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The Australian Banking Sector Reforms: Progress and Challenges

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The Australian Banking Sector Reforms: Progress and Challenges Corporate Ownership & Control / Volume 10, Issue 4, 2013, Continued - 5 THE AUSTRALIAN BANKING SECTOR REFORMS: PROGRESS AND CHALLENGES Sheilla Nyasha*, N M Odhiambo** Abstract This paper gives an overview of the Australian banking sector; it highlights the reforms since the 1970s; it tracks the growth of the banking sector in response to the reforms implemented over the past five decades; and finally, it highlights the challenges facing the Australian banking sector. The country’s banking sector consists of more than 60 commercial banks, with the Reserve Bank of Australia, the country’s central bank, at the apex. Since the 1980s, the Australian government has implemented a number of banking sector reforms in order to safeguard and improve the banking sector. The response to these reforms by the banking sector has been varied. As a result of these reforms, there has been an increase in the number of banks and a decrease in the number of building societies and credit unions. There has also been an improvement in the central bank’s oversight of the financial institutions, and an enforcement of the banks’ capital-adequacy requirements. Currently, Australia has one of the most developed banking systems in the world. The country has enjoyed a substantial bank-based financial sector development over the years, and its institutional framework has also grown stronger. However, like any other country’s financial system, the Australian banking system still faces wide-ranging challenges, such as bank concentration and exposure. Keywords: Australia, Reserve Bank of Australia, banking sector, reforms *Corresponding author. Department of Economics, University of South Africa, P.O Box 392, UNISA, 0003, Pretoria, South Africa Email: [email protected] **Department of Economics, University of South Africa, P.O Box 392, UNISA, 0003, Pretoria, South Africa Email: [email protected], [email protected] 1 Introduction sample of more than 80 countries. Levine (1999) and Levine, Loayza, and Beck (2000) confirm this The role of banks in economic development is widely finding. acknowledged in the literature. In particular, The endogenous growth literature also supports Schumpeter (1911) put the role of financial the argument that financial development has a intermediation at the centre of economic positive impact on growth (Bencivenga and Smith development. He argued that financial 1991). Well-functioning bank-based financial intermediation, through the banking system, plays a systems are able to mobilise household savings, to pivotal role in the economic development; and it does allocate resources efficiently, to enhance the flow of this by affecting the allocation of savings, thereby liquidity, to reduce information asymmetry and improving productivity, technical change and the rate transaction costs, and to provide an alternative to of economic growth. Additionally, banks play a raising funds through individual savings (Bencivenga central role in the development of every economy by and Smith, 1991). In the light of these functions, it mobilising resources for productive investments, and may confidently be stated that banks have a positive by being the conduit for the implementation of impact on growth. monetary policy (Sanusi, 2011). In Australia, the bank-based segment of the In support of the importance of banks in the financial sector plays a crucial role in both financial- economic growth of a country, Boyd and Prescott sector development and economic development. (1986) model the critical role that banks play in Australia’s banks offer a wide range of financial easing information frictions and therefore in services to individuals and businesses and play an improving resource allocation, while Stiglitz (1985) important role in the economy (Australian Bankers’ and Bhide (1993) stress that stock markets will not Association, 2013). The banking system ensures the produce the same improvement in resource allocation efficient allocation of resources in the Australian and corporate governance as banks. In a separate economy, through lending to businesses and study, King and Levine (1993) show that bank individuals. Banks facilitate business through the development helps to explain economic growth in a settlement of funds and the provision of credit to 469 Corporate Ownership & Control / Volume 10, Issue 4, 2013, Continued - 5 consumers. They provide 24-hour access to funds and Netting Act 1998 and Corporations Act 2001. and facilities, thereby enabling institutions and The Bank is a statutory authority, established by an individuals to save and invest with safety. Act of Parliament, the Reserve Bank Act 1959, Additionally, banks in Australia value the which gives it specific powers and obligations. In communities in which they find themselves and are terms of the Act, there are two Boards: the Reserve committed to giving something back to those Bank Board and the Payments System Board communities. Every year, community organisations (Reserve Bank of Australia, 2013). receive millions of dollars of