Reserve Bank of Australia Annual Report – 1995 Surveillance of the Financial System

Efficient financial and payments arrangements are an asset to any economy. Part of the Reserve Bank's responsibilities is to help deliver such arrangements. The Bank also has specific responsibilities for the prudential supervision of banks and the protection of bank depositors. In pursuing these various responsibilities, the Bank seeks to preserve the gains to be had from deregulation, and to minimise the risks of serious problems arising, although it cannot totally eliminate such risks.

The financial system further consolidated its generally sound position in 1994/95. Banks and other financial intermediaries again reported strong profits, which were underpinned by lower bad and doubtful debt expenses, higher lending volumes and tight control of costs. Capital ratios of most groups of intermediaries rose. Earnings of life insurance companies and various other funds managers, however, were affected by lower prices in certain securities markets.

For the banking industry as a whole, profitability has returned to the levels of the 1980s. To help maintain profits, banks are continuing to invest heavily in new technology, to develop new products and novel ways of delivering services to customers, and to make further cost savings. Competition for new lending business has intensified, especially in housing and some areas of corporate finance. In this environment, banks need to maintain high prudential standards and ensure that interest margins and loan covenants are appropriate to the risks they take on. As in some other countries, changes in market conditions have exposed an overcapacity in trading activities, leading several banks to make cut-backs in some areas, including proprietary trading.

Reflecting the lower level of problem loans, the average quality of banks' assets improved further in 1994/95, but at a more moderate pace than in the previous two years. While some banks have scope for further reductions, lower charges for bad and doubtful debts have largely run their course as a general source of growth in profits. New guidelines for the identification and reporting of problem loans and other impaired assets were introduced in September 1994. At end June 1995, banks' total impaired assets were around $11 billion (equivalent to 1.8 per cent of total assets), down from $14 billion (2.5 per cent of total assets) at end September 1994, and the peak in non-performing loans of about $30 billion (nearly 6 per cent) in March 1992. Specific provisions, as a percentage of banks' impaired assets, rose to 37 per cent at end June 1995, from 34 per cent at end September 1994.

Australian banks remain strongly capitalised, both by world standards and relative to minimum supervisory requirements. In line with internationally accepted standards, Australian banks are required to maintain risk-weighted capital ratios of at least 8 per cent, including at least 4 per cent in the form of Tier 1 (or core) capital, which comprises items such as ordinary shares and retained earnings and provides depositors with the surest protection against losses. At end June 1995, the average risk-weighted capital ratio of Australian banks had risen to 12.1 per cent, from 11.9 per cent a year earlier; Tier 1 capital ratios averaged 9.1 per cent. Retained earnings accounted for the bulk of the increase in the aggregate capital ratio. Banks' risk-weighted assets, which had fallen slightly in each of the previous two years, rose by 7 per cent in 1994/95.

With their ratios in good shape, some banks took steps during the year to slow the growth in their total capital, including through adjustments to dividend re-investment schemes and repayments of term-subordinated debt raisings (which qualify as Tier 2, or supplementary, capital). The Bank's approval is required for capital repayments and is dependent on the bank's post-repayment capital ratios remaining healthy compared with regulatory minima, and on its risk profile more generally.

Developments in supervision

Prudential supervision of banks continues to evolve in response to local and international developments. Major activities during the past year have focused on:

• ensuring that banks maintain capital buffers commensurate with the risks in their business;
• encouraging banks to establish and maintain sound risk management systems; and
• strengthening mechanisms for the early detection of potential problems.

Asset quality: In January 1995, the Bank released its new Prudential Statement on the quality of bank assets. This Statement incorporated guidelines on the identification of impaired assets, which came into effect in September 1994. It also provided guidance on the valuation of loan security aimed at improving the consistency of provisioning decisions, as well as encouraging banks to maintain appropriate credit-risk-grading systems as an aid to monitoring the quality of their asset portfolios. The Bank now receives quarterly information from banks which is derived from their credit-risk-grading systems.

