the separation issue in Australia in their respective inquiries in 1981 and 1991; both concluded that prudential supervision of banks should remain with the Reserve Bank.
Recent Policy Developments
Some of the more significant policy changes which were discussed and/or implemented over the past year are summarised in this section.
Quality of assets: Rapid declines in the quality of banks' assets can be precursors to serious problems in the banking system, as was witnessed in the early 1990s. As a step towards improving data on asset quality, in December 1993 the Bank released new guidelines to banks for classifying and reporting their problem loans and other impaired assets. These guidelines, which were developed after extensive consultation with banks, will make for more consistent reporting of problem loans for supervisory purposes, and in published financial statements. The new guidelines will be effective from September 1994.
As important as improved reporting of already impaired loans is, improvement in forward-looking indicators of problem loans is even more so. To this end, the banks have been encouraged to develop systems to measure the quality of their overall lending portfolios. Many banks now have effective loan-grading systems to help in identifying poorer quality loans. Rather than seek to establish a standard, formal loan-grading model for supervisory purposes, the Bank relies, wherever possible, on systems developed by the banks themselves. Analysis of loan “migration” through the different grades should be helpful in providing an early warning of any deterioration in a bank's asset quality.
Over the past year, the Bank has continued its program of visits to banks aimed at developing the kind of expertise that would be required to undertake in-depth investigations into the affairs of a particular bank should serious doubts arise about its soundness. Such visits are leading to a better understanding of credit management procedures across a range of banks, including loan approval processes, account management, valuation policies, and provisioning. The visits confirm that banks now devote more resources to measuring and monitoring credit risks than they did in the 1980s, and are moving to adopt pricing policies based more closely on the relative riskiness of their various exposures.
Derivatives: The use of derivatives and their attendant risks have become lively topics for debate. Derivatives are financial contracts which vary in value depending on the value of some underlying asset (itself generally a financial instrument) – for example, the value of a gold futures contract depends, among other things, on the price of gold. The most commonly traded derivative instruments include forward contracts, futures, interest rate and currency swaps and options.
The market for derivatives in Australia grew strongly in the early 1990s, encouraged by volatility in exchange rates, interest rates and commodity prices, and by advances in computer technology. Although activity of Australian banks has levelled out in recent years, the newness and complexity of many derivative instruments, and the large nominal magnitudes involved, have raised some concerns about these products, including questions about the extent to which the risks are properly understood, and the extent to which they are used for speculative purposes.
Used wisely, derivatives can help to manage financial risk but they can also encourage individual institutions to take on excessive levels of risk. For its part, the Bank seeks to ensure that the banking system is properly managing these risks. Credit risks (that is, the possibility of loss if a counterparty defaults) associated with derivatives are already covered by the Bank's capital adequacy standards, in that banks must hold capital against such risks. Nominal values of derivative products greatly overstate the credit risk in derivatives, which is more realistically measured as the replacement value of the instrument, plus an “add on” for possible future changes in value. Credit risks, measured in this way, represent a little over 2 per cent of the nominal values of derivative contracts outstanding, or about 8 per cent of banks' aggregate assets.
The Bank also has been active in monitoring banks' derivatives activities and discussing developments in derivatives markets with the other regulators involved. Over the past year, Bank staff have visited several banks with substantial derivatives and trading activities to gain a better understanding of their operations and systems for identifying, measuring and containing risks. These visits are continuing.
In March the Bank sought detailed information from the banks on their derivatives and other market-related activities. A preliminary analysis of bank responses indicates that:
- the vast bulk of Australian banks' derivatives business is in straightforward, “plain vanilla” instruments such as futures, forwards and swaps, although several banks expected more complex instruments to grow in importance over coming years;
- most derivatives activity by banks is in instruments with a short or medium maturity (less than five years), where the risk of loss is generally less than in longer-dated instruments;
- credit losses on derivatives to date have been extremely low, totalling around $13 million over the past five years; and
- most banks have made significant progress in developing systems for monitoring and managing risk exposures.
Market risk: Interest in derivatives is but one aspect of the increasing attention being paid by supervisors to banks' exposures to various kinds of market risks. In April 1993, the Basle Committee on Banking Supervision issued a series of consultative papers containing proposals to incorporate market risk within the capital adequacy framework. Specifically, the papers outlined a methodology to measure and apply a capital charge to the risks faced by banks, both on and off-balance sheet, from adverse movements in interest rates, exchange rates and equity prices. The Bank circulated these proposals for comment in May 1993 and discussed their implications with banks and other interested parties. It also conducted extensive empirical work on the applicability of the proposals to Australian banks.
