About Financial System Stability

Stability of the financial system is a long-standing responsibility of the Reserve Bank – a mandate reconfirmed by the Government when it introduced significant changes to Australia’s financial regulatory structure in July 1998. These included the transfer of responsibility for the supervision of banks to a new integrated regulator, the Australian Prudential Regulation Authority (APRA), and the establishment of the Payments System Board within the Bank.

Stability of the financial system is a long-standing responsibility of the Reserve Bank – a mandate reconfirmed by the Government when it introduced significant changes to Australia’s financial regulatory structure in July 1998. These included the transfer of responsibility for the supervision of banks to a new integrated regulator, the Australian Prudential Regulation Authority (APRA), and the establishment of the Payments System Board within the Bank.

 

What is Financial System Stability?

 

A stable financial system is one in which financial intermediaries, markets and market infrastructure facilitate the smooth flow of funds between savers and investors and, by doing so, helps promote growth in economic activity. By extension, financial instability is a material disruption to this intermediation process with potentially damaging implications for the real economy. From this perspective, the safeguarding of financial stability can be seen to be a forward looking task – one which seeks to identify vulnerabilities within the financial system and, where possible, take mitigating action. Some of these vulnerabilities have a macro-economic dimension, such as changes in the condition of household and corporate sector balance sheets, and to asset price developments – both of which have the potential to affect the level and distribution of financial risk within the economy. Other vulnerabilities relate to the way in which financial intermediaries and financial market participants price and manage their various risks. In addition, a resilient financial system is one in which there are well developed crisis management arrangements for handling the potential failure of a distressed financial institution in such a way that public confidence in the financial system will not be undermined.

 

The Reserve Bank’s Role in Maintaining Financial System Stability

 

In meeting its responsibility for financial stability, the Reserve Bank focuses on the prevention of financial disturbances with potentially systemic consequences. The Reserve Bank has policies in place that help prevent these types of disturbances or to respond in the event that a financial system disturbance does occur.

 

Policies that help prevent crises

 

There are several ways in which the Reserve Bank attempts to reduce the likelihood of financial instability. One is by laying the foundation for low and stable inflation and sustainable economic growth. Crises often have their origin in periods of rapid and prolonged credit growth, particularly when coupled with speculative activity and high asset price inflation.

Associated with this is the role that the Reserve Bank plays in monitoring the health of the financial system. On an ongoing basis, the Bank assesses a range of aggregate financial and economic data which help gauge the soundness of the financial system and potential vulnerabilities. The results of such analysis are published half-yearly in the Reserve Bank’s Financial Stability Review.

 

The Bank also works to ensure that the payments system is safe and robust, so as to minimise the scope for difficulties at an individual institution to be spread to others. The Payments System Board within the Bank has explicit authority for payments system safety and stability, and has the backing of strong regulatory powers.

The Bank regularly shares its views on these matters with other relevant agencies. Domestically, the main forum is the Council of Financial Regulators. The Council, which is chaired by the Reserve Bank Governor, brings together the Bank, APRA, the Treasury, and ASIC, with a mandate to contribute to the efficiency and effectiveness of regulation and the stability of the financial system.

Internationally, the Reserve Bank contributes to the debate on the reform of the international financial system, primarily through its membership of the Financial Stability Forum. The Forum was established in 1999 to promote international financial stability through enhanced information exchange and co-operation in financial supervision and surveillance.

 

Management of a financial crisis

 

The Reserve Bank’s mandate to uphold financial stability does not equate to a guarantee of solvency for financial institutions. The risk of loss or failure is a cornerstone of a competitive and efficient financial system, and the Reserve Bank’s mandate is not meant to be exercised in a way which would compromise that principle.

In exceptional circumstances, however, the Reserve Bank may act to help minimise the costs of systemic financial disturbances. In responding to such an event, the Reserve Bank may use its balance sheet to provide liquidity to the financial system. It does so, wherever possible, by making funds available to the market as a whole through its domestic market operations. The Bank would lend directly to an illiquid deposit-taking institution authorised by APRA only if it was of the view that the failure of the institution to make its payments could have serious implications for the rest of the financial system. In principle, the Reserve Bank may also be willing to consider applications for emergency liquidity support from non-APRA supervised institutions that have been provided with an exchange settlement account by the Reserve Bank. The Reserve Bank does not see its balance sheet as being available to support insolvent institutions.

 

. "Reserve Bank of Australia." . . Reserve Bank of Australia. 1.31.08 <http://www.rba.gov.au/>.