Reserve Bank of Australia Annual Report – 1991 Financial System Surveillance

The past year has seen a working through of many of the trends which developed in the financial system during 1989/90. With the economy in recession, growth in financing has been modest; some institutional groups have contracted. Assets on banks' Australian books rose by 9 per cent over the year, compared with an increase of 15 per cent in 1989/90. Assets of the main non-bank financial intermediaries fell by around 8 per cent in 1990/91. In contrast, partial figures suggest there was modest growth for life offices/superannuation funds.

The profitability of all financial groups was generally depressed, with several banks and many merchant banks and finance companies reporting losses. The common element in these poor results was further rises in bad debts and in non-performing loans. As in the previous year, a high proportion of write-offs was against loans to “entrepreneurial” borrowers and against property-related lending. As the effects of the recession spread through the community, however, provisioning became necessary against other categories of lending, including to small and medium sized commercial borrowers and to farmers. Financial institutions with heavy concentrations of business in Victoria showed the effects of the relatively large decline in activity and confidence in that State.

In response to large loan losses, financial institutions have turned their attention increasingly to improving management systems for the assessment and control of credit risk. Resources administering problem loans have been increased and management is overseeing new lending more closely. Banks have continued to draw subsidiary operations more closely under their own control, both to improve the oversight of lending and to economise on management overheads. Opportunities also have been taken to rationalise operations, reduce unprofitable activities and cut costs.

Several financial institutions have left, or have signalled their intention to leave, the Australian financial scene. Many of these are merchant banking offshoots of international banks which are under pressure to make better use of their capital on a world-wide basis. The number of merchant banks has fallen from 109 in 1987 to 82; the number of finance company groups has also declined – from 160 to 124 over the same period.

Some groups of non-bank financial institutions continued to cope with the damage to public confidence occasioned by well-publicised failures of similar institutions in 1990. Building societies, credit unions, friendly societies, unit trusts and life offices have all encountered such difficulties. In the event, the various “crises” have been handled without major threat to the general stability of the financial system. More recently, there have been signs of improved confidence, but this will need to be nurtured carefully by both managers of financial institutions and the relevant supervisors.

Notwithstanding some problems and strains, the Australian financial system remains fundamentally sound. The banking system, which (including banks' subsidiaries) accounts for around 80 per cent of assets of financial intermediaries, remains well capitalised; at June 1991 its ratio of capital to aggregate risk-weighted assets was close to 10 per cent, compared with 9.3 per cent a year earlier and the minimum 8 per cent required by the Bank. Since June there have been further capital raisings by some banks.

Similarly, the building society and credit union sectors have, on the whole, maintained their capital ratios, with the average ratio, on a risk-weighted basis, for building societies estimated at around 10 per cent in 1990 and for credit unions just over 8 per cent.

Weak spots remain in the financial system, notably those areas vulnerable to further falls in property values; these bear close monitoring. A large core of business, however, continues to be sound and profitable.

While financial institutions themselves are directing more attention to managing credit risks, the relevant authorities are reviewing their approaches to prudential supervision and regulation. These include the Reserve Bank in respect of banks, the Insurance and Superannuation Commission, the Australian Securities Commission, and State Governments with responsibility for co-operative-type financial institutions. There are important lessons for supervisors, as for managements and boards of financial institutions, in recent experience. All have undertaken a good deal of soul-searching. Many current difficulties appear to stem from the rapidity of Australia's transition to a deregulated financial environment, including inadequate preparation (especially in terms of new skills) for the more competitive environment. In particular, deregulation put a premium on well-developed credit assessment skills which had been a lesser requirement in the regulated environment when banks were constrained to deal mainly with high quality borrowers.

Among most supervisors there appears to be a predilection for tougher regulatory requirements. This extends, in the case of non-bank institutions, to information to be disclosed to investors, standards to be met for capital, liquidity and so on, and controls over ownership. The Bank, meanwhile, is seeking to improve the effectiveness of its “early warning” devices for identifying problems in banks. It is also reviewing its policies on banks' relationships with subsidiaries and other associates which do not come within the “depositor protection” provisions of the Banking Act but which can affect a bank's soundness.

