Reserve Bank of Australia Annual Report – 1993 Financial Surveillance

The Reserve Bank has particular responsibilities for promoting stability in the banking system, and a more general responsibility for the financial system as a whole. Those responsibilities are exercised in ways which are intended to minimise the risks of the systems encountering serious problems, but they do not extend to preventing individual institutions from making losses or even failing. If an institution were to fail, the Bank would seek to contain the flow-on effects and to maintain confidence in the system as a whole.

The Bank has legislative powers to protect the depositors of any authorised bank which might get into difficulties but it has no responsibility to supervise non-banks.

This chapter summarises recent developments in the financial system, focusing mainly on the banks. It canvasses policy issues, changes in bank supervision, and reforms in the payments system. The final section examines some consumer banking issues.

Recent Developments

The financial system has weathered the recession and associated slump in asset prices. Performance in terms of profits remains patchy, but improving. Pressures to control costs have been intense, and have resulted in widespread shedding of non-core activities and staff reductions. Restructuring, sometimes with a good deal of pain, has forged leaner institutions, better equipped to contribute to – and benefit from – improvements in the economy. In the process, banks and funds managers, such as life offices and superannuation funds, have increased their share in the financial system at the expense of non-bank financial intermediaries. Many banks have absorbed the operations of their non-bank intermediary subsidiaries.

Graph showing Assets of selected financial institutions

Despite the longer-term trend in market shares, growth in assets controlled by funds managers has declined in the past year or so. High unemployment and slow wages growth have constrained net investment inflows, while further declines in asset values have also contributed. More recently, however, the stock market recovery has had a positive influence, and growth has picked up again. Bank-owned funds managers have expanded their share of total funds under management.

Graph showing Financial system structure

Major factors in the improvement in bank profitability in 1992/93 were a fall in charges for bad and doubtful debts, and the sharper focus by bank boards and management on strategy and costs, with the major banks deciding to place greater emphasis on their domestic operations. Partly offsetting these factors have been the continuing slow growth in banks' assets and the funding drag of non-performing loans.

Graph showing Major banks

Average interest margins charged by banks appear to have changed little over the past year. Non-accrual loans remain substantial but have fallen from their peak and are less costly to fund in the current low interest rate environment. The following table shows the spreads achieved by the major bank groups on their Australian business in the past two years:

  1991/92 1992/93
(Per cent) First half
(Per cent)
Reported spread1 3.8 4.0
Reported spread adjusted for non-accrual loans2 4.6 4.6
1 Difference between the average rate received on assets (including zero returns on non-accrual loans) and the average rate paid on liabilities (including zero-interest deposits)
2 Reported spread adjusted by notionally adding back interest forgone on non-accrual loans to estimate the implied spread on “good” business

The stock of banks' non-performing loans fell by around $8 billion over the year, to $22 billion, its lowest level for more than two years. As a proportion of banks' total assets, non-performing loans have fallen from a peak of 6 per cent in March 1992 to 4 per cent in June 1993. This fall reflects the transfer of some non-performing loans off banks' books, a high rate of write-offs of loans and, most importantly, a sharp slowing in the incidence of new non-performing loans. Specific provisions, as a proportion of non-performing loans, rose to 36 per cent in June 1993, compared with 31 per cent a year earlier.

Graph showing Banks' total non-performing loans as a per cent of total assets

Despite its problems, the banking system in Australia has remained well capitalised in recent years, with the aggregate risk-weighted capital ratio edging up to close to 11 per cent. At 30 June 1993 all banks had risk-weighted capital ratios above the 8 per cent minimum, while the majority had ratios in excess of 10 per cent. Although helped by a modest rise in retained earnings and a fall in risk-weighted assets, the main boost to banks' capital ratios during the year was from new capital raisings, which totalled $3 billion.

Graph showing Banks' consolidated capital ratio

Bank Supervision

(a) Objectives The Bank's prudential supervisory role has come under considerable scrutiny in recent years, prompted largely by the difficulties experienced by some State banks and their subsidiaries, and the general slump in bank profitability. Similar examinations have occurred in several other countries, including the United States, United Kingdom, Japan and in Scandinavia, where banks and other financial institutions have reported high levels of non-performing loans (often associated with real estate lending) and some large losses. In some countries, substantial direct government support has been extended to help meet obligations to depositors in privately owned banks.