These processes formed the basis of the Bank's formal submission to the Basle Committee in January. This supported the principle that banks should hold capital against market risks, but questioned aspects of the methodology in the proposals to measure such risks, as well as some of the assumptions on which the proposals were based. In particular, the Bank contended that some banks had internal risk-management systems which could provide a better base for the calculation of capital charges than the standard system proposed by the Committee. Some other banking supervisors expressed a similar view in their submissions. The Committee has examined the various responses and has commissioned further work from its technical sub-committees on how banks' own risk-management systems might be utilised for supervisory purposes.
Netting: Banks active in foreign exchange and derivatives markets typically enter a large number of contracts with other banks and generate obligations flowing in both directions. If such obligations could be offset in a legally robust way, it would reduce the total credit risk of banks and the amount of capital required to be held. Currently, bilateral netting of off-balance sheet positions is permitted within the capital adequacy framework only in a limited contractual form – namely, netting by novation where, in effect, a new contract replaces the original one. Under new arrangements issued by the Basle Committee in July 1994, other forms of netting may be recognised for capital adequacy purposes, at the discretion of each country's bank supervisor.
Before the Bank can move in this direction, the question of whether netting agreements are legally sustainable in Australia needs to be resolved. This question has been the subject of widespread debate among market participants, lawyers and Bank officers. One body of opinion is that a wider range of netting arrangements would be supported by Australian law, but the absence of case law means that, without clarifying legislation, some uncertainty will remain. The Bank, in conjunction with other interested parties, is seeking to determine the nature of legislation which might be required to validate bilateral netting in Australia.
Another outstanding issue relates to the measurement of netted exposures. The Basle Committee has agreed to allow netting of banks' current exposures, which relate to currency and interest rate movements which have already occurred. In addition, the Committee has proposed a formula to recognise netting effects in the calculation of potential future exposures. The Bank has conducted some empirical work in this area and will provide its comments to the Basle Committee in coming months.
Funds management and securitisation: Early in 1992, the Bank issued prudential guidelines covering banks' involvement in funds management and securitisation programs. These guidelines were introduced in recognition of banks' increasing involvement in funds management and trends in some overseas markets for banks to securitise their assets. Since then, banks' funds management activities have continued to grow strongly and, while banks have securitised only a small amount of their own assets, they have been increasingly active in the securitisation of assets of other institutions, such as the debt of semi-government enterprises.
The first stage of a promised review of the guidelines has been completed, and revised guidelines were circulated to banks in July 1994 for comment. The latest guidelines continue to reflect the concern that a bank might, through its participation in securitisation or funds management, encounter “commercial” or “moral” risk – that is, risks that a bank could feel obliged – not out of any legal obligation but as a means of protecting its broader commercial interest – to support a scheme with which it is associated should that scheme encounter difficulties. To address that risk, the guidelines emphasise that a bank must disclose fully its rights and obligations under such programs and that investors should be fully informed about, and expressly acknowledge, the risks they face in investing in these schemes. The revised guidelines also specify the capital requirements which will be applied to the various support activities (such as credit enhancement, liquidity support, role as servicing agent or manager) which banks and their subsidiaries are permitted to undertake.
External auditors: The Bank met with external auditors of banks as a group, under a newly agreed format, in August 1993. At this meeting, auditors were updated on trends in the banking industry, and in supervisory developments. The Bank also canvassed a number of options for improving auditors' current reporting arrangements, including a clearer definition of the role which auditors are expected to fulfil, and proposals for detailed audit reports targeted on specific aspects of a bank's operations.
Loans secured by residential mortgage: The guidelines specifying the circumstances whereby loans secured by residential mortgages receive a concessional 50 per cent risk weight for capital adequacy purposes were revised in December. The revision extends the concessional weight to residentially secured loans whether or not the mortgaged property is owned by the borrower (so that loans to small businesses, for example, which do not directly own the houses against which their loans may be secured would be eligible). This revision clarified the changes made in April 1993 which dropped the requirement that loans qualifying for a concessional risk weight had to be for the purpose of housing. Those earlier changes reflected difficulties banks were experiencing in ascertaining the real purpose of loans, and the Bank's judgment that risks faced by banks were similar whenever a loan is secured by a mortgage over residential property and other relevant criteria for granting a loan are met. Where security is provided by third parties (that is, by parties other than the specific borrower), banks are required to ensure that those parties understand fully the consequences of default on the loans and their legal obligations.