Since 1992, officers of the Bank have visited banks to learn first-hand how different banks approach the question of asset quality. The main focus is on management systems, not the soundness or otherwise of particular lending decisions. The visits help supervisors to assess the effectiveness of banks' systems for monitoring and controlling credit risk, and their consistency with good industry practice. Drawing on the experience gained from these visits, the Bank has codified what it regards as “good practice” standards, which are helpful in benchmarking different banks' systems. In the process, staff also acquire experience which would be invaluable should the Bank ever wish to conduct an in-depth investigation into the affairs of any bank it might be concerned about. It is envisaged that, in future, each bank will be visited approximately every two years, or more frequently if this is judged necessary.

Market risk: Another major area of policy development has been market risk, that is, the risk of loss faced by banks as a result of movements in market prices. Such risks have become more prominent in recent years, with greater price volatility in financial markets and the proliferation of traded financial instruments. This work has revolved around the proposals circulated by the Basle Committee on Banking Supervision in April 1993 for extending the capital adequacy framework to market (as well as credit) risks. A revised set of proposals was issued by the Committee in April 1995, under which banks would be required to hold capital to cover market risks associated with their foreign exchange operations and their trading activities in debt securities, equities and commodities. The guidelines are scheduled to be finalised by the end of 1995 and to be implemented over the following two years.

The proposals, which cover both on- and off-balance sheet transactions, contain a standard methodology for calculating capital requirements for market risk. Banks will, however, have the option of using their own models to measure market risk and calculate the associated capital requirement. The availability of this option, which is the main change from the proposals circulated in 1993, acknowledges the sophisticated risk-management systems already in place in many banks, which are capable of assessing risks more accurately than the proposed standard methodology. Minimum criteria have been established for the use of banks' models to ensure reasonable comparability of results from such models, and national supervisors will have considerable discretion in approving their use for calculating capital requirements.

Associated with the impending implementation of these proposals in Australia, the Bank is developing its capacity to assess the adequacy of the systems of individual banks for identifying, measuring and controlling market risks. To this end, the Bank has commenced a program of visits to banks along the lines of the asset quality visits; these will help the Bank to assess the adequacy of banks' internal models for calculating capital requirements for market risk. The visits involve specialist supervisory teams observing and discussing trading and treasury operations with senior management in the relevant areas of the banks. It is expected that all banks with substantial treasury operations will have been visited by the end of 1995, with visits to the remainder scheduled for 1996.

Derivatives: As in other countries, supervisors in Australia are devoting a good deal of attention to derivatives. No bank in Australia has experienced major losses as a result of its derivatives activities but public concerns about the perceived risks have been refuelled by the collapse of Barings plc in London in February 1995. This followed several other well-publicised losses involving derivatives by overseas corporate and government bodies.

In simple terms, derivative instruments are financial contracts the value of which depends on the value of some other instrument or asset; for example, the value of a bill futures contract depends on, among other things, the yield (or price) of bank bills of exchange. Risks in derivatives can be assessed sensibly only together with risks arising from the instruments on which they are based. Of themselves, derivatives do not add to the risks inherent in fluctuating market prices, but they do permit those risks to be shifted to market participants who are more able and/or willing to bear them.

Several Australian banks are prominent players in derivatives markets but this does not mean they are gambling with depositors' money. Derivatives are used extensively by banks to manage their own market risks and to provide risk-management services to their customers, which can bring benefits to the community as a whole. Banks can also trade in derivatives and other market instruments on their own account, but such activities are subject invariably to internal limits on amounts that might be lost (often expressed as “value at risk”) in the event of large adverse price movements. Transactions in derivatives are a natural extension of the traditional business of banking, and the risks involved are not fundamentally different. Banks already are required to hold capital against the credit risks associated with derivatives and will shortly be required to do so in respect of market risks.

Banks' derivatives activity
(Contracts outstanding – $ billion)

Derivatives, however, are not without their operational complexities and, because of their newness, raise legal and accounting issues which can expose banks to additional risk. The opportunities to leverage exposure through derivatives also create the potential for some institutions, or their customers, to assume excessive amounts of risk. These aspects help to explain the increased attention being given by supervisors everywhere to the adequacy of banks' systems to measure and limit the risks associated with derivatives. Information available to the Bank, including through its program of specialised visits, suggests that Australian banks generally have in place controls which are appropriate to the nature and extent of their derivatives business, although scope exists for improvement in some areas.

