AUSTRALIA'S FINANCIAL SYSTEM
Australia's Banks Sturdy, Closely Connected
IMF Survey online
November 15, 2012
- Four major banks dominate the financial system
- Oversight and supervision of risks is effective
- Reforms needed to improve supervision of banks’ liquidity risk management, stress testing
Five years after the global economic crisis, Australia’s financial sector continues to outperform most of its peers, but the country will need to manage risks from a combination of high household debt and house prices, reliance on funding from overseas, and a highly concentrated and interconnected banking system.
Australia is a member of the Group of Twenty advanced and emerging economies and among the world’s largest commodities exporters. Australia takes over the rotating presidency of the Group of Twenty in 2014.
The country was one of the few advanced economies to avoid a recession during the global crisis, and stress tests by the government and the IMF show the banking system is likely to withstand severe shocks.
The IMF said the financial system is sound, resilient and well managed.
“The government’s timely response to the fallout from the global crisis, their prudent economic management, and strong supervision of the financial sector has kept Australia on the dwindling list of AAA rated countries,” said Cheng Hoon Lim, a division chief in the IMF’s Monetary and Capital Markets Department and head of the team that conducted the assessment.
The IMF assessment said the global outlook remains uncertain and Australia’s financial sector is not immune to volatile global markets. The country’s financial system has assets more than three times the size of GDP.
Four large banks dominate Australia’s financial sector, which have similar business models and rely on wholesale funding, such as interbank loans and covered bonds. Residential mortgages are banks’ single largest asset, and a combination of high household debt and elevated house prices increases the risk in this portfolio. Other potential risks identified by the IMF are:
• Banks rely on funding from outside the country, and with the crisis in Europe and the global economy suffering, these funding sources are volatile.
• Four major banks dominate the banking system, and they share many similarities that can be a cause of risk spreading from one to another in the event of a crisis.
In the wake of the crisis, the IMF has strengthened its surveillance of countries’ financial systems. Since 1999 the IMF has monitored countries’ financial sectors on a voluntary basis through a joint review process with the World Bank called the Financial Sector Assessment Program.
Australia is one of the major 25 financial sectors that must undergo a review of its financial health as part of the IMF’s surveillance. The global economic crisis laid bare the devastating economic consequences a financial crisis in one country can have on the global economy. Countries with financial sectors that have the greatest impact on global financial stability have been required since 2010 to undergo in-depth reviews of their financial health every five years.
In its assessment of the health of Australia’s financial system, the IMF recommended the government enact a series of reforms, including the following:
• Improve stress testing to enhance the country’s ability to identify and monitor risks to the system as a whole, and devote more resources to stress testing.
• The four major banks are systemically important which means difficulties in any one of them would have severe repercussions for the financial system and the economy. A higher minimum capital requirement would provide a bigger cushion against potential losses.
• Strengthen the supervision of the banks by improving their oversight of bank liquidity risk.
The IMF said the government has an effective system in place to coordinate the oversight of the financial system, the Council of Financial Regulators, which could publish a report of its deliberations to enhance the transparency of its process.
Australia’s last assessment under the program was in 2006, and the IMF said the steps taken since then to strengthen the financial safety net and crisis management are impressive. A key priority for the years ahead should be to enhance crisis preparedness through early planning and to introduce an already funded deposit insurance system.