To the special guests and delegates to the 10th International Conference of Bank Supervisors I wish you a warm welcome to the conference and to Australia.
Your work is important for the future of this region, indeed for the future international financial system.
Your work is always important. We sometimes forget the importance of financial supervisors when things are running well. Like motor car maintenance, the mechanic is no less important because he has the engine running well, than if it is broken down.
But at this time we are facing repair.
As we are all aware, at the moment there is a high level of volatility on stock markets, financial markets and currency markets. We know in this region, apart from Australia and China, practically all the economies are in recession. We know there are economies where financial institutions are insolvent, and it is clear that emerging markets in Latin America and elsewhere are at risk. And the fragility in emerging markets now has financial implications in the worlds strongest economy, the United States.
International financial developments
These difficulties reinforce the need for sound, rigorous prudential supervision both in emerging and developed economies. A topic, which I know, is a central focus of your conference.
Intensive work is underway in various international forums to assist countries facing difficulties, to strengthen the operation of the international financial institutions, and to improve cooperation between them.
Earlier this month, the Special Meeting of Finance Ministers and Governors, or G-22, met in Washington at the time of the IMF and World Bank Annual meetings. The meeting received three working party reports which made a number of recommendations on increasing transparency and accountability; strengthening national financial systems; and resolving international financial crises. These reports provide a valuable roadmap for navigating the complex issues with which we must now deal.
Addressing these issues is central to guarding against shifts in market sentiment and contagion effects from policy weaknesses.
But we should not lose sight of some basics. Overall, capital flows to developing countries have had enormous benefits. They enabled stronger economic growth, rising living standards and pulled people out of poverty.
Overall, a market is the best way of introducing a lender to a borrower and of pricing resources between them.
Overall, price should allow for risk. And in financial transactions risk cannot be abolished.
But clearly in recent days severe problems have occurred. There was a mismatch between short term capital and long term investment. There was poor pricing of risk and a systemic threat which could have arisen from an unordered allocation of liability.
With the recent disclosure of the problems in the Long Term Capital Management Fund, it is clear that a significant financial position, on large financial gearings, with apparently little disclosure can pose significant problems to established sections of the financial system such as banks.
It illustrates one of the problems of financial supervision. With technological developments and financial innovation new institutions can emerge and bypass supervision. Supervision can end up looking at institutions whose business has been passed on. Supervisors can end up not just with new products but with new institutions offering them.
Strong national financial systems, infrastructure and policies
In 1996 Australia recognised the need to update the financial sector regulatory framework to keep up with the rapid pace of change in financial markets. Even then, our prudential framework was sound and in line with the Basle Core Banking Principles. However, the Government realised that Australia had to aim to lead worlds best practice and ensure that our regulatory system was flexible and responsive enough to accommodate further rapid change in the financial sector.
In 1996 the Government established the Financial System Inquiry (known as the Wallis Inquiry) to provide recommendations on appropriate regulatory arrangements that would best ensure an efficient, competitive and flexible financial system, consistent with financial stability, prudence, integrity and fairness.
The Inquiry reported in March 1997, and the Government announced its response to the recommendations in the same year. The changes came into effect on 1 July 1998.
In my remarks today I want to make some observations about the key findings of the Wallis Inquiry as I believe they pick up issues which are relevant to discussion occurring in groups like the G22 and the subject matter of this conference.
Australia first embarked on reform of the financial sector in the early 1980s when the Campbell committee recommended promoting efficiency in the financial system by deregulation of the banking sector, floating the Australian dollar and allowing the entry of foreign trading banks. The underlying philosophy of the approach was one of liberalising markets.
The more recent Wallis Inquiry found that while the overall system was sound, there was room for improvement in every area, and that further reform was required to respond to changes occurring in financial markets.
The main drivers of change identified by the Inquiry were technology and innovation in products and delivery of financial services.
Technological innovation has not only fostered innovation in products and delivery channels, but it has made global access to markets and products easier, and is allowing consumers to pursue lower cost more convenient means of accessing financial services. The use of electronic transactions is already widespread but will accelerate as the ease of use and security improves further.