Supervisory arrangements should be reviewed and adjusted in the light of experience, but from the vantage-point of a clear appreciation of the nature of the existing arrangements and their underlying principles. A basic principle in the Reserve Bank's approach is that prudential supervision should not supplant the primary responsibility which a bank's management and board of directors have for its sound operation. The Bank cannot substitute for effective internal management, nor can it “shadow” bank managers, and seek to second-guess their strategies and lending decisions. The Bank obviously does not like to see banks in difficulties, but it does not set out to prevent banks from making losses, or to protect their shareholders from losses.

Ultimately, should a bank face serious problems, the role of the Reserve Bank is to protect the interests of depositors and, more broadly, to maintain stability in the financial system. The Bank aims to reduce the risk of serious problems through effective prudential guidelines. Among other things, these guidelines currently encompass banks' capital adequacy, liquidity arrangements, associations with non-bank institutions, questions of ownership and control, and funds management and securitisation. Along with regular consultations, they are intended to lessen the likelihood that bank depositors' funds will be put at risk. Within the broad parameters established by these standards, banks have considerable flexibility in the ways they conduct their business.

The degree to which prudential supervision should intrude into the activities of banks is a matter of history and culture, and ultimately of judgment. The Bank is against highly intrusive prudential supervision, which it sees as inhibiting efficiency and innovation in banking without guaranteeing the “safety” of banks. It is, however, in favour of modifying and strengthening supervisory arrangements in the light of changes in banking practices and conditions.

(b) Policy developments To this end, work has continued in several areas, including aspects of banks' “asset quality”. One purpose of this particular work is to achieve more consistency in banks' reporting of their problem loans. At present, in the absence of an accounting standard designed specifically for financial institutions, banks have adopted different approaches to accounting for problem loans, including the point at which loans are classified as non-accrual, and the treatment of interest receipts on problem loans. Standardising the approach to the identification of problem loans will benefit both the Bank and financial markets in making comparisons of banks' performance.

Three policy discussion papers on appropriate methods of identifying and measuring problem loans have been circulated to interested parties for comment. The first paper, issued in June 1992, provided the backdrop for a series of meetings with groups of banks. In October 1992, a discussion paper on asset quality and problem loans was circulated to banks. After the receipt of written comments, and further discussions, the Bank released a more definitive paper in June 1993. When comments on this latest paper have been considered, the Bank will issue guidelines on the reporting of problem loans for prudential supervision purposes. Given the desirability of consistency in reporting by banks for supervisory and public purposes, members of the accounting profession have been included in the Bank's consultations.

The second purpose of the work on asset quality has been to encourage banks to install systems to track changes in the quality of their entire asset portfolio. Analysis of trends in asset quality can provide insights into a bank's credit controls, the adequacy of its provisioning policies and, ultimately, its health. To assist banks to establish appropriate loan-grading systems, the Bank has prepared a standard model for classifying poorer-quality loans although, to the extent possible, the Bank will rely on loan-grading systems already in place. During the coming year, the Bank expects to receive regular data from banks' loan-grading systems.

Over the past year, the Bank has made a number of “on-site” visits to banks. These visits are part of an ongoing program to assist the Bank to acquire expertise of a kind relevant to an independent investigation of the affairs of a bank should serious doubts arise about its soundness. To date, these visits have focused on credit quality, with Bank officers observing first-hand the credit allocation and review processes practised in individual banks, and how these relate to individual clients.

The Bank met with the external auditors of banks in March to discuss possibilities for improving their reporting arrangements with the Bank. Similar meetings are expected to occur at least annually. With the agreement of auditors and banks, auditors in future will copy their audit report direct to the Reserve Bank, rather than transmit the report through the client bank. To assist the communication process, the Bank has instituted the practice of providing a copy of its summary note on the annual prudential consultations to the bank concerned. The Bank expects management of banks to report to their boards on the substance of these prudential consultations, and the distribution of summary notes is intended to facilitate that process.

Effective May 1993, the Bank amended the risk weights applied to certain housing loans under the capital adequacy guidelines. In the past, a concessional risk weight was applied only to loans which were fully secured against residential property of the borrower, and which were for the purpose of housing. Given some difficulties in administering the latter test, the requirement that the relevant loan be for the purpose of housing was dropped. The revised approach is consistent with terms of the Basle capital adequacy framework, and is in line with the practice in a number of countries, including the United Kingdom and United States.