No amount of supervisory oversight can provide complete protection against the possibility of problems arising within banks as a result of their derivatives (or any other banking) activity. The prime responsibility for the sound management of a bank, and for the maintenance of effective systems to control risks, must rest with the management and board of individual banks. Generally speaking, banks have been reviewing their current practices in relation to derivatives and, where necessary, upgrading those practices. The Bank encourages such upgrading. It also supports efforts to increase the transparency of the derivatives operations of banks through improved public disclosure. Some banks are now providing additional information in their published financial statements, but more remains to be done.

The report of the investigations by the Bank of England's Board of Banking Supervision into the failure of Barings was released in July 1995. The Board concluded that Barings' collapse was attributable to unauthorised and concealed trading which was not detected because of the breakdown of basic management and internal controls. The major lessons drawn out in the report are:

• management has a duty to understand the broad nature of the businesses in which their institution is engaged;
• reporting lines must be clearly established and understood;
• front and back office functions should be clearly segregated;
• strong internal controls need to be established and enforced, including an independent risk-management function; and
• top management and the audit committee should ensure that weaknesses identified by internal audit or otherwise are resolved quickly.

The Board did not advocate any fundamental changes to banking regulation or legislation in the United Kingdom, but it did make a number of recommendations intended to improve current practices. The Reserve Bank is reviewing these recommendations to see if they suggest any useful changes to its own practices.

Funds management and securitisation: Banking groups are becoming increasingly involved in funds management and the securitisation of assets. These “non-traditional” activities of banks, which have the potential to proliferate over time, raise a number of supervisory issues. The Bank is keen to see that banks undertaking these activities properly identify and control the risks involved, including the risk that banks, for “image” or other reasons, might be dragged into supporting associated funds management or securitisation schemes which get into difficulties.

Guidelines directed towards these issues have been in place since 1992. Last year the Bank issued for comment a set of revised guidelines covering banks' funds management and securitisation activities. Extensive comments were received on these draft guidelines, prompting the Bank to release a second draft in January 1995. The consultative process has now been completed and the Bank will shortly release final guidelines.

Compared with the existing requirements, the new guidelines will lessen the constraints on banking groups undertaking a range of funds management and securitisation activities, including credit enhancement, liquidity support and underwriting. The new guidelines also will more clearly specify the capital requirements associated with banks' funds management and securitisation activities, and tighten disclosure and other requirements aimed at ensuring investors understand that they have no claims against banks, beyond any explicit legal entitlements, if their investments should perform poorly.

Loans secured by residential property: With effect from September 1994, the capital adequacy guidelines were amended so that new housing loans with loan-to-valuation ratios exceeding 80 per cent would no longer qualify for a 50 per cent concessional risk weight. This change reflected a concern that, in periods of low inflation, rapid growth in housing lending and associated intense competition among housing lenders for market share (including from non-traditional mortgage lenders), an additional element of risk was likely to attach to loans with very high loan-to-valuation ratios. The change was made primarily on prudential grounds, although at the time it was made any effect which it might have had on housing lending would have been supportive of broader macroeconomic policy objectives.

Bank directors: New prudential guidelines relating to bank boards were issued in October 1994. These made clear the need for directors of banks to avoid situations which could give rise to conflicts of interest, and for the oversight of the management of banks by independent boards. The guidelines specifically preclude bank directors from serving as directors or executives of other banks (or their subsidiaries). They also require the chairman and a majority of directors of bank boards to be non-executives, and for the Bank to receive advance notice of proposed changes in board composition. In the case of subsidiaries of foreign-owned banks, at least two non-executive directors should be independent of the parent institution.

Single banking authorities: The Treasurer announced in March 1995 that a bank acquiring another bank would in future be permitted to continue to use the brand name of the acquired bank for some or all of its activities. This was subject to appropriate signage and documentation in respect of the acquired bank which disclosed clearly to customers the legal entity with which they are dealing. At the same time, the policy that each Australian bank should hold only one banking authority (except in transitional periods) was reaffirmed. This policy avoids possible conflicts of interest and other problems for prudential supervision and depositor protection which could arise if two banks were authorised to operate within the same group. It serves also to discourage unwarranted fragmentation of the banking system.