Institutional Developments
In February 1992, the Government announced that it would consider applications from foreign banks for banking authorities, and that foreign banks, including those already in Australia, would have the option of operating as branches, rather than as (or in addition to) locally-incorporated subsidiaries. In the event, the full implementation of this policy was delayed, pending resolution of taxation arrangements to apply to branches. The issues were settled, in principle, by the Treasurer in his Banking Policy Statement of 18 June 1993, and in legislation passed by Parliament in December 1993 (the Foreign Corporations (Transfer of Assets and Liabilities) Act 1994), and introduced into Parliament in June 1994 (the Taxation Laws Amendment Bill (No. 3) 1994).
The continuation of interest-withholding tax on intrabank funding – albeit at an effectively concessional rate – has made overseas borrowing relatively more expensive for some foreign bank branches than for locally-incorporated institutions, which can raise funds, free of interest-withholding tax, through Section 128F of the Income Tax Assessment Act. This, combined with the Bank's requirement that, unless there were good reasons to the contrary, the bulk of intermediation business conducted by a foreign bank in Australia should be undertaken through its branch (rather than a non-bank subsidiary), limited the attractiveness of branch status to many foreign banks. This situation was changed to some extent by the Bank's announcement in December 1993 that it would accept the desirability of continued access to Section 128F funding from abroad as an adequate reason for related intermediation business to continue in a non-bank subsidiary. This opened the way for several foreign banks to seek authorisation with branch status.
Although supervised by the Reserve Bank, foreign bank branches do not fall within the depositor protection provisions of the Banking Act, nor are they permitted to accept “retail” deposits (defined as initial deposits of less than $250,000) from Australian residents (other than corporations and employees of the bank). Foreign banks wishing to conduct retail deposit-taking business are required to establish a locally-incorporated subsidiary bank.
| July | ||
|---|---|---|
| 1993 | 1994 | |
| Banks | 39 | 44* |
| Banking groups of which: | 32 | 37 |
| – foreign-owned | 17 | 21 |
| • locally-incorporated | 14 | 11* |
| • branches# | 3 | 10 |
|
* Excludes the subsidiary of a foreign bank expected to surrender its banking authority
following the recent opening of a branch of its parent # Excludes the Australian branches of Bank of New Zealand which, in turn, forms part of the National Australia Bank group |
||
By July 1994, eight foreign banks had commenced branch operations in Australia. Of these, three were previously authorised to operate through locally-incorporated subsidiary banks; the other five operated in Australia through non-bank (“merchant bank”) subsidiaries. The Bank is currently considering applications from several other foreign banks to establish branch and/or subsidiary banking operations.
In addition to the new foreign banks, the Adelaide Bank (formerly The Co-operative Building Society of South Australia) commenced trading as a bank on 1 January 1994.
Effective 1 July 1994, the South Australian Government referred its powers over State banking to the Commonwealth Government. From the same date, it created the Bank of South Australia Limited (BSA) to conduct the core banking business of the State Bank of South Australia (SBS); the bulk of SBS's problem assets have remained with SBS, which has been renamed the South Australian Asset Management Corporation. BSA has been defined as a bank under section 5 of the Banking Act and brought formally under Reserve Bank supervision. This replaces the previous agreement with the South Australian Government under which SBS observed the Bank's prudential requirements. BSA will, in due course, apply for a banking authority under section 9 of the Act.
The South Australian Government's decision to refer its powers over State banking in respect of BSA follows similar action last year by the New South Wales Government in respect of the State Bank of New South Wales (SBN). During the year, SBN applied for a banking authority under section 9 of the Banking Act and this was granted on 1 July 1994. During the year, the State Government also commenced a process under which SBN would be offered for sale by tender. One bidder has been invited to undertake a detailed due diligence of the bank's assets and systems. Throughout the tender process the Reserve Bank has liaised with potential bidders on prudential and regulatory aspects of the sale.
Legal Actions
In 1993, the Victorian Government initiated legal action against the former external auditors of the State Bank of Victoria in relation to losses incurred by its merchant bank subsidiary, Tricontinental Corporation. Tricontinental also took action against its own former external auditors. The Reserve Bank, and several former directors and officers of Tricontinental, were joined as codefendants in these cases. The Bank intended to defend the actions brought against it but, following an out-of-court settlement reached by the other parties, all related claims against it were discontinued in early 1994; the Bank made no contribution towards this settlement.
