Exam 2: The Financial Service Industry: Depository Institutions

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The maintenance of high lending standards and risk conservatism during the 2000s was one of the reasons why the Australian economy generally was less impacted by the GFC than many other countries.Despite the changes in structure of the banking industry, the Australian banks' performance during the GFC was relatively good compared to global markets.Some features that prevented excessive risk-taking by Australian financial institutions include the following:
a.Internal governance characteristics are one possible factor.Inherent conservatism induced by memory of the banking crisis at the start of the 1990s may have been another, inducing lower risk lending and limiting exposure.
b.External influences may also have been important influences upon risk-taking.For example, deposit and debt markets could have exerted discipline against excessive risk-taking, if depositors believed that their funds were at risk and subordination of debt holder claims due to depositor preference increased monitoring.
c.Another external influence is regulation and strong prudential supervision.The 'twin-peaks' model adopted just prior to the start of the decade created a specialist prudential regulator (APRA) and a specialist corporate, markets and financial services regulator (ASIC).Such specialisation may have facilitated more effective prudential regulation and prevention of excessive risk-taking.Also, with the collapse of the major insurance company HIH at the start of the decade, a tougher approach to prudential regulation was induced.
d.Another factor may have been the overall structure of financing in the economy.With (major) Australian banks borrowing extensively offshore (helping to finance Australia's current account deficit) and able to profitably use those funds for housing and other domestic lending, there were limited incentives to invest in ultimately 'toxic' assets and have very limited involvement in securities trading on their own account and consequently did not have material holdings of assets (such as collateralised debt obligations) that caused large asset write-downs by many large international banks.