Institutional developments

Australia currently has 49 authorised banks organised into 43 banking groups. Since the decision in early 1992 to permit additional foreign banks to enter (and to allow foreign banks to operate as branches), the number of authorised foreign banks has increased to 30 (15 wholly owned subsidiaries and 15 branches); these banks account for around 12 per cent of total banking assets. Over the past year, four foreign banks commenced branch operations and two others established locally incorporated subsidiary banks. In addition, the Primary Industry Bank of Australia was acquired by a foreign bank.

Authorised banks in Australia

August	1994	1995
Banks	45	49
of which:
• Domestic	21	19
• Foreign	24	30
– locally incorporated	13	15
– branches	11	15
Banking groups*	37	43
of which:
• Domestic	16	16
• Foreign	21	27
* Some banking groups include more than one authorised bank (eg foreign banks which operate in Australia through both a branch operation and locally incorporated bank subsidiary; local banking groups which temporarily comprise more than one authorised bank following a takeover).

There is no time limit on the receipt of applications from foreign banks wishing to obtain Australian banking authorities. From the end of 1996, however, the benefits of the Foreign Corporations (Transfer of Assets and Liabilities) Act 1993 will no longer be available; this Act provides for the transfer of assets and liabilities from foreign banks' subsidiaries to branches free of stamp duty and capital gains tax.

Subject to offshore regulatory approvals, the National Australia Bank Group is to acquire Michigan National Bank, an American bank with assets in excess of $11 billion. Following this acquisition, which is expected to be completed by the end of 1995, nearly half of that group's assets will be located outside Australia, primarily in the United Kingdom/Ireland, New Zealand and the United States. On 31 December 1994, the NSW Government sold the State Bank of New South Wales to The Colonial Mutual Life Association. Consistent with policy on the ownership of banks by life offices, Colonial Mutual has undertaken to demutualise by no later than the end of 1998. In June 1995, the South Australian Government accepted an offer from Advance Bank to acquire the Bank of South Australia. After a transition period, this will be merged with Advance, to become the fifth-largest bank in Australia.

The Western Australian Government is seeking to privatise its wholly owned Bank of Western Australia and, while the Government is considering various sale options, it has asked potential buyers to submit indicative bids. The Commonwealth Government has announced its intention to sell its remaining 50.4 per cent interest in the Commonwealth Bank. The bank is proposing to buy back around $1 billion of the Government's shareholding, with the remainder being offered to the public in two tranches – the majority towards the end of 1995/96 and the balance early in 1997/98.

Bendigo Bank Limited, formerly the second-largest building society in Australia with assets of $1.7 billion, was granted a banking authority on 1 July 1995. Around the same time, Town and Country Bank merged its banking business with that of its owner, the ANZ, and surrendered its authority. The trading and savings bank operations of the Bank of Queensland and of Citibank were integrated on 1 September and 1 November 1994, respectively; these were the only banks still operating their former savings banks under separate authorities.

Banks are required to keep with the Reserve Bank non-callable deposits (NCDs) equivalent to 1 per cent of their liabilities (excluding capital) in Australia. From July 1993 to June 1995 a rate of interest was paid on these deposits equal to the average yield at tender in the previous month on 13-week Treasury notes. As a budget measure, the interest rate payable from 1 July 1995 has been set at 5 percentage points below this yield, effectively reverting to the formula which applied from 1989 to 1993. This measure is estimated to add $185 million to the Bank's profits in 1995/96, and thereby augment Commonwealth budget revenues by a similar amount.

The decision to pay the higher interest rate in 1993 related in part to a package of measures designed to improve the availability of bank finance for small businesses. That situation has improved in a number of respects over recent years, and the budget change to NCDs will not detract from that improvement. The below-market interest rate on NCDs can be viewed as being in the nature of a payment for the benefits which accrue to banks from being authorised by the Government and prudentially supervised by the Reserve Bank.

