Maintaining stability in the financial system requires prudent management by financial institutions, sound macroeconomic policy, and a strong regulatory and supervisory framework. The Government should minimise the expectation of taxpayer funds being used to support the financial system. Nonetheless, given the Government may intervene during a financial crisis to avoid disorderly failures, a strong Government balance sheet is important.
The Global Financial Crisis (GFC) provided many lessons about the global financial system. This included: complexity and interconnectedness was greater than appreciated; many global financial institutions had too little capital to withstand a large shock; moral hazard was prevalent; liquidity can disappear in a crisis; and there was a lack of focus on system-wide risks. In response, governments and regulators implemented, or will implement, a number of international and domestic policy reforms.
The Inquiry has made the following observations about stability in the Australian financial system:
- During the GFC, significant government actions in a number of countries, including Australia, entrenched perceptions that some institutions are too-big-to-fail. These perceptions can be reduced in Australia by making it more credible to resolve these institutions without Government support.
- A number of jurisdictions have implemented new macroprudential toolkits to assist with managing systemic risks. The effectiveness of these for a country like Australia is not yet well established, and there are significant practical difficulties in using such tools.
- Australia has implemented some aspects of global prudential frameworks earlier than a number of jurisdictions. It has also used national discretion in defining capital ratios. When combined with other aspects of the prudential framework and calculated on a consistent basis, Australian banks’ capital ratios (common equity tier 1) are around the middle of the range relative to other countries. However, differences such as those in definitions of capital do limit international comparability.
- To contribute to the effectiveness of the financial system, sound corporate governance requires clarity of the responsibilities and authority of boards and management. There are differences in the duties and requirements of governing bodies for different types of financial institutions and, within institutions, substantial regulator focus on boards has confused the delineation between the role of the board and that of management.