Effective supervision is critical but supervisors should not over-react to today's problems in determining tomorrow's rules. A careful balance needs to be struck between the protection which regulation can provide to investors, on the one hand, and the value of a flexible and innovative financial system on the other. Regulations which make financial institutions safe can also make them dull and slow in responding to the needs of borrowers. For some financial institutions it should be sufficient that regulations ensure that investors clearly understand the risk characteristics of the products, so that they can make properly informed choices. In other cases more is required and the responsible supervisory authorities need the resources, skills and powers to deliver to investors and depositors the degree of protection which they promise.

All supervisors can learn some lessons from the recent past. The more important challenge for the immediate future, however, is to devise supervisory arrangements which can cope with changes in the structure of the financial system. These changes currently focus on the expansion of funds management activities, including life insurance and superannuation, and the growing interest of financial institutions in securitising their assets. The Bank is assessing how these trends are likely to affect its general responsibilities for the financial system and its specific responsibilities for the soundness of the banking system.

Bank Supervision

As part of its responsibilities under the Banking Act, the Bank conducts prudential supervision of banks. The ultimate responsibility for sound management of banks resides with their boards and managements but, in consultation with banks, the Bank has a framework of prudential standards within which each authorised bank must operate. The standards cover a bank's capital, liquidity management, large credit exposures and various other aspects of its operations.

The Bank's prudential policies in 1990/91 were pursued against the backdrop of an economy in recession and a banking system under pressure from non-performing loans and provisioning. Profitability declined, with several banks recording losses. In the first part of the year financial markets were particularly nervous and prone to rumours.

The Bank's capacity to monitor the level of bad or doubtful loans of banks has been improved by a new statistical collection introduced in June 1990. That collection is still being refined to allow for differences in banks' systems for identifying and classifying doubtful loans, but it suggests that non-performing loans of Australian banks (including their overseas operations) were around $29 billion in June 1991, up from around $16 billion a year earlier. As a proportion of banks' total assets, the increase has been from 3 per cent to around 5½ per cent.

Non-performing loans diminish banks' profits in two ways: they have to be funded even though no income is being received and they also raise a need for provisioning against possible write-off. Banks had set aside reserves of around $8 billion in specific provisions against non-performing loans at June 1991. Non-performing loans, net of these provisions, were equivalent to about half of banks' total capital. The extent of further write-offs will depend on whether the fortunes of borrowers improve and the value of security available if they do not. Some foreign-owned banks have arrangements for their parents to absorb part of loan losses.

Despite the big increase in non-performing loans, and associated increases in doubtful debt provisions, the Australian banking system remains well capitalised. The Bank has insisted that banks take action to maintain their capital positions whenever these have appeared threatened; indeed, the banks have been encouraged to hold a reasonable buffer of capital over minimum requirements. As noted earlier, the banking system has, on average, a capital ratio of about 10 per cent. There is some dispersion around this, with many of the smaller banks particularly well capitalised. The aggregate capital base of banks increased by about $2½ billion over 1990/91, with new capital issues partially offset by a fall in retained earnings.

Most banks experienced difficulties in 1990/91, with some State banks and foreign-owned banks under particular pressures. Strains on the capacity of the State Bank of Victoria (SBV) to meet the Bank's capital adequacy requirements, because of losses in its subsidiary merchant bank Tricontinental, became apparent in the latter half of 1989/90. In the event, SBV was sold to the Commonwealth Bank while Tricontinental was retained by the Victorian Government. The amalgamation of the Commonwealth Bank and SBV was effected on 1 January 1991, creating the largest bank in Australia. To facilitate the acquisition and to restore its capital ratio, the Commonwealth Bank is to offer shares to the public representing about 30 per cent of its capital.

In February 1991, the Government of South Australia provided an indemnity to protect the capital of the State Bank of South Australia Group against a deterioration in the quality of its assets. This followed a review of the Group's loan portfolio which identified a significant increase in the level of non-performing loans and potential losses. This indemnity is in addition to the statutory guarantee by the State Government of the bank's deposits and other liabilities. Several changes were also made to the Group's Board of Directors and management and steps taken to reassess the Group's strategic aims and its organisational structure.

The South Australian Government has established two inquiries into the State Bank Group, one being conducted by a Royal Commission, the other by the State Auditor-General. The Victorian Government also appointed a Royal Commission to inquire into some aspects of Tricontinental's operations. The Bank has provided evidence to these inquiries.