Again in May, the Bank circulated to banks the consultative papers prepared by the Basle Committee on Banking Supervision on market risk. The existing risk-based capital adequacy guidelines, which are applied by supervisors internationally, focus on the problem of credit risk – that is, the risk of the borrower or counterparty failing to repay. In addition to credit risks, banks can be exposed to potentially large losses as a result of movements in prices in financial markets – so-called market risks which arise from dealings with customers, or from banks taking positions with a view to profiting from market price movements. Under the standards proposed by the Basle Committee, banks would be required to hold a minimum level of capital to cover the risks associated with changes in interest rates, share prices and exchange rates. The Basle Committee has sought comments on its proposals by the end of 1993; it plans to issue formal guidelines on market risk late in 1994, although full implementation might not occur until the end of 1996. In its evaluation of the Committee's proposals, the Bank will consider their applicability to Australian banks and their likely implications in terms of additional capital and reporting requirements. Early indications are that their impact overall is likely to be small, relative to banks' existing levels of capital.

The Basle Committee released a discussion paper in April 1993 canvassing the issue of whether its current guidelines should be amended to extend the forms of “netting” of obligations which might be recognised as reducing credit risk for capital adequacy purposes. Under the current capital guidelines, only a particular form of netting, known as “netting by novation”, is accepted as reducing credit risk. The Committee has invited comments on the paper by the end of 1993.

The Bank has been assessing the implications of strong growth in financial products like swaps and options where the price is “derived” from movements in the price of the underlying security or currency, so-called “derivatives”. Much of this work has focused on the nature and measurement of risks in derivatives, as well as on analysis of new products and risk-management techniques. The Bank also contributed to a review by the Australian Securities Commission of the regulation of the “over-the-counter” market for derivatives; the Bank generally favours relatively light regulation of transactions in professional or wholesale markets but acknowledges the need for more protection where institutions are offering retail products.

The interest of banks in offering superannuation products has been growing strongly, prompted in part by the Government's moves to encourage national savings through superannuation. At present, banks' involvement in the provision of superannuation products is confined to their life office and funds management subsidiaries. Subject to acceptable criteria being established, the Bank has no objections to banks' providing such products on their own books.

Reflecting innovation and regulatory changes over the past decade, financial conglomerates are becoming a more prominent feature of the financial system. These can offer substantial benefits to their customers, but they also raise important issues for financial supervisors, including the risks of problems in one part of the group spreading to other parts; possible conflicts of interest; and potential duplication or conflicts in regulation where two or more supervisors are involved. Because they are usually headed by a bank or insurance company, which is carefully supervised, financial conglomerates in Australia tend to raise fewer concerns than in some other countries. Moreover, the relative significance of unsupervised financial intermediaries, such as finance companies and money market corporations, in conglomerates has been declining.

The Bank seeks to ensure that banking groups, overall, are well-capitalised and prudently managed, without erecting barriers which create rigidities or inefficiencies. In the absence of good commercial reasons for their retention, however, the Bank has been encouraging banks to absorb their financial intermediary subsidiaries. In developing its approach to conglomerates headed by banks, the Bank has been concerned primarily with its obligations to bank depositors. To this end, investors are required to be made aware that the Bank's depositor protection obligations do not extend to investment products offered by subsidiaries of banks, and that banks are not permitted to guarantee or support (beyond defined limits) the products offered by their subsidiaries.

Institutional Developments

In December 1992, the Banking Legislation Amendment Act amended the Banking Act 1959 to give effect to the Government's policy on foreign bank branches, which had been announced on 26 February 1992. The amendments provide that a foreign bank, which is authorised to operate as a branch in Australia, is not subject to the depositor protection provisions in Division 2, Part II of the Banking Act. Before accepting a deposit in Australia, an authorised foreign bank (operating as a branch) is required to disclose to the depositor the fact that deposits with it are not protected. In addition, foreign bank branches are prevented from accepting “retail” deposits; they will be allowed to take deposits and other funds, without restriction, only from incorporated entities, non-residents and employees of the bank concerned. A foreign bank may accept deposits from other customers only if the initial deposit is of an amount not less than $250,000.

Three foreign banks were operating in Australia as branches when the amendments to the Banking Act were passed. Of these, Banque Nationale de Paris chose to adopt the new foreign bank (branch) status – thereby excluding itself from accepting “retail” deposits but freeing itself of some supervisory restrictions which had applied previously. The other two – Bank of New Zealand and Bank of China – elected to retain their existing position, which enables them to continue their retail activities while remaining subject to endowed capital and associated requirements. For purposes of the amended Banking Act, these two banks are deemed specifically not to be “foreign banks”, so that their depositors are still subject to protection by the Reserve Bank under the Act.

So far, two Singaporean banks have obtained authorities to operate in Australia as branches under the new arrangements. They are Overseas Union Bank Limited, which began operations on 3 May 1993, and United Overseas Bank Limited, which is expected to take up its authority in August 1993.

