On 21 November 2012, the IMF released a series of reports relating to the state of Australia’s financial system. The reports found that Australia generally complies with most important international financial standards. However, there is room for improvement, and most reports outline methods by which Australian can build a more resilient financial system.

Many of the IMF’s concerns related to the concentration of Australia’s banking and financial system, particularly around the Big Four banks. This is a familiar theme from the IMF. On 15 November, 2012 the IMF released a report titled “Australia: Financial System Stability Assessment”, (November Report) which argued that Australia complies with most international financial standards but suggested that the overwhelming market dominance of the ‘Big Four’ of the National Australia Bank, Commonwealth Bank, Westpac and ANZ, means that these institutions should possibly hold more capital to further bolster financial system stability.

The concept of increased capital from the November Report was met with hostility from the Big Four and Australian regulators. Australian Prudential Regulation Authority chairman John Laker and ANZ's John Morschel rejected the finding, and Westpac's Lindsay Maxsted warned the banking industry risked becoming globally uncompetitive if there was a further increase in capital requirements. Westpac chief executive Gail Kelly stated that a higher capital threshold is not required given that Australia’s banks are “amongst the most highly capitalised banks in the world”.

The hostile response to the November Report suggests that the Big Four may be uneasy about the emphasis on market concentration that the IMF has placed in the reports, particularly when this emphasis is applied to these banks. This piece summarises the basic findings of each of the IMF’s report.

Australia: Financial Safety Net and Crisis Management Framework—Technical Note (Technical Note)

The Technical Note commented that Australia has a history of few bank failures, even fewer financial crises, and its banking sector emerged from the global financial crisis relatively well. Furthermore, the Government has taken effective measures to improve the resilience of the financial system over the past few years. This resilience could be improved through implementing recommendations relating to crisis preparedness, financial claims scheme, crisis management and resolution of systemically important banks, crisis management and resolution of systemically important banks, and cross border resolution and crisis management.

Australia: Addressing Systemic Risk Through Higher Loss Absorbency— Technical Note (Absorbency Note)

The Absorbency Note focused on the Big Four. Like in the November Report, the IMF emphasised that the Big Four can be considered domestically systemic because they make up the lion’s share of the banking system, use similar business models, and are interconnected. A key statistic supporting the contention that Australia’s banking system is much more concentrated than most other countries, is that the Big Four accounting for almost 80 percent of resident assets. Some smaller banks may be regionally important, but their activities can relatively easily be taken over by the rest of the banking system, subject to competition policy requirements.

The four-way concentration was due the Australian Government’s Four Pillars regulatory policy, which bans mergers between the Big Four. The concentration may be even higher if this policy was removed as the banks may begin to swallow each other up. The Absorbency Note applied a series of highly technical material to Australia to develop a range of estimates of higher loss absorbency requirements for systemic institutions and a transparent framework for discussion and selection of these requirements.

Australia: Insurance Core Principles—Detailed Assessment of Observance (ICP Assessment)

The ICP Assessment dealt with Australia’s observance of the Insurance Core Principles (ICPs) issued by the International Association of Insurance Supervisors (IAIS). The ICP Assessment found that Australia’s insurance industry weathered the global financial crisis well, in part due to effective co-ordination of Australian supervisors through the Council of Financial Regulators. Much of the report then focused on the concentration of the insurance industry, particularly in the life insurance industry. Like the Absorbency Note, the ICP Assessment also commented that the Big Four banks continue to dominate the Australian wealth management markets partly through wholly owned life insurance subsidiaries.

Australian authorities have made significant progress in updating the insurance regulatory regime since the 2006 FSAP, including broadening the enforcement powers of APRA; restrictions on unauthorized foreign insurers; and clarifying the Treasurer‘s role in supervisory matters. This updated regulatory framework has a high level of observance with the ICPs. Crucially, APRA has adequate supervisory resources and technical capacity to conduct effective supervision. The effectiveness of the current regulatory regime and supervisory approach could be improved through, for example, broadening the Australian Securities and Investment Commissions’ (ASIC) legal power in ensuring fair treatment of customers, e.g., group-wide market conduct requirements, claims handling practices; servicing of life policies; and requiring insurers to take accounts of interests of different types of customers during product development.

Australia: Basel Core Principles for Effective Banking Supervision— Detailed Assessment of Observance (Basel Assessment)

The Basel Assessment stated that the growth of Australia’s financial system in recent years is due particularly to the increase of home mortgages and superannuation funds. Like with the Absorbency Note and ICP Assessment, a main concern of the Basel Assessment was that Australia’s financial system is relatively concentrated: authorised deposit taking institutions, mostly banks, are the dominant group of financial institutions with 60 percent of financial sector assets, followed by superannuation funds. This centration creates most of the main risks in the industry, particularly due to the overwhelming dominance of the Big Four banks.

The Basel Assessment found that Australia has a very high level of compliance with the Basel Core Principles for Effective Banking Supervision (BSPs). This is particularly due to responses made by Australian authorities in response to the global financial crisis. For example, APRA has intensified its supervisory practices and moved to an early, and conservative, adoption of key aspects of the international regulatory reform agenda, especially the Basel III capital and liquidity framework.  Australian authorised deposit taking institutions have been increasing regulatory capital in advance of the implementation of Basel III from 2013. The Basel Assessment found that the Australian banking system weathered the global financial crisis better than most countries, due to the relative concentration of the system on a well performing domestic economy, and the country’s well-developed regulatory and supervisory structure, including the reforms above.

The Basel Assessment contained some suggestions for ensuring that APRA will be able to act in a fully effective and efficient manner should weaknesses emerge within the banking system such as ensuring “unambiguous independence within APRA”. In addition, the Basel Assessment suggested that APRA’s Risk Management and Audit Committee be split in two and that membership of the new audit committee be comprised solely of external members.

Australia: IOSCO Objectives and Principles of Securities Regulation—Detailed Assessment of Implementation (IOSCO Assessment)

The Assessment considered the level of Australia’s implementation of the International Organization of Securities Commissions Principles (IOSCO Principles, using the version approved in 2010 and the methodology updated in 2011). Overall, the Australian legal and regulatory framework for securities markets exhibits a high level of compliance with the IOSCO Principles. However, there are some shortcomings in Australia’s regulatory structure. For example, inadequate independence and resources for the Australian Securities and Investments Commission (ASIC), impairs its ability to discharge its supervisory functions adequately and effectively across the entire regulated population. ASIC will need to continue to further develop the work of the Emerging Risk Committee, and should devote resources to supervision to complement the current enforcement efforts and to add to their deterrent effect. 

The regulatory framework and supervisory practices for collective investment schemes need to be improved to comply with the IOSCO Principles. ASIC has recently expanded its supervisory activities on hedge funds, but is constrained by lack of powers on wholesale hedge funds and on cross-border supervisory cooperation.

Conclusion

Taken together, the IMF reports paint a relatively positive picture of Australia’s financial system. Politicians and regulators appear to have helped Australia to comply with most of the key international standards issued by important institutions such as Basel, the IAIS and IOSCO.

The ongoing concentration of Australia’s banking and financial system remains a concern for the IMF, particularly as this concentration applies to the overwhelming dominance of the Big Four banks.  It is unlikely that fundamental reform will occur as a result of the IMF’s reports. The Big Four would lobby hard against any chances, given each institutions’ high profitability. And this profitability stetches back a long way: no Big Four bank has posted a full-year loss in two decades. Previous comments relating to the November Report suggest that the IMF, Australian regulators and the Big Four banks are unlikely to agree on this point any time soon.