In April 1991, the Treasurer approved the acquisition of the State government-owned Tasmania Bank by the Savings Bank of Tasmania (SBT). The Tasmanian Government's decision to sell Tasmania Bank was prompted by its recognition of the need for additional provisioning for bad and doubtful debts, which would have put the bank's capital under pressure. The enlarged bank, to be known as Trust Bank from 1 September 1991, retains the trustee structure of the SBT.

Most foreign-owned banks recorded further poor results in 1990, mainly because of the need for substantial provisions against corporate loan portfolios. As a group, their losses amounted to $750 million. This compared with aggregate capital of $3.2 billion at the beginning of the year. To restore their capital positions, these banks undertook new capital issues of $1 billion in 1990, mostly from parents; several have also sought to economise on capital by reducing their operations, rearranging asset portfolios and obtaining guarantees from parents.

Two of the smaller domestically-owned banks experienced short-lived runs on retail deposits during 1990/91. The first affected the Bank of Melbourne early in the year and was mentioned in last year's Report. Metway Bank had similar problems in September/October with heavy outflows of deposits following the circulation of unfounded rumours about its financial stability. On 3 October, the Bank issued a statement confirming the soundness of Metway Bank. This, together with some positive media comments, halted the run.

The major banks, which account for about three-quarters of Australian banks' assets, also found 1990/91 to be a difficult year. While all four remained profitable, their profits were mostly down on the preceding year and returns on equity were modest. Non-performing loans rose through the year but showed signs of levelling off around mid 1991.

Issues in Bank Supervision

Some experiences in 1990/91 have raised questions about the effectiveness of bank supervision. Could the Bank have prevented the large losses of some banks? What steps might be taken to avoid a recurrence of recent difficulties?

It is argued that tighter supervision could have headed off certain of the banks' problems. This may be true at the margin, but assertions that “better” supervision could have prevented the whole episode fail to recognise the many powerful and inter-related forces which contributed to the rapid growth in bank lending and the subsequent loan losses; these include the swing from strong economic growth to recession, an inflationary environment and certain biases in the tax system, and the competitive forces unleashed by the move to a deregulated financial system. Even if the supervisors had possessed better foresight than those in the market place, they may not have been able to provide a perfect counterweight to those forces.

Some confusion about objectives is also apparent in this debate. Prudential supervision does not have as an objective the immunisation of banks from the risk of loss, the economic cycle, or from the mistakes of their managers. Managers and shareholders should factor the inevitability of the economic cycle into their decision-making, and they must pay the price for errors of judgment and carelessness. In the past year they have been paying in various ways – bank staff through loss of bonuses and salary rises in some cases, loss of jobs in some others; shareholders through lower share prices and dividends.

The Bank's supervisory role has three primary objectives, namely:

• preservation of confidence in the banking system as a whole;
• the stability and integrity of the banking system and of the domestic and international payments systems; and
• the protection of bank deposits.

Assessments of prudential supervision need to bear these objectives in mind. Depositors, and other creditors of banks, have been “protected”. And, notwithstanding weak points, the banking system remains sound and intact; generally speaking, banks in Australia appear to have faced up to the seriousness of the problems confronting them and set in train corrective measures. In a relative sense, the community's perception of the safety of the banking system has been enhanced over the recent past; deposits with banks grew by almost $12 billion over 1990/91 while comparable funds placed with non-bank financial intermediaries fell by $8 billion.

The Bank is looking at ways of reviewing banks' operations more intensively than at present. One question being considered, and discussed with the auditing profession, is whether more or better information can realistically be extracted from reporting arrangements with banks' external auditors. Another area under review is the scope for the Bank itself to conduct detailed “on-site” reviews from time to time to gain additional information to that currently available through frequent reporting by banks and periodic consultation with their senior management (as well as the reports from auditors). (The Bank already has authority under the Banking Act to appoint an investigator to a bank, as well as to take control of and manage a bank whose depositors' interests are judged to be at risk.)

The Bank also sees merit in establishing a more formal basis for its supervision of State banks. At present these banks comply voluntarily with the Bank's prudential requirements but it has no statutory power to enforce such requirements nor to conduct an investigation if necessary. Possible methods of formalising the arrangements are being pursued with the relevant State authorities.