Legal actions and judicial inquiries

The fall in asset prices in the late 1980s and early 1990s saw many financial institutions record large losses, particularly on exposures related to commercial property. In several cases, these losses led to the establishment of Royal Commissions and judicial and other inquiries by various State governments. In addition, a number of criminal and civil proceedings has been initiated by Commonwealth and State regulatory authorities, investors in various financial institutions, and others.

The Bank has been drawn into some of these inquiries and actions. It received some criticism in the now-completed inquiries into losses by Tricontinental and the State Bank of South Australia but did not contribute to any settlements of claims in legal proceedings involving the former. The Bank also remains entangled in a number of legal actions arising from the failure in 1990 of the Farrow group, including Pyramid Building Society. It has been joined to cases against the Victorian Government and others, while the Victorian Government is pursuing separate claims directly against the Bank for its losses arising from the Farrow group collapse. Mediation ordered by the Victorian Supreme Court on the two key groups of cases was unsuccessful. The Bank believes the actions against it are without foundation but it will be obliged nonetheless to engage in a costly defence of the claims.

Some of the issues raised in these legal actions were traversed in the Report of the inquiry by Mr Habersberger QC into the collapse of the Farrow group of building societies, which was released in December 1994. Mr Habersberger came to the view that the bulk of the responsibility for the collapse rested with Mr Farrow and Mr Clarke, the principals of the group. Several other parties, including the Victorian Registrar of Building Societies, the Government of Victoria, the external auditors and the Reserve Bank, were also named as sharing some responsibility.

For its part, the Bank was criticised for perceived inadequacies in its communications with the Victorian Government regarding the Farrow group, and for its failure to meet what were assumed to be its statutory responsibilities. The Bank does not accept these criticisms. It has never been responsible for the supervision of building societies. Nor did it have access to as much information as the Victorian authorities who were statutorily responsible for that supervision. Moreover, such concerns as the Bank did have were passed to the Registrar, who was appointed by the Victorian Government to supervise building societies in that State. The Bank does have a general responsibility to promote the stability of the Australian financial system, but its assessment throughout the period in question was (correctly) that the system was not at risk from any difficulties surrounding the Farrow group.

Other financial institutions

Under the Banking (Foreign Exchange) Regulations, dealers in foreign exchange in Australia require authorisation by the Bank. There are currently 75 authorised foreign exchange dealers (including 40 banks), one more than a year earlier. The same Regulations have been the basis for implementing sanctions in accordance with relevant Resolutions of the United Nations Security Council. Sanctions were introduced against Iraq in August 1990, the Federal Republic of Yugoslavia (Serbia and Montenegro) in June 1992, and Libya and Haiti in July 1994. In December 1994, sanctions were imposed against entities in the Republic of Bosnia and Herzegovina, while those imposed earlier against Haiti were lifted.

The Bank also authorises and supervises dealers in the short-term money market. During the past year, two dealers – Fay Richwhite Australia Limited and Colonial Mutual Discount Company Limited – ceased trading and surrendered their authorisations. This reduced the number of authorised dealers from ten to eight. Their role is planned to disappear altogether in mid 1996, as part of the move to a real-time gross settlement (RTGS) system. In the meanwhile, the Bank will continue to support the existing arrangements and the role of the authorised money market dealers in them.

Relations with other supervisors

The Bank maintains close and strengthening links with other regulators of financial institutions and markets, domestically and across international borders. In addition to their ongoing bilateral contacts, the main domestic regulatory agencies meet regularly in the Council of Financial Supervisors. The Council is a non-statutory body formed in 1992 to improve the overall quality and effectiveness of financial supervision and regulation in Australia. It is chaired by the Governor of the Bank and includes also the heads of the Insurance and Superannuation Commission (ISC), the Australian Securities Commission (ASC) and the Australian Financial Institutions Commission (AFIC).

Over the past year, the Council has focused on issues involved in the supervision of financial conglomerates. In common with many countries, financial conglomerates are becoming increasingly prominent in Australia – the largest 30 conglomerates currently control around two-thirds of the financial system's total assets. This trend has emphasised the need for the different regulators of the institutions within financial conglomerates to effectively co-ordinate their activities, and to minimise duplication and inconsistencies in regulation. Guidelines for co-ordinating the supervision of such institutions have been agreed. Impediments to the sharing of information between member agencies of the Council have been reviewed and, where necessary, members are examining changes to legislation under which they operate. Consideration also is being given to the appropriateness of holding company structures for financial conglomerates, and to gaps and overlaps in ASC and ISC requirements relating to financial products. Other topics considered at recent meetings have included derivatives and the national regulation of friendly societies and trustee companies. The Bank believes the framework of the Council, and the flexibility and relative informality of its operations, make it an effective body for co-ordinating supervisory issues in a rapidly changing financial system.