Innovation in product design and distribution has blurred the boundaries between financial instruments and institutions. The traditional categories of banking, insurance and financial exchanges are breaking down and the system will have a progressively greater array of participants, products and distribution channels. The emergence of large conglomerates offering an array of services and often operating globally is likely to accelerate change. Changing customer needs and profiles drives the innovation.
The Governments reforms are aimed at providing responsive and flexible regulatory arrangements that encourage innovation and competition, so that the most efficient players offer the best prices and services within the overall objectives of financial system stability.
Another frequently observed global trend to which the regulatory system must respond is the shift from financial intermediaries. While disintermediation in credit markets has been limited to the larger corporate players, technological advances and lower information costs will help extend the reach of this financing technique to other groups.
Similarly, the trend towards securitisation will change the role of financial institutions. In Australia, securitisation has been limited to assets which have very low risk or which represent a homogeneous asset class, such as house mortgages, but now we are seeing securitisation being extended to other areas.
These trends are occurring across the world and need to be addressed by regulators and international financial institutions to ensure regulatory frameworks adapt and take account of any new risks.
The Financial Sector Reforms
Our own reforms, designed to ensure that our national system of financial regulation is world class for the benefit of consumers and business, consisted of:
- a new organisational framework for the regulation of the financial system, based on "Twin Peaks" of regulatory focus; and
- a variety of measures to improve efficiency and contestability in financial markets and the payments system.
Each dedicated agency is responsible for clear regulatory objectives across the financial system enhancing their accountability.
The Reserve Bank of Australia has been strengthened and its role focussed on the objectives of monetary policy, overall financial system stability, and the regulation of the payments system. The new Payments System Board within the Bank has been established with greater powers to ensure safety, greater competition and ease of entry into the payments system.
The new Australian Prudential Regulation Authority, or APRA, is a separate statutory body responsible for prudential regulation. It provides a single licensing regime not just for banks but a broad range of institutions, including the deposit taking institutions, life and general insurance companies, and superannuation funds. Neutral regulatory treatment (enhancing competition) and the maintenance of financial safety across all providers of similar deposit products will be achieved.
APRA will be able to assume control of financial institutions, which fail or are likely to fail, and has a range of other tools to manage early resolution of any failures. Existing depositor protection provisions have been retained and extended to all licensed deposit takers. This is the first peak of financial regulation prudential supervision.
Secondly, the new Australian Securities and Investments Commission focuses on market integrity, disclosure and other consumer protection issues. This is the second peak of regulation. The Commission brings together, under one organisation, responsibility for conduct and disclosure regulation which previously had been provided through a variety of agencies and which was inconsistent with the emerging structure of markets. This will achieve more effective and efficient disclosures, better regulation of securities and futures markets, and improve the coordination and extension of dispute resolution schemes.
Each regulatory agency has substantial autonomy and a clear charter of objectives. They have boards of directors or commissioners responsible for operational and administrative policies, and are accountable through me as Treasurer to the Parliament of Australia.
Close co-operation between the regulators is crucial and in addition to bilateral arrangements will be formalised through a coordinating body, the Council of Financial Regulators.
We recognise that it is not the role of regulators to eliminate financial risk. Their role is to allow financial markets to manage, allocate and price risk within a framework of disclosure and transparency so that consumers of financial services can assess the level of risk and reward they are willing to manage.
Prudential regulation should maintain safety while being sufficiently flexible to respond to financial sector developments, and should also be in accord with international developments and best practice. The reforms included a range of changes to encourage new entry and competition in the financial system by streamlining regulation, providing for new entry to the payments system and deposit-taking market and facilitating a wider range of corporate structures.
I have also established the Financial Sector Advisory Council, comprising financial sector representatives, to provide advice on financial sector developments and appropriate policies and undertake a review of the reforms in five years time.
In implementing these financial reforms, I believe we are putting in place not just a world class regulatory structure, but also a structure that includes a great deal of flexibility and a capacity to evolve as the structure of the financial sector changes over the years.
We have done this by not relying on heavy regulation, but by seeking appropriate market-based incentives that promote a balance of efficiency, competitiveness and stability.
Other countries are adopting a similar framework.
The underpinnings for financial system regulation
Sound prudential arrangements are not sufficient to ensure financial stability. Other core conditions as recognised by the Basle Committee on Banking Supervision, are: sound and sustainable macroeconomic policies; a well developed national infrastructure; effective market discipline; procedures for efficient resolution of problems in banks; and mechanisms for providing an appropriate level of systemic protection.