The Treasurer announced in a Statement in June that the Government proposed to bring forward, in the Budget sittings of Parliament, legislation to facilitate the conversion of foreign banks' Australian subsidiary operations to branches. This will permit subsidiaries which were in existence prior to February 1992 to transfer eligible assets and liabilities into authorised branch operations, free of normal Commonwealth and State fees and charges. In addition, the legislation will provide that Australian subsidiaries of foreign banks will be entitled to transfer certain existing tax losses into newly authorised branches.

The Treasurer also announced the Government's policy with respect to the ongoing taxation treatment to be applied to bank branches, an issue of considerable interest to many prospective foreign bank applicants for branch authorities. A key element in the policy is that interest withholding tax will apply only to half of the interest payments made from branches to head office and other overseas branches of the bank. The Treasurer observed that to meet the industry's request for complete exemption from interest withholding tax would have involved revenue losses which were inconsistent with the Government's budgetary objectives.

Following a review of the Non-Callable Deposit (NCD) arrangements, the Bank announced that from 1 July 1993 it would increase the interest paid on NCDs, which banks are required to hold with it, to the rate payable on 13-week Treasury notes. Previously, the rate on NCDs had been 5 percentage points below the Treasury note rate. The chief executives of the banks have assured the Bank that they will use their best endeavours to see that the benefits of this change are passed on to small and medium-sized business borrowers.

The New South Wales State Government referred its powers over State banking to the Commonwealth Government during the year. As a result, the State Bank of New South Wales Limited (SBN) came formally under the Banking Act and the Reserve Bank's supervisory authority in early 1993. Prior to this change, SBN had complied with the Bank's guidelines for prudential supervision on a voluntary basis.

Inquiries and Legal Actions

During the past year, three official inquiries into the large losses incurred by State Government owned financial enterprises commented on the Bank's supervision. These were the Royal Commission into the Tricontinental group of companies (Trico), which was owned by the State Bank of Victoria (SBV); the Royal Commission into the State Bank of South Australia (SBSA); and the South Australian Auditor-General's Inquiry into SBSA.

In each case the inquiries attributed primary responsibility for the losses incurred to the managements and boards of the institutions concerned.

The Trico Royal Commission found that Trico lent too much to too few and against inadequate security. Its credit management policies were said to have been flawed and ineffective, while its board was found to be complacent and to have failed in its duty to exercise oversight and control of management. Directors common to the boards of SBV and Trico were criticised for failing to alert the board of SBV to the risks emerging in its subsidiary.

The Royal Commission into SBSA found that SBSA had adopted a “culture of unrestrained growth” which put the stability of the bank at risk. Both the Commission and the Auditor-General criticised SBSA's senior management for the group's inadequate lending quality and credit procedures. Both concluded that SBSA's board had effectively abdicated its responsibilities by placing too much reliance on the management. The South Australian Government was also criticised for fostering SBSA's expansion in pursuit of dividend revenue. In addition, the Auditor-General found that the audit opinions provided by external auditors over a number of years were inappropriate and based on inadequate processes.

The Royal Commissions (but not the Auditor-General) also criticised certain aspects of the Bank's prudential supervision of SBV and SBSA. Both accepted that the Bank had no legal power at the time to supervise State banks and acknowledged that it had attempted to fill this gap by persuading them to follow its standard prudential guidelines. The Trico Royal Commission, however, came to the view that the Bank, having monitored the prudential practices of SBV, failed to take sufficient action over its concerns about the viability of the bank's subsidiary, Trico. In particular, the Commission suggested that the Bank should have shared its misgivings about the SBV group with the Victorian Government. The Royal Commission into SBSA concluded similarly that, while the Bank pursued its concerns about SBSA with the management of the bank, it should have been aware that its views often went unheeded. In these circumstances, the Commission found that the Bank should have moved sooner to take up these issues with the South Australian Government.

Both Commissions indicated that any responsibility to be borne by the Reserve Bank was secondary, and considerably less than that of the directors and management of the institutions involved. Neither Royal Commission found there to be any deficiency in the Bank's prudential standards, nor did they criticise the Bank's ability to identify potential problem areas at an early stage. Rather, the central criticism of the Bank by the Royal Commissions was that, having spotted some warning signs, the Bank should have pursued its concerns with the banks' State Government owners more vigorously.

