Bank Regulation in Australia Essay Example

including the assessment of total capital requirements and a review of capital levels. 3. Pillar 3 – achieving market discipline through disclosure of information to the supervisor which may be made public. Implications of meeting the minimum capital adequacy requirements – Pillar 1 Banks must meet the capital adequacy requirements (meet a minimum risk based capital ratio of 8%) in order to engage in risky loans sufficient enough to cover their losses.If capital is low therefore, they should be cautious when lending to its obligors.

Banks, particularly Bear Sterns, have worked around the boundaries of Pillar 1 of the Basel 2 accord by implying a strategy where they can increase their riskiness and extend their credit with the insurance of government central banks. By exposing themselves to more ‘credit risk’ by making risky loans to its customers to increase profitability in turn becoming ‘insolvent’ as soon as loans begin to default and housing prices decrease such as the current sub-prime mortgage crisis.This mis-match of liquidity by banks has made Banks vulnerable to cash squeezes which is damaging to the economy causing instability and high interest rates. The central bank therefore ultimately have to intervene to meet the demands of ready cash from the banks’ limited capital. A secure deposit base under Deposit insurance, which is not offered in Australia, is another strategy implemented by banks to take on more risk without regulatory constraint. Regulation needs to be reviewed when calculating their capital adequacies and measure all types of risks accordingly to prevent failures and banks relying on central banks as ‘safety nets’.

Implications of providing a supervisory review process – Pillar 2 Bank supervisors are expected

to intervene and assess how well the bank actually assesses its capital needs relative to the level of risk. The supervisors of Bear Sterns failed to assess the risky, fraudulent lending under a deregulated financial market. Supervision was below Bear Sterns risk bearing activities and banks failed to internally assess their capital adequacies which allowed banks to operate risky lending activities.Supervisors in banks have failed to assess the banks’ liquidity position over the economic cycle to ensure whether banks had enough liquidity in the future.

The vulnerability of banks makes them candidates for supervision because in times of panic, depositors will have an incentive to withdraw their cash. If people suddenly need cash, then banks will not be able to supply them at an affordable price. The review process for banks therefore should be regulated more heavily at measuring and managing risk exposures to identify capital adequacies below the minimum.Implications of achieving market discipline – Pillar 3 Achieving market discipline is difficult if banks fail to develop a set of disclosures that allow market participants to assess important information regarding its capital adequacy. A lot of market participants would not have been well informed about all the risk bearing activities made by Bear Stearns and other banks as the disclosure of all information would raise concerns of stability and confidence in the financial system, which may prevent such activities from happening.

Market discipline however must add to the effectiveness of supervision and disclosing information provides a stronger basis for the role markets can play in identifying risk exposures. Why regulation is likely to change in the future It is apparent that the rescue of Bear Sterns

and other market failures signals deregulation of banks in today’s capital markets. If deregulation remains, then banks will continue to exploit the central bank as saviours in times of crisis.Basel 2 undergoes the risk capital framework but there needs to be stricter regulations about provisions for funding shortages.

Regulations need to be put in place to ensure credit risk is not transferred to the central bank and to prevent moral hazard from occurring. Some reform on the regulatory process which requires institutions to pay for protection they receive from central banks should be implemented otherwise investors will continue to resist regulation of capital requirements and liquidity.Evidently there is inadequate regulation response to insufficient capital within the Basel 2 framework and banks are operating strategically to avoid regulatory constraints in order to profit from greater risks. The downside is that deregulated markets will spawn market failures and regulation needs to be updated and consistent with the ever changing demands of the economy. References: Viney, C.

, (2006) Financial Institutions, Instruments and Markets 5th ed. McGraw Hill Wolf, M. ‘The Rescue of Bear Sterns marks liberalisations limits’ Financial Times, March 25 2008. ‘When to bail out’, the Economist, October 4, 2007