The Bank has been involved in legal actions flowing from the failure of the Farrow group of companies in 1990. It has been joined as a third-party defendant in an action for loss and damages brought by a holder of non-withdrawable shares in the Pyramid Building Society, part of the Farrow group. The Victorian Government also is continuing separate claims against the Bank, and others, seeking indemnity for claims from depositors and non-withdrawable shareholders of the Farrow group, as well as damages and costs. The Bank believes these legal actions are groundless and is defending them.
Other Financial Institutions
The Bank admitted two new companies as authorised short-term money market dealers during the year. SBC Dominguez Barry Discount Limited commenced operations in August 1993 and Merrill Lynch (Australia) Discount Limited in February 1994. The number of authorised dealers is now ten.
Under the Banking (Foreign Exchange) Regulations, foreign exchange dealers in Australia are authorised by the Bank. During 1993/94, the number of dealers increased by 2 to 74, of which 35 are banks and 39 non-banks.
In recent years, the Bank, at the direction of the Commonwealth Government, has implemented financial sanctions under the Banking (Foreign Exchange) Regulations in response to relevant United Nations Security Council Resolutions. Sanctions introduced against Iraq in August 1990 and Federal Republic of Yugoslavia (Serbia and Montenegro) in June 1992 have remained in place. Financial transactions which involve the governments of these countries, their agencies or nationals are prohibited without the Bank's specific approval.
In July 1994, selective sanctions were also imposed against Libya and Haiti. Financial transactions involving the governments and public authorities of these countries are prohibited, as are financial transactions with the de facto authorities of Haiti and their families.
During the year, the Bank's authority to impose financial sanctions under the Banking (Foreign Exchange) Regulations, in accord with Government policy on relevant United Nations Security Council Resolutions, was challenged in the Federal Court. The Bank successfully defended its powers in this area.
Relations with Other Supervisors
Forging closer links with other agencies involved in the supervision or regulation of financial institutions and markets in Australia is a high priority of the Bank. On a multilateral level, the Bank chairs the Council of Financial Supervisors, a non-statutory body formed in late 1992 which includes the heads of the Insurance and Superannuation Commission, the Australian Securities Commission and the Australian Financial Institutions Commission. The Council seeks to enhance the quality of overall financial supervision and regulation in Australia. Guidelines to promote effective co-ordination among supervisors responsible for institutions which are part of financial conglomerates have been agreed, and the Council is currently reviewing impediments to the sharing of information between the relevant agencies. Since its establishment, the Council has met on seven occasions; topics discussed in more recent meetings have included derivatives markets, the Corporations Law (particularly as it affects financial institutions), lead regulation of financial conglomerates, and the national regulation of friendly societies. The Council's first Annual Report was tabled in Parliament in December.
The Bank has extensive bilateral contacts with individual supervisory and regulatory agencies, as well as a wide range of industry groups and other bodies. Reflecting the increasing linkages of institutions and markets, these contacts are becoming more regular, at both policy and operational levels. Over the past year, the Bank has worked closely with the Australian Securities Commission on issues affecting financial markets, including the regulation of over-the-counter derivatives and short selling.
Regular contact continues with overseas banking supervisors and the Basle Committee on Banking Supervision. During the year, senior officers participated in several regional conferences on prudential supervision, and visited financial supervisors in a number of countries. The Bank hosted visits to Australia by supervisors from New Zealand, the United Kingdom, China, Cambodia and Fiji. An officer of the Bank was seconded for 12 months to the bank supervision areas of the US Federal Reserve Board and the Federal Reserve Bank of Philadelphia; a second officer was seconded recently to the US Office of the Comptroller of the Currency.
Payments System
Payments clearing and settlement systems comprise the set of instruments and banking procedures which link financial institutions and allow individuals and institutions to transfer funds from one to another. Quick and secure transfers are essential for the efficient functioning of any economy. Like central banks in many other countries, the Reserve Bank is working to introduce reforms to the payments system aimed at better identifying and controlling risk, improving efficiency, and enhancing opportunities for equitable participation. The Bank also, of course, is a direct participant in the system; it is an important issuer of cheques, and its processing of government payments gives it the largest share of transactions in the bulk electronic direct entry system.
