Submission to the Financial System Inquiry Appendix D: International Framework of Bank Supervision

  1. Much of the supervisory architecture in Australia is of fairly recent origin, and has been shaped in the full knowledge of international best practice. Finance must rank with telecommunications and air travel among the most international of industries. Australian financial institutions operate in a growing number of countries (for example, ANZ operates in 43 countries). A large number of foreign financial institutions operate in Australia (27 banking groups are foreign owned, a further 36 merchant bank groups have parents who are banks in their home countries, and 23 life insurance companies are foreign-owned). The supervision and regulation of the finance industry is as international as the industry itself. There are well-regarded and well-functioning international groupings of supervisors in each of the banking, securities and, more recently, insurance businesses. The constant refrain from the international conferences organised by these bodies over the past decade has been the need for harmonisation, co-operation and co-ordination.
  2. In the area of banking supervision international harmonisation has been guided by the Basle Committee on Banking Supervision. This Committee was established by, and reports to, the Governors of the central banks of the G10 countries; its permanent Secretariat is located at the Bank for International Settlements in Basle, Switzerland. The Basle Committee's 1975 Concordat stated the principle that all international banks should be subject to effective consolidated supervision, and set out the division of responsibilities between home and host country supervisors. The Committee is probably best known, however, for its 1988 guidelines on the measurement and minimum levels for bank capital. These were developed to underpin a concerted response to the secular decline in bank capital. The definition of capital (Tier 1 and Tier 2 capital), the concept of risk weights which differentiated between broad classes of assets according to risks, the inclusion of off-balance sheet risks in the framework, and the 8 per cent minimum requirement, have been adopted by supervisors all around the world.
  3. The original intention of the Basle Committee had been to produce a common capital standard for all internationally operating banks, but most countries adopted the BIS standards for all of their banks. It is not much of an exaggeration to say that it is no longer possible to be a bank and have a BIS capital ratio below 8 per cent. Close consultation between banking supervisors has meant that a reasonable degree of uniformity has been achieved in the implementation of the BIS capital regime. In Australia, it has been applied to all banks and also to building societies and credit unions.
  4. In recent years the international banking community has agreed that the 1988 capital accord should be extended to capture the market risk in banks' trading activities. The design of the capital regime for market risk has involved consultation between international groups of banking and securities supervisors, consultation with groups of banks and consultation and opportunity to comment for non-G10 supervisors like the RBA. In other words, a gigantic effort has been made over half a decade to come up with a system which, by its acceptability to the broad sweep of banking supervisors around the world, would ensure that the status of the BIS capital ratio as the global benchmark for a bank would be retained.
  5. The Basle Committee over its twenty-year history has produced work on most aspects of banking supervision – restrictions on concentrations of risk/large exposures, liquidity management, risk management systems for derivatives, to name just a few. There is a global orthodoxy for the methods to be employed in supervising a bank. It is normal for the authorities to have requirements about who can own a bank, who can manage a bank, how much capital it needs, how much liquidity, how big a single exposure it can have, how much information it has to publish and how much it must report to the regulatory authority.
  6. The RBA has been a keen contributor to the international development of the techniques of bank supervision. While Australia is not a member of the G10, the RBA maintains close links with the Basle Committee on Banking Supervision through its membership of the BIS. At each stage of the development of the common standards for imposing a capital requirement for market risk, Australia has made a comprehensive submission to the Basle Committee.
  7. The Basle Committee has continued to aim for the implementation of effective supervision for all international banks. In 1992, it released Minimum Standards which contained four main principles:
    • All international banks should be supervised by a home country authority that capably performs consolidated supervision.
    • The creation of a cross-border banking establishment should receive the prior consent of both the host country and the home country authority.
    • Home country authorities should possess the right to gather information from their cross-border banking establishments.
    • If the host country authority determines that any of these three standards is not being met, it could impose restrictive measures or prohibit the establishment of banking offices.
  1. The International Conference of Banking Supervisors in Stockholm in 1996 adopted a paper designed to strengthen the implementation of these principles. As implied by the second Minimum Standard, supervisors in host countries increasingly apply pressure on home country supervisors of banks wishing to expand internationally, to adopt internationally accepted approaches. The most notable example of this is the US, where the Federal Reserve rates the ability of a foreign head office to provide support to its US operations; this includes giving a specific rating to the quality of bank supervision in the home country. In Australia's case, US supervisors visit the RBA annually as part of their assessments. Similarly, the Bank of England has felt obliged to make assessments of the soundness of international banking groups with a presence in their country, taking into account the quality of home country supervision. In short, there are great pressures for countries to conform to international norms in supervision.
  2. Nevertheless, not all supervision policy reflects international agreements. In some areas such as definitions of impaired loans, and bank involvement in funds management and securitisation, the RBA has produced prudential guidelines without clear international precedents. This reflects a reaction to Australian experience with bad debts in the early 1990s, growth in banks' involvement in funds management and interest in securitisation.
  3. In the area of securities market and insurance industry regulation, harmonisation has not been as successful as in banking but strong efforts are now being made through international bodies of supervisors. Australia has played a prominent role in the growing status of both IOSCO and, more recently, in the IAIS.
  4. The trend towards conglomerate structures, which include banks, insurance companies and investment houses has not been restricted to Australia. Concern with the need to develop a consistent approach to the supervision of financial conglomerates is an international one. The Basle Committee, IOSCO and IAIS have formed a Joint Forum on Financial Conglomerates to develop internationally agreed standards for supervising such groups. Through the ISC and the ASC, Australia has two seats of twenty eight on the Forum. Its work is described in Appendix E.
  5. The Joint Forum's mandate does not extend to reviewing the approaches of the banking, securities and insurance supervisors to the companies within their jurisdictions. The international community will, therefore, continue to think in terms of separate supervision for the banking, insurance and securities arms of a conglomerate. This illustrates that the need for a level playing field internationally for each of the banking, insurance and securities businesses, may be at least as powerful as the demands for a level playing field between the three different classes of financial institution domestically.