Apart from reviewing its supervisory techniques, the Bank has been refining its policies on aspects of banks' operations, some of which stem from the increasing involvement of banks in financial services outside the traditional field of banking. One example is the development of a detailed statement of policy on securitisation. The basic objective here is to ensure that where bank assets are sold as part of a securitisation arrangement, the sale is effected in such a way that the bank may legitimately avoid the need to hold capital against those assets.

In its discussions with banks, the Bank's starting point has been that if banks are to avoid a capital charge on the assets sold, they cannot subsequently be underwriting the credit-worthiness, liquidity or market value of these assets, nor underwriting the solvency or liquidity of purchasers of such assets, or the securities which are ultimately created from such a transaction. A bank must also be sufficiently distant from the scheme to avoid “moral risk” – the risk that the bank may feel obliged, as a means of protecting its own commercial interests, to support the securitisation scheme if difficulties are encountered. This obligation could arise even in the absence of a specific legal obligation. The Bank aims to issue final guidelines on securitisation before the end of 1991.

The Bank also has had discussions with banks on their involvement in funds management. Subsidiaries of banks are estimated to manage about $45 billion of assets in life offices, superannuation funds, public unit trusts and common funds. This business has grown rapidly over recent years and now accounts for about 10 per cent of total assets of banking groups' Australian books. The Bank has proposed guidelines which are intended to ensure that a bank's managed funds are clearly separate from the bank, that the bank has no commitment to support the funds under management, and that investors are fully aware that it is they who bear the risk of any loss on assets held. If sufficient separation is not achieved then a capital charge against managed funds might be warranted; discussions with banks are continuing.

Similar considerations apply to “alliances” between banks and other financial institutions; again customers should clearly understand which institution is the ultimate underwriter of risks attaching to products distributed by banks. The AMP/Westpac alliance, announced in May 1991, is a case in point. Before approving the arrangements for Westpac to market products underwritten by a subsidiary of AMP, the Bank required that Westpac take effective steps to make clear that the bank will not guarantee these products.

The increasing involvement of banks in funds management activities and related life insurance/superannuation business also highlights the need for closer co-ordination between the Bank and other regulators, such as the Australian Securities Commission and the Insurance and Superannuation Commission.

The Bank has been looking to refine the measurement of capital for capital adequacy tests. Prospective changes relate to:

1. Holdings of other banks' capital

   The Bank announced in September 1990 that from 30 September 1991 a bank's holdings of other banks' capital instruments (other than instruments held as part of the investing bank's normal trading operations) would, for the purposes of assessing capital adequacy, be deducted from the investing bank's total capital. This approach seeks to ensure that capital for the banking system as a whole is adequate, by preventing the capital of one bank effectively being employed in the capital base of another. The change will not have a major effect on the aggregate capital position of the banking system; for a few banks it will result in a small reduction in capital ratios.

2. Future income tax benefits

   In assessing the capital adequacy of banks, the Bank has required that, for banks making losses, future income tax benefits (net of liabilities) not count in measuring capital. This is because there is no certainty that these “benefits” will ever be available to absorb loss. The Bank sees merit in applying this policy to all banks, but is still considering some aspects of the issue.

3. General provisions

   In line with international standards, the Bank foreshadowed two changes to policy on the extent to which general provisions against doubtful debts may qualify as part of a bank's capital. From end 1992 general provisions will count as capital up to a maximum of 1.25 per cent of risk-weighted assets; this compares with a maximum now of 1.5 per cent. In the second change, from September 1993, general provisions associated with specific assets or specific classes of assets – such as provisions against LDC debt – will no longer count as capital. This is because such provisions, being earmarked to meet particular losses, are not available to absorb losses generally.

In some debt restructuring schemes, the question of substituting equity for debt often arises. The bank's view is that banks' equity investments in non-financial businesses should not be substantial. This is because a bank's soundness, and public perceptions of that, should not be hostage to the fortunes of non-financial companies. The risks of this tend to be greater when the links are through equity rather than lending. Nonetheless, as foreshadowed in last year's Annual Report, the Bank in administering this policy will consider relatively short-term equity involvement by banks when this is judged an appropriate component of a “work out” of a particular problem loan.

The Bank has asked to be kept informed of plans to restructure outstanding debt of substantial borrowers, particularly where proposals might include an option for banks to exchange some part of debt for equity. To date it has approved only a small number of schemes involving such exchanges. In approving these, the Bank has required that banks value appropriately the equity (or new debt) which comes onto their books, and specify an acceptable timetable for disposal of the investment.