It is difficult to overstate the importance of these preconditions, especially in the light of events in the recent period. These preconditions are now receiving international attention.
Macroeconomic policies
The Australian Governments macroeconomic policy framework is also a leader in the policies endorsed in international forums. I note in particular that the work undertaken on transparency and accountability does not just apply to the financial sector regulation but to government policies in general and in this respect our approach is at the forefront of thinking on the fiscal and monetary policy transparency.
Australias monetary policy is set by the Reserve Bank with its focus on maintaining low inflation over the medium term. The Governor and I released a joint statement on monetary policy in 1996 to strengthen the policy framework by providing a clear statement of the nature of the relationship between the Reserve Bank and the Government, the objectives of monetary policy, and the independence of the Bank.
These included explicit mechanisms for ensuring transparency and accountability in the way policy is conducted. The Government and Bank have an inflation target and policy credibility has been enhanced by the clear recognition of the RBA's independent role in setting monetary policy. These initiatives have been widely welcomed and have resulted in a more open, transparent and accountable process.
The Government has also adopted a medium-term fiscal strategy of pursuing, as a guiding principle, the objective of underlying budget balance over the course of the economic cycle. Australias last three budgets have been framed against this strategy. Last financial year the Budget was in surplus. And the Governments efforts to ensure sound economic policies including maintaining the budget in underlying surplus over the medium term have been crucial in shielding the impact of the Asian economic crisis on the Australian economy.
A Charter of Budget Honesty, backed by legislation, is in operation and aims to improve fiscal outcomes by enhancing the transparency of and accountability for fiscal policy. In particular, the Government is required to set out its medium-term fiscal strategy in each budget, along with its shorter term fiscal objectives and targets. Full economic and fiscal outlook reports are required at the time of the budget, at mid-year and prior to elections.
Australia has for some time pursued a significant degree of transparency in the fiscal management at both the Commonwealth and State level. The Commonwealth Budget papers provide detailed information on budget outlays by portfolio, and provide estimates of expenditure, revenue, fiscal outcomes for the following four financial years.
Corporate law reforms
An effective legal and institutional framework for the regulation of financial markets and corporations is well recognised as a critical foundation for the efficient functioning of the economy and market confidence.
To complement the financial sector regulatory reforms, I have also embarked upon a strategic review of the laws regulating conduct and disclosure practices of corporations and financial institutions. The Corporate Law Economic Reform program seeks to modernise the law regulating fundraising, takeovers, directors duties, corporate governance, financial reporting and conduct and disclosure practices in financial markets.
The program seeks to ensure that Australias laws and regulation operate at best international practice and provides an appropriately safe and secure environment for investment. It will bring about improvements in the transparency of financial information and the accountability of participants in financial markets. This is a comprehensive initiative to improve Australias business and company regulation. It will modernize and harmonize our corporations law and will give it a more economic focus, so that business will be able to operate in the framework of much simplified and efficient regulation.
The reforms will enhance accountability and transparency as well as allow the industry to embrace the new technology for the benefit of business and consumers alike.
Australias initiatives in this area are designed to attain world best practice and are also consistent with the policies advocated in the G22 meeting. The philosophy behind our reforms was of minimal regulation of markets with appropriate protections in place, while encouraging the development of efficient and competitive markets. While each country represented here is likely to have different priorities and circumstances, I am sure there is broad consensus on the overall objectives.
The future - need for flexibility and review
Your conference takes place at a critical juncture in the management and development of financial systems throughout the world.
We need to ensure that our prudential systems attain best practice and are vigorously applied. This conference, with its review of the implementation of the Basle Core Principles and discussion of emerging issues in operational risk, is very much a part of the current international initiatives to strengthen financial systems.
However, we also need look ahead and ensure that our approaches can encompass new trends and developments and any areas of potential risk. This, I suspect is work that is never finished. It is important work. It will shape our countries and the lives of our citizens.
May I urge all of you at this conference to continue your discussions with renewed vigour, and to ensure that the quality of your supervision continues to improve so our financial systems are strengthened in support of the economic development so important to the living standards of those we serve.