The Bank is continuing its work with the Australian Payments Clearing Association (APCA) on the development of the Payments Registration and Electronic Settlement System (PRESS) and the associated Payment Delivery System (PDS), which together will form the core of the reformed Australian payments system. PRESS will allow, for the first time, the measurement and limitation of intraday payment exposures between participating institutions. It will register individual high-value electronic payments continuously (in “real time”) and keep track of the resulting multilateral net interbank obligations, which will be settled at 9.00 a.m. each (following) day. Banks' ability to have payments registered in PRESS will be strictly limited as they will need either to pre-fund payments with exchange settlement balances, or to operate within a credit limit. Such limits will be determined by the underwriting commitments, or guarantees, which each bank has been able to secure from other participants in the system. In the event that a participant was unable to settle its PRESS obligations, its underwriters would be legally obliged to do so on its behalf. The Bank has indicated that it would be prepared to extend limited underwriting commitments to others, on commercial terms, in the initial stages of the operation of PRESS, to help provide liquidity to the system.
As PRESS will be a deferred net settlement system, participating institutions need to be assured that the net amounts they expect to receive and pay are legally enforceable. The Bank is working with other interested parties to determine the necessary legislative amendments to achieve this.
While settlement in PRESS will be deferred, registration of individual high-value electronic payments in real time, and the fact that payments will be queued if they would breach participants' credit limits, will give it many of the characteristics of a real-time gross settlement system; participants will be able to operate effectively on this basis if they wish. In real-time gross settlement systems participants pre-fund all payments, or make payments against explicit overdrafts at the central bank; increasingly, central banks are requiring such overdrafts to be fully collateralised. It would not be difficult to convert PRESS in its entirety to a real-time gross settlement system, should this become desirable.
The PRESS/PDS project is at the stage where formal tenders have been sought from three suppliers. A final tenderer is expected to be selected shortly and the system should be running, at least in trial mode, before the end of 1995.
The Bank is also working with APCA on a number of projects to improve directly the day-to-day operation of the payments system. Its active role in APCA brings a public-interest perspective to that company's policies and operations. APCA assumed responsibility for the paper-clearing system in December 1993, and since then has been working on two key projects. One is to speed up the cheque-clearing cycle, by shortening significantly the time institutions currently need to advise whether or not a cheque has been dishonoured. (This has the potential to make funds available one or two days sooner than the five days which are normally required at present.) The second will alter agency arrangements under which larger banks clear cheques for smaller ones. The planned changes will allow agent banks to price separately for processing, and for assuming settlement risk; one result should be more competition for agency business.
Attorney-General's Department is reviewing the main piece of legislation on which the paper-clearing system is based, the Cheques and Payment Orders Act 1986. In the course of this review, the Bank has recommended that, with the approval of their prudential supervisor, building societies and credit unions should be permitted to issue cheques in their own right. The Australian Financial Institutions Commission has substantially strengthened the prudential framework within which these two groups of intermediaries function. The reforms being introduced in the payments system by APCA also have allowed both groups to be involved more closely in the operations of the payments system. During 1993/94 the Bank opened accounts for Special Service Providers in the building society and credit union industries for settling certain electronic transactions.
In its efforts to improve the efficiency of the payments system, the Bank has been mindful of the influence of banks' broad pricing policies. The many cross-subsidies which exist in their charging structures have tended to inhibit efficiency by sending misleading signals to consumers on the relative costs of providing particular services. In particular, banks have continued to absorb the high costs associated with paper-based payments, and this has slowed the movement from paper to more efficient (and potentially less risky) electronic payments systems. Cross-subsidisation of this kind in the provision of payments services helps to keep banks' interest margins higher than they would be if all payments services were priced explicitly.
Consumer Issues
Financial deregulation has widened the range of financial services available to consumers and increased the number of suppliers. Consumers of financial services have benefited from these developments. Getting the maximum benefits from deregulation, however, requires adequate disclosure of relevant information, and the preparedness of consumers to act on it. It also requires that appropriate dispute-handling mechanisms be in place to resolve the conflicts that will arise from time to time between financial institutions and their customers.
The Code of Banking Practice issued in November 1993 should be helpful here. Responsibility for monitoring the Code rests with the Australian Payments System Council (APSC), which is chaired by the Bank; the Bank will gather information from banks, which will be aggregated and submitted to the Council. Building societies and credit unions are developing their own codes of practice which, like the Code of Banking Practice, place substantial weight on effective and accessible dispute resolution processes.