FINM3006 Week 2 (1)

If monetary policy doesn't work anymore what incentive do you have.'QE' Increased money supply by the purchase of existing assets (bonds, securities). US beginning to unwind purchases and reduce the money supply (speed at which money supply in entering)-> interest rates increase in US-> capital flows start shifting into US and emerging countries are concerned that capital flows may move too fast out of their countries.

One key issue is how much banks fund from wholesale markets. In the GFC wholesale markets crashed. Our four big banks. Concern is if wholesale market seizes up, banks may suffer greatly and not able to refinance

Initiatives from Rudd government->allows smaller banks to enter wholesale market and let big four banks to enter wholesale market and borrow with a written promise from the government (meaning they could borrow with AAA rating)

Foreign banks focus on commercial banking and capital market activities. This means competition is increased (good for consumers)Larger banks have more diversification in assets, small institution has large amount in mortgage lending.If you take deposits (ADI) you must hold license and be regulated by APRA.  Our banking industry is very concentrated by the big 4 banks.

Difference between building societies, credit unions and banks?The first two are known as mutuals and member owned and in principle are not for profit. So if you held an account with them then you are actually a shareholder as well. (Banks->not owner even if you hold deposit)Usually special bond between members with credit unions (not so much these days). THey are very small compared to our big banks. Went through process of de-mutualisation where they converted to banks

Big four banks have more wholesale funding and larger amounts of other types of firms and BS and CU don't have much wholesale and are more housing loans. Historically they had an advantage with lending because banks interest rates were regulated-> making them competitive with price but after de-regulation and removal of interest rate ceiling then the two became much less competitive and became banks.

Mutual ADIs has a different ownership structure, liabilities structure is slightly different. THere are non-deposit taking finance companies that still provide lending services. *Shadow banking*

The Australian Banking Industry- Competition Government has sought to change structure of banking industry via new policies. In 2010 treasury announced reforms (A Competitive and Sustainable Banking System) of three streams across banking system1. Empower consumers to get a better deal2. Support smaller lenders to compete with big banks (THey didn't realise that with increased competition price will come down and profits will come down which will reduce the banks' charter value. When you allow banks to operate at very low levels of equity they don't have much to lose in the event of failure and risk will be increased)3.Secure the long term safety of sustainability of our financial system

The Australian Banking Industry-ReformGovernment banned exit mortgage fees, now you can switch banks or lenders without cost-> fostering competition because it will encourage banks to try and keep consumers happy with lowering rates. However, the problem with this is the small lenders don't have access to wholesale funding which is cheap so they can't compete on price (since they can't charge exit fees hence ability to fund themselves)Government introduced portability- wanted it to be easy for individuals to port deposits and reduce the paperwork involved and so if banks know that it's easier for people to switch banks then they will increase interest rates that they offer on deposit accounts to try and reduce outflow. This was targeted at real estate Start up a national e-conveyancy system to reduce cost of investing in real estate and increase volume of people investing. Deposit portability increases deposit rates.During the crisis, on top of the guaratee to lend, the government introduced a deposit guarantee (free insurance) the government stepped in during the crisis because it was worried depositors may run on one of our banks here. Free insurance->more reckless. Then government capped the insurance because they realised this. (1m->250k). Last major reform allowed banks to issue 'covered bonds'- allowed bondholders claim to cash-flow from the bonds. The idea was to give small lenders access to wholesale markets so they were able to borrow at cheaper rates

The Australian Banking Industry- Reform One way to increase competition was to increase access to funds (wholesale market) for smaller competitors-> legislation allowed for issuance of covered bonds. They allow banks to cover off one side of their asset side of the balance sheet and issue bonds back by loan portfolio 2. The cash flows that are promised to the loans are transferred to bondholders. Loans stay on balance sheet (this is the key point). Coprorate bond doesn't section off parts of the asset side of the balance sheet

The ANZ and covered bonds lengthen its debt maturity- maturity mismatch gives rise to interest rate risk gives rise to interest rate risk, how you hedge interest rate risk(duration gap is reduced)  is matching maturities-> in this case covered bonds which have a longer maturity than deposits allows banks to do this

Consumer Credit in Australia Private debt in Australia is incredibly highMargin Lending in Australia Borrowing and using funds to investDeposits in Australia-Regulation Most of the structure we see today has come out of the Wallis enquiry- recommended deregulation and set up regulatory institution  

In Australia we have three main regulations RBA, APRA and ASICASIC is the securities commission-in charge of regulating any firm that is listed- deals with corporate fraudRBA this is the central bank in charge of monetary policy and financial stabilityAPRA-> we focus on this. We look at prudential regulation. In Australia we have a single, federal regulator

Prudential Standards for ADIs APRA implements Basel 3-> name given to capital regulation

Key US Regulatory Agencies (currently) FDIC (federal deposit insurance corporation) is the regulatory agency in charge of providing deposit insurance to the banks. Charges a fee for deposit insurance and oversees and monitors bank behaviour. Current deposits are insured up to $250000. Auctions off assets when banks fail. The OCC is a federal regulator and looks over the federal bank. It allows banks to open and shut banks. If banks looks like equity values are falling too much OCC can ask to re-capitalise or shut it down.The FRS-> on top of monetary policy that our reserve bank is in charge of, it is o=also in charge of regulating FRS banks. State-charted banks can elect to become members. In the US the charter authority is the state regulator or the OCC. If you want to open a bank you can open a state bank and be regulated by the state regulator or if federal bank, be regulated by the OCCHistorically, FIS were regulated by THRIFT supervisions. But this was transferred to the OCC and it had it's own insurance (federal savings and loan insurance corporation) but even that got transferred to the OCC

Early Regulatory ResponsesPre 1986 (National Bank Act) banks existed in what was known as the free banking era. Banks were allowed to issue their own currency. Lead to instability and banks and institutions failed and so the national bank Act was introduced to try and charter banks. So you had to hold a license to open a bankIn the US there are state regulators and federal onesFederal Reserve Act Established the Federal Reserve system (where US currency was created)

1927 McFadden Act Prohibits banks from branching interstate. So if you opened a branch you could branch within the state if that state allowed you to. But it prohibited interstate cross boarder branding.