Work on major debt-restructuring schemes during the year has been very costly for banks in time and resources. These negotiations are more difficult when many banks are involved and where the banks are of different sizes and backgrounds. Particular difficulties arose on occasions during 1990/91 in obtaining the agreement of some small foreign banks to schemes of arrangement. At the end of the day, it is for banks to make their own commercial judgments in these situations but the Bank looks to all banks, both domestic and foreign-based, to have a responsible attitude to participation in restructuring schemes where there is a reasonable prospect that the borrower could, with support, be viable in the medium term.

Over the year, the Bank received submissions from some foreign-owned banks requesting that they be permitted to convert from subsidiaries of their parent bank to branches. They argued that the requirement to establish locally incorporated subsidiaries adds to costs and limits their capacity to compete effectively, and that branches would be able to operate on the basis of the parent's capital base, thereby providing better access to wholesale banking markets. Against that consideration is the question of how effectively Australian authorities could supervise a bank not incorporated locally and not clearly subject to Australian law. The task of protecting local depositors of a bank in difficulty might also be more complex if a branch is involved. This issue is under discussion within the Bank, and between the Bank and the Government; the Parliamentary Inquiry into banking also is understood to be examining the matter.

A related issue has been the question of whether foreign banks should be permitted to convert their non-bank subsidiaries to branches. This issue raises rather more problems: in particular, it would be difficult for the public to comprehend why such institutions, being the same legal entity as (and inseparable from) their parents, were not banks under Australian banking law, and were not subject to Reserve Bank supervision or to the depositor protection provisions of the Banking Act.

International Issues

Capital adequacy continued to be a major concern of bank supervisors around the world through 1990/91 as banks' capital was squeezed by slowing economic growth and the end of asset price booms. Whereas banks in Australia have been required to meet a minimum capital ratio of 8 per cent for some time, many countries will not fully implement the Basle capital requirements until the end of 1992. In several countries, notably the United States and Japan, banks are currently observing a minimum ratio of 7.25 per cent.

In some countries there have been claims by banks and others that the transition period should be extended, given difficult economic conditions and a scarcity of capital. This has not been a real issue in Australia and the Bank firmly supports recent comments by the Bank for International Settlements and the Basle Committee opposing any delay in full implementation of the capital standard internationally; the world banking system needs to be adequately capitalised.

At present, the capital adequacy guidelines deal almost exclusively with credit risk – that is, the risk of counterparty failure. However, banks are also exposed to losses from market risk – risks arising from movements in prices such as exchange rates, interest rates or share prices. Work has continued within the international supervision community on developing requirements to protect against market risk. As part of this, extensive liaison has taken place between the Basle Committee and the International Organisation of Securities Commissions (IOSCO), with the objective of agreeing an approach which could be applied both to stand-alone securities firms and to banks doing securities business.

Management of market risk involves some complex issues of measurement and judgment. The Bank is wary of complicating the present capital adequacy framework to incorporate market risk; for the moment, it is monitoring the international debate and has consulted with banks and the Australian Securities Commission.

The Basle Committee issued guidelines in January 1991 detailing “best practice” on monitoring and control of large credit exposures. The new guidelines aim to limit the concentration of credit risks. In Australia, the Bank introduced in 1983 a policy on large exposures, which required banks to report exposures outstanding to individual or related clients in excess of 10 per cent of capital. This basic policy evolved over the next few years to the present set of arrangements which came into being in 1989. Banks are now required to report regularly the number and amount of exposures in excess of 10 per cent of their capital base. Before committing to an exposure of 30 per cent or more of capital to a non-bank, private-sector entity, a bank is required to consult with the Bank and to explain why the exposure is necessary and when it will be brought within 30 per cent. Few such exposures are approved. A feature of large exposure policies over the years has been the broadening of the concept of “related” clients to one which focusses more on control than ownership. The Bank's current policy is broadly in line with that proposed by the Basle Committee.

The Committee on Interbank Netting Schemes, comprising representatives of the central banks of the Group of Ten countries, published its report in November 1990. The Committee recognised that netting, if properly implemented, could help to contain risks in payments systems. The Committee recommended minimum standards for the design of schemes for netting cross-border and multi-currency payments. The Bank has been discussing the implementation of those principles in Australia with banks and others.