Bank officers liaise closely with their counterpart supervisors in other countries, and with the Basle Committee on Banking Supervision. Contacts are developed and strengthened in a number of ways, including through regional and international conferences and courses on prudential supervision, and visits to Australia by supervisors from other countries. In the past year, an officer of the Bank also completed a 12-month secondment to the US Office of the Comptroller of the Currency and another was seconded to the Bank of England.

Payments system

Reference was made in last year's Annual Report to work then under way with the Australian Payments Clearing Association (APCA) to strengthen Australia's deferred net settlement payments system. The focus at that time was on the development of a high-value Payment Registration and Electronic Settlement System (PRESS) aimed at limiting banks' exposures in the payments system and ensuring the timely settlement of high-value payments. It was envisaged that the PRESS system would be convertible to a real-time gross settlement (RTGS) system at a later date if this should be considered desirable. In a RTGS system, payments are settled progressively throughout the day, provided adequate balances are available in the Exchange Settlement Accounts which banks hold with the Reserve Bank.

In the event, the accumulation of new information has led to a decision to abandon the PRESS project. For one thing, the costs of tenders to build that system turned out to be a good deal higher than had been expected. This prompted a re-assessment of the earlier decision to support the strengthening of the deferred net settlement system, rather than move directly to a RTGS system. That earlier decision had reflected the then state of play internationally; it also reflected concerns on the part of the banks about the liquidity demands which could be imposed on them under RTGS. Since then, many more countries have opted for a RTGS system as the core of their payments arrangements, believing that system to give greater certainty to high-value domestic payments and to provide a basis for reducing settlement risk in foreign exchange markets. Moreover, as these systems have been developed, ways have been found to provide liquidity to markets without excessive financial or operational burdens for participants.

In light of these developments, the Bank in April outlined a proposal to implement a RTGS system for high-value payments which would be based on its existing settlement arrangements for Commonwealth Government securities, the Reserve Bank Information and Transfer System (RITS). The relative simplicity of the system's design and its construction on the existing RITS base suggested that it would be cheaper than the PRESS alternative. The Bank also sees considerable benefits in integrating the securities settlement operations of RITS with the Austraclear securities settlement system (FINTRACS). Discussions on this possible integration are under way with Austraclear, although the use of RITS as a platform for RTGS is not dependent on such an integration.

Following extensive discussions with banks, APCA and other relevant parties, the Bank confirmed its intention in July 1995 to proceed with the RTGS proposal based on RITS.

These decisions are of long-term significance for Australia. Secure and efficient payments arrangements are a vital but unseen part of the financial system. The Bank's initiative on RTGS reflects its particular responsibility to see that Australia's payments systems are up with world best practice. The Bank will be co-operating closely with the industry in reaching decisions on the detailed specifications and operations of the system; with the continued co-operation of the banks and other participants, the Bank expects that the RTGS system will be fully operational in 1997.

Moving to RTGS will require significant changes in banks' treasury operations, as banks will need to fund their Exchange Settlement Accounts throughout the day as they make and receive payments. This will be facilitated by the Reserve Bank paying interest at the prevailing cash rate on banks' overnight balances in their Settlement Accounts, and by providing a within-day repurchase facility to allow banks temporarily in need of Exchange Settlement balances to acquire them by selling government securities to the Bank for repurchase by the end of the day. The proposed changes also mean that the authorised dealers in the short-term money market will no longer have any special role to play.

The introduction of a RTGS system will make the need for legislative underpinning of multilateral netting arrangements less urgent in the case of high-value payments, but legislation is still needed to confirm the validity of netting in low-value retail payment systems. The Bank has been working with the Treasury, Attorney General's Department and APCA to formulate legislative proposals to protect multilateral netting in payments clearing systems approved by the Bank, thereby bringing certainty to longstanding practice in the banking industry.