Regulatory Response to the Great Depression The Great Depression- Devastating to industrial production1930 Hawley-Smoot Tariff Act The US and a lot of countries around the world shut their doors ('if we have a problem with employment, we will reduce competition by closing our borders) but when they did this other countries retaliated and the effects amplified throughout the economy (reduction in free trade made things worse)

1932 Reconstruction Finance Corporation Act President Hoover's attempt to stimulate the economy. Heading towards the end of the crisis, unemployment was 25% national income was half what it was shen the depression began. The stock market is only a quarter of what it used to be and people were willing to invest in government bonds that paid a negative interest rate (because they knew it was safe).1933 At the height of the crisis, Roosevelt closed all banks (because of bank runs) and suspended all trading. 4000 banks failed1933 Emergency Banking Act (OCC)1933 Banking Act (Glass-Steagall Act) Separated commercial banking from investment banking. So if you're an investment bank you can't do commercial bank stuff. Investment bank, brokerage, underwriters and taking deposits issuing loans were separated. Some people argued this separation was beginning of most recent criss. This was the first time there was a national supervisor that looked after all the banks (FDIC only temporary at this point).The National Housing Act of 1934- FSLIC (Federal savings and loans insurance corporation) went bankrupt, all the deposits were insured by the FSLIC and they had to pay up on the deposits, the government stepped in and had to bail out this corporation and their power was transferred to the FDRC1934 The SEcurities Exchange Act- This act creates the securities and exchange commission SEC1935 The Federal Credit Union Act1935 The Banking Act We can contrast what happened post great depressions with what happened post GFC1999 Financial Services Modernisation Allowed commercial banks to enter into investor bank activities and vice versa-banking became very universal. This act was part of deregulation climate of the time and strong lobbying efforts from US banks (losing market share to Japanese and German banksFed cut interest rates in the early 2000s. Households kept borrowing and housing market boomed. Development of new financial instruments such as CD and mortgage backed securities helped firms shift credit risk from their balance sheet to financial markets and insurance firms

Banking Profitability  in the early 2000s Fed cut interest rates 13 times in early 2000s. Lower interest rates made debt cheaper to service so households kept borrowing. What the Fed did, some people attribute the crisis to the Fed reserve and their loose monetary policy. In 1999, there was a lot of concern from going to 2000. There was a lot of uncertainty between 2001-2009 so Fed cut rates to very low level-> record low. Period was coupled with rising house prices-> sub prime borrowers and individuals could now enter the mortgage market as long s interest rates stayed low. But around 2005 interest rates started to increase and as inflation started rising, interest rates started rising as well-> people couldn't make repayments. The Fed slashed interest rates to zero and they've stayed there ever since. What we can do is track performance of banks over timeThe Global Financial Crisis 2007-2010 People were lending at low interest rates to risky people who demanded high interest rates (or shouldn't have been given loans at all) In 07-10 the yield curve flattened out. RBA suggests main causes of GFC (on slide) APRA will say one of the key reasons why Australia didn't suffer is because our banks are so well regulated. Wanted to make money by increasing volume of lending (low doc or no doc, they just wanted the volume)FIs increased the volume by lending a lot to the sub-prime market they took the riskiest portion and shifted it off their balance sheet-> mortgages backed securities issued. Securitised loans lead to huge financial losses and were possible the root cause of US economic weakness. Rating agencies failed to rate these products well. Virtually everything that was securities was rated AAA.The failure of big companies led to seizing up of all money markets (banks weren't willing to lend to each other and LIBOR spiked up!) FDIC insurance increased from 100k to 250k.Regulatory Response to the GFC (godfrey Act) Wall Street Reform and Consumer Protection Act was response to create sound economic foundation to grow jobs, protect consumers, rein in Wall Street, end bailout and Too Big to Fail and prevent another financial crisis

The Volcker and Bank Holding Companies- banks have been fighting against-> banks prohibited from engaging in proprietary trading activities. Blamed for excessive risk and volatility. Current debate on Volcker centres around:1. the distinction between market making and proprietary trading2. the investment in hedge funds and private equity by banks implication of banning proprietary trading is if it works firms will be exposed to less market risk from trading lessTrading leads to market risk, implication of banning trading means they will reduce market riskReactions to the Volcker Rule Population is supportive of banks being banned from excessive trading-> banks don't like it because they make huge revenue from excessive trading.For bank balance sheet

US DIs and their balance sheets Commercial banks, if the trading is done on balance sheet you suspect that on balance sheet, the risk section might change. There's a lot of regulation coming in. Large variation in commercial banks Balance Sheets and RegulationCommercial Bank Balance Sheets, Dec 2009New regulation are directly going to regulate liquid assets so we expect to see shift in balance sheetCapital adequacy- is the amount banks hold adequate to something*Breakdown of Loan Portfolios Commercial Bank Balance Sheets Amount of cash is very small-> this is why we run to the bankLarge and small banks here have assets less than one billion

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