Contacts with Other Supervisors

The Bank has continued its regular contacts with overseas banking supervisors and with the Basle Committee on Banking Supervision.

Bank examiners from the United States and Hong Kong visited Australia during 1990/91 to examine the local operations of institutions from their jurisdictions, and Bank of England supervisors had discussions with Australian banks which have operations in the United Kingdom. Senior officers of the Bank attended the Sixth International Conference of Banking Supervisors in October 1990 and a meeting with the Basle Committee in March 1991, to discuss international supervision. Discussions were also held with banking supervisors and senior management of Australian banks in the United Kingdom and New Zealand.

Both in Australia and internationally, banks continued to develop their capacity to offer financial services outside traditional deposit-taking and lending, particularly in securities business and insurance. As discussed earlier, this often involves business being done through subsidiaries or in co-operative arrangements with other financial enterprises, and carries with it some concerns for supervisors. Important among these is the risk of contagion – the danger of damage to one of the parties involved because of problems in another party.

This trend highlights the need for all substantial segments of financial conglomerates to be supervised appropriately and for close co-operation and communication between supervisors responsible for the different segments. Overseas, there is some support for the “lead regulator” concept, where one supervisor becomes responsible for forming a view about the condition of the group as a whole. In Australia the degree of consultation among financial regulators, including the Bank, has been increasing and can be expected to become much more extensive over the years ahead.

Non-Bank Financial Institutions

The Bank's responsibilities for supervising or regulating financial institutions other than banks are essentially limited to authorised dealers in the short-term money market or in foreign exchange. Its responsibilities to oversee the stability of the financial system as a whole, however, require it to take a close interest in trends affecting the non-bank parts of the financial system. In particular, it is interested in current developments aimed at upgrading the regulation and prudential supervision of the various non-bank groups and has offered advice to the relevant authorities where it believes it can make a useful contribution. In doing this, the Bank is not looking to force non-bank groups into the “banking mould”. It continues to see considerable advantage for the community in having a diverse range of financial institutions covering a spectrum of risks and rewards, and offering a wide range of products. Prudential standards and practices can be raised and, where appropriate, made more uniform across an industry, without all financial institutions coming under the same detailed supervisory approach or having, at the extreme, one supervisory body.

The Bank has been involved with plans to upgrade supervision of State-regulated institutions such as building societies and credit unions. Following a review by a working group of State and Commonwealth officials, State Premiers have endorsed proposals for higher and more uniform prudential standards and practices, co-ordination of these arrangements by a national body, and industry-funded emergency liquidity support. Restructured State bodies will continue to be responsible for supervision of individual institutions, but will be more independent than hitherto from the industries they supervise, and from State political and bureaucratic processes.

The Bank has helped in developing these plans and will have an ongoing involvement with the national co-ordinating body. This is in keeping with its desire that these new arrangements work effectively. The Bank, however, will not be supervising individual institutions, nor will it be providing liquidity support. There will be no change in its long-standing policy that if banks decide to provide short-term liquidity support to a non-bank financial institution in need, and in so doing run short of liquidity themselves, the Bank would consider special assistance for those banks. While the Bank does not expect banks to lend to others against their own well based commercial judgments, it does expect them to respond sympathetically to requests for liquidity assistance from otherwise soundly-based institutions.

There is also considerable momentum for prudential reform in the funds management industry, including life offices and superannuation funds, friendly societies, and unit trusts. As elsewhere, disturbances in these industries have provided a sharper focus on areas in particular need of overhaul.

Payments System

Reform of the Australian payments system continues to have a high priority for the Bank. Secure, efficient and equitable payments and associated clearing systems are fundamental to the functioning of a modern economy. In the Bank's view it is vital that banks, other financial institutions, and other businesses which provide payment services to the community, be aware of, and participate fully in, the reform process.

Reform of the Clearing System

Plans to reform the Australian clearing system were detailed in the Bank's 1990 Annual Report. The Steering Committee engaged on this reform is chaired by the Reserve Bank and includes representatives of banks, building societies and credit unions. The objectives of the reforms are a clearing system which:

• promotes operational efficiency, reliability and security;
• contributes to reduced risks in the payments system at all levels; and
• promotes competition by allowing entry to all providers of payments services meeting appropriate, objective criteria.