direct support from The Reserve Bank Board’s obligation is to banks in various forms. The industry also has a ensure that the monetary and banking policy of the strong tradition of free education in financial skills Bank is directed to the greatest advantage of the and in 2003 embarked on a major new initiative in people of Australia and that the powers of the Bank financial literacy (Australian Bankers’ Association, are exercised in such a manner as to best contribute 2013). to the stability of the currency of Australia. The Although Australia has one of the most Payments System Board’s obligation is to ensure that developed financial sectors in the world, its financial the Bank’s payments system policy is directed to the development, as in other developed countries, is greatest advantage of the people of Australia, and largely driven by the market-based segment. Thus the that the powers of the Bank under the Payment market-based financial segment tends to overshadow Systems (Regulation) Act 1998 and the Payment its bank-based counterpart. Despite the important role Systems and Netting Act 1998 are exercised in a way banks play in the economic development of that will best contribute: to controlling risk in the Australia, the Australian banking sector has not financial system; to promoting the efficiency of received adequate coverage in terms of research. Not payments system; and to promoting competition in much has been documented on the bank-based the market for payment services, consistent with the segment of the financial sector in Australia, except overall stability of the financial system (Reserve for fragmented policy documents and a couple of Bank of Australia, 2013). papers, which fall short of bringing out a clear The history of the RBA dates back to as early as picture of such an important segment (Thomson and 1911 when legislation established the Abbott, 2000; Merrett, 2002; Neal, 2004; Kirkwood Commonwealth Bank of Australia, which opened for and Nahm, 2006; Hogan and Sharpe, 2007; Gray, business in mid-1912. With the Federation of the 2008). This paper aims to put the Australian banking Australian States into the Commonwealth of sector in the limelight – by providing an overview of Australia, the Australian Parliament assumed power the country’s banking sector, its reforms, growth and to make laws with respect to banking and currency. challenges since the 1970s and through to 2010. The first Commonwealth Bank Act, in 1911, gave the The rest of this paper is organised as follows: Bank only the ordinary functions of commercial and Section 2 gives an overview of the Australian bank- savings banking. The Bank did not specifically have based financial system. Section 3 outlines the a central banking remit and it operated as both a reforms implemented to revitalise the banking sector. savings and a trading bank (Merrett, 2002). Section 4 tracks the growth of the Australian banking In 1924, the Commonwealth Bank Act was sector, in response to the reforms. Section 5 amended and the Bank was given control over the highlights the challenges facing the development of note issue. From this time until 1945 – when there the Australian bank-based financial sector. This is were major changes to the legislation – the Bank followed by the concluding section. gradually evolved its central banking activities, initially in response to the pressures of the depression 2 An Overview of Bank-Based Financial in the early 1930s and later by formal, albeit System in Australia temporary, expansion of its powers under wartime regulations. These included exchange control and a The Reserve Bank of Australia (RBA) is Australia’s wide range of controls over the banking system central bank. It conducts monetary policy, works to (Reserve Bank of Australia, 2013). maintain a strong financial system and issues the The new Commonwealth Bank Act and the nation’s currency. As well as being a policy-making Banking Act, both of 1945, formalised the Bank's body, the RBA provides selected banking and powers in relation to the administration of monetary registry services to a range of Australian government and banking policy, and exchange control. In 1959, agencies and to a number of overseas central banks the Reserve Bank Act 1959 preserved the original and official institutions. It also manages Australia's corporate body, under the new name of the Reserve gold and foreign exchange reserves (Reserve Bank of Bank of Australia, specifically to carry on the central Australia, 2013). banking functions of the Commonwealth Bank, The role and functions of the Reserve Bank are which had evolved over time. The Reserve Bank Act underpinned by various pieces of legislation, which 1959 took effect from 14 January 1960 (Reserve includes the Reserve Bank Act 1959, Payment Bank of Australia, 2013). Systems (Regulation) Act 1998, Payment Systems 470 Corporate Ownership & Control / Volume 10, Issue 4, 2013, Continued - 5 There were no major changes in the functions of of services they could offer. Above all, they were not the RBA until the abolition of Exchange Control, allowed to call themselves ‘banks’ (Australian following the floating of the Australian dollar in Bankers’ Association, 2012).
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