Following a review of the Cheques and Payment Orders Act, the Government has decided to pursue amendments to allow credit unions, building societies and their industry Special Service Providers (SSPs) to issue their own cheques. At present, these institutions can offer cheque account facilities to their customers only through agency arrangements with banks. The Bank has indicated that, subject to appropriate prudential arrangements, it will permit SSPs to use their accounts at the Reserve Bank to settle building society and credit union obligations arising in the cheque-clearing system.

The Bank is following closely several proposals for the introduction of stored-value cards, which could function as a form of electronic currency for small-value purchases. These cards will have a far wider range of applications than existing stored-value cards, such as phone cards, and will incorporate a high level of security. They have the potential to displace other payments instruments – particularly cash – and thereby lower costs for banks, merchants and their customers. Trials to assess the acceptance, security and cost-effectiveness of the technology are under way overseas and in Australia. Central banks are understandably interested in these initiatives from a number of aspects, including the security of the cards and their potential for money-laundering; the financial integrity of potential issuers; and the possible longer-term impact of stored-value cards on the revenue governments currently earn on the issue of currency. The latter aspect would become a more substantial matter than it now is if stored-value cards were to displace conventional currency in a substantial way.

Consumer issues

The retail payments system is an integral part of economic life of all Australians. It is the main mechanism through which individuals transact with other individuals, businesses and governments. It comprises a wide range of payment instruments, including cheques, cash through ATMs and branch networks, and electronic transfers through EFTPOS and direct entry facilities.

In the regulatory era, when interest rates were controlled, banks competed for deposits by providing payments services at low or no charge to customers. Following deregulation, banks have moved towards explicit pricing of transactions and services on retail accounts, although these moves have been somewhat hesitant, not least because of community resistance to paying for services that were long perceived to be free. The services are not, of course, costless; if they are not paid for explicitly, they will be paid for in ways which are not immediately transparent, such as higher loan rates and lower deposit rates for other customers. In other words, the interest margins of banks are wider than they would otherwise be. This situation is changing as increased competition begins to bite into interest margins, putting more pressure on banks to recoup transaction costs directly through fees and charges. Explicit charges can also be seen as encouragement to customers to use their accounts more efficiently, such as using ATMs to replace more expensive over-the-counter transactions, and electronic transfers instead of cheques.

These developments have helped to focus public attention on access to the retail payments system. Consumer groups have argued that banking is an essential service and that banks have a social obligation to service disadvantaged members of the community free of charge. Banks generally have responded that efficiency and competition considerations warrant fees and charges which reflect the cost of offering services. The Prices Surveillance Authority (PSA), which was commissioned by the Government to inquire into matters of these kinds, released its report in July 1995. In brief, it did not support calls to require banks to provide a basic banking service at no cost to customers, arguing that market solutions which related charges to costs “will deliver appropriate outcomes for consumers”. The PSA was not convinced, however, that current pricing regimes accurately reflected costs, arguing that banks placed too much emphasis on account maintenance fees and not enough on transaction fees. The Bank also is of the view that pricing of bank services should broadly reflect costs, and if that should throw up real problems of a social welfare kind, then governments, rather than banks, are best placed to respond to such problems.

Consumer issues come to the attention of the Bank in a number of ways, including through direct approaches from disaffected bank customers, and from contacts with consumer and industry groups. The Bank is also represented on the board of the Australian Banking Industry Ombudsman Scheme, which seeks to provide a low-cost alternative to court action for resolving disputes between customers and their banks. The Australian Payments System Council (APSC), the Secretariat of which is supplied by the Bank, is charged with monitoring the implementation of Codes of Practice for banks, building societies and credit unions, as well as compliance with the Electronic Funds Transfer (EFT) Code. The APSC's initial report on the implementation of the Banking Code was submitted to the Treasurer in December 1994. The Council found that banks had made significant progress in implementing their Code; the adoption in full of that Code (and of the Codes for building societies and credit unions) has been held up by delays in the introduction into State parliaments of Uniform Consumer Credit Legislation, which overlaps some key areas of the Codes.