The basic design of the new clearing arrangements has been determined, although some legal issues have still to be resolved. The arrangements will embrace four separate clearing streams covering paper instruments, such as: cheques; bulk, direct-entry transactions; low-value electronic transactions, mostly based on plastic cards; and high-value transactions. The aim is to have clear rules which allow any providers of payments services meeting appropriate prudential and other tests of membership to belong to clearing streams. Financial institutions would apply for membership only of the clearing streams in which they have a specific interest. Obligations on participants could vary according to technical and risk characteristics of the different streams. The emphasis will be on self-regulation but the new arrangements will need to withstand public scrutiny, including by the Bank itself and the Trade Practices Commission.

The Steering Committee is co-ordinating the establishment of a body to oversee the new clearing arrangements. This organisation, provisionally called Australian Payments Clearing Association Limited (APCA), will be incorporated as a public company, with attendant reporting obligations. APCA is expected to be an administrative and policy-making body, and will not be involved in the financial operations of the proposed clearing systems. Its charter will include:

• co-ordinating and implementing operational policies and procedures in the clearing streams;
• providing the public with information on the clearing system; and
• resolving disputes among members.

APCA aims to have a broad-based membership drawn from all financial intermediaries providing payment services to their customers, including those which participate in clearing through agency arrangements. It will develop contacts with other interested groups, such as consumer representatives. APCA will initially be chaired by the Reserve Bank. Other board members will represent each of the four largest banks, State banks, “other” banks, building societies and credit unions.

Review of Exchange Settlement Accounts

Participants in clearing systems place considerable importance on the ability to offer finality of settlement. Settlement through accounts held with the central bank is the most common method by which this is achieved. In Australia, the Bank traditionally has offered such clearing accounts only to banks (Exchange Settlement Accounts) and to authorised short-term money market dealers. Non-bank financial intermediaries settle obligations through their banks under agency arrangements.

The long-established operational procedures for the conduct of Exchange Settlement Accounts are now under review. The aim is to place a greater onus on banks to monitor and control their settlement exposures in a timely fashion, and to reduce the risk that, in some circumstances, the Bank might have to underwrite the system. The Bank is investigating how the risks to which it is exposed by the present system can be reduced or eliminated without undermining general confidence in, and effectiveness of, the current arrangements.

The Bank is also reconsidering the range of institutions which might be offered clearing accounts and, in particular, the claims of building societies and credit unions which have made submissions on this issue. Satisfactory means of controlling risks to the Bank and others are an obvious prerequisite to any expansion of present arrangements.

Consumer Issues

The Bank believes that protection of the general public is best achieved through an open, efficient and stable financial system where all participants are well informed. It is involved in the work of various bodies established to protect, and better inform, consumers of financial products and services. The Australian Payments System Council, chaired by a senior officer of the Bank, has taken an increasing interest in consumer matters in recent years. The Bank is also represented on the Board of the Australian Banking Industry Ombudsman scheme.

Better communication between banks and other financial institutions and their customers would help to avoid some of the problems that have occurred in the past, especially when new financial products and technologies are introduced. The ombudsman scheme arrangements for the banking industry, which have been operating for a little over a year, are a good illustration of the industry's effort to improve communications.

The Australian Payments System Council has responsibility for the monitoring of the Code of Conduct governing electronic funds transfers (EFT). Overall compliance with the Code, for the year to June 1990, was found to be very high; 97 per cent of EFT transactions, for example, were handled by institutions reporting either no, or only one, infringement of a Code with some 65 requirements. There was, however, scope for improvement in some areas which the Bank has been taking up with the institutions concerned. Through the Australian Payments System Council, the Bank was also involved in a major survey of the security of EFT transactions. The results were generally encouraging, although again there were some areas where performance could be improved.

The Bank is following a number of topical issues in the general area of consumer protection. The Privacy Commissioner has issued a draft Code of Conduct to protect information on the financial affairs of individuals. This is part of an international focus to control access to data on individuals held on databases. There are obviously fine judgments to be made when balancing the need for privacy, the wishes of financial institutions to avoid bad debts, and the desire of consumer groups to avoid consumer over-commitment. The Standing Committee of Consumer Affairs Ministers is seeking to develop laws to apply uniformly on a national basis to cover the terms and conditions on which credit is granted, although progress has been slow.