The Auditor-General's Report into SBSA also observed that, in hindsight, the arrangements for supervising State banks such as SBSA would have been more effective if the Bank had adopted a more vigorous approach, and if the Bank had done more to compel SBSA to respond to its concerns. In contrast to the line followed by the Commissions, the Auditor-General went on to acknowledge that it was not hard to identify why the Bank did not do this, noting it had no legal power over SBSA (or other State banks at the time); that it (along with everyone else) under-estimated the magnitude of the problems; and that it had received appropriate assurances from senior SBSA managers and, eventually, from SBSA's external auditors regarding its concerns about SBSA.

The Auditor-General noted that the Bank had encouraged and prompted the adoption of sound prudential practices at SBSA, and did what it could to obtain undertakings from SBSA in respect of the prudential guidelines which the Bank had established, including using all means of leverage available to it. He also observed that the Bank went as far as it thought it could reasonably go to see that SBSA addressed the concerns which had been raised. He emphasised that the Bank had raised most of the important questions which, had they been properly communicated by SBSA's management to its board (and properly understood by directors and acted upon), would almost certainly have reduced SBSA's difficulties.

Given the legal framework and other circumstances at the time, the Bank does not accept the thrust of the criticisms made, with the benefit of hindsight, by the Royal Commissions. The “voluntary” nature of supervision of State banks, and absence of any formal understandings with their owners, served to inhibit approaches by the Bank to the owners of the State banks. More importantly, the Bank was entitled to view the boards of the State banks as the legitimate representatives of their government owners, and to expect that they would communicate the Bank's concerns to those owners.

Following the SBV and SBSA episodes, the Bank has moved to strengthen its supervisory arrangements for State banks. The current arrangements include provision for regular communications between the Bank and the government owners of State banks; these arrangements were welcomed in the final report of the SBSA Royal Commission.

The Victorian Government has initiated legal action against the former external auditors of SBV in relation to the losses incurred by Trico, while Trico is also taking action against its own former external auditors. The Reserve Bank and others have been joined as co-defendants in these cases. The Bank also has been drawn into a legal action for loss and damages by a holder of non-withdrawable shares in Pyramid Building Society, part of the failed Farrow group of companies. The action is against a number of parties including a former Victorian Treasurer and the Victorian Government, which has joined the Bank to the case as a third-party defendant. The Victorian Government has lodged a separate claim against the Bank and others, seeking to recoup payments to depositors of the Farrow group, along with damages and costs.

The Bank believes that it acted properly and in keeping with its responsibilities and powers in all these matters and that the legal actions against it are both groundless and frivolous. It is now obliged to pursue costly processes to defend the claims.

Other Financial Institutions

In April 1993, the Bank's guidelines on ownership of authorised short-term money market dealers were changed to permit a bank to own up to 75 per cent of the capital of an authorised dealer, subject to a number of requirements, including that the bank owner's presence in the Australian banking market is minimal and that there is strict separation of the dealer's operations from those of the bank owner. This change reflected the Bank's wish not to exclude automatically from authorised dealer status groups owned fully or partly by banks whose presence in Australia is so small as to rule out any serious conflict between the respective roles.

Two new companies were admitted as authorised money market dealers during the past year: Australian Gilt Discount Limited commenced operations in December 1992 and SBC Dominguez Barry Discount Australia Limited is expected to commence operations by September 1993.

The arrangements under which the Bank operates in the secondary market for Treasury bonds have been changed. From early 1985, the Bank had dealt with a list of counterparties designated as Reporting Bond Dealers (RBDs); the list was reviewed annually, taking into account dealers' market turnover. In July 1992, the list of RBDs was replaced by a wider group comprising all members of RITS (Reserve Bank Information and Transfer System), the Bank's electronic settlement system for CGS. The changes have given the Bank greater flexibility in its bond market operations, as well as access to a broader group of counterparties, including specialist firms whose turnover was not sufficient to gain designation as RBDs. In practice, most of the Bank's trading is with a small number of firms who are the most active and competitive participants in the bond market.

Under the Banking (Foreign Exchange) Regulations, dealers in foreign exchange in Australia require authorisation by the Bank. During 1992/93, the number of dealers remained unchanged at 72, of which 30 are banks and 42 non-bank financial institutions. Following changes to taxation arrangements announced in February 1992, the number of offshore banking units authorised in Australia increased by 18 to 57; the volume of business conducted by these institutions remains very small, however, at less than 1 per cent of total turnover in the foreign exchange market.

The Foreign Exchange Market Consultative Group was disbanded during the year. This Group was established shortly after the dollar was floated to serve as a formal avenue for Bank liaison with foreign exchange market participants, with the aim of assisting the market's development. As the foreign exchange market has matured, the need for such a Group has diminished. The Bank maintains close contact with the market at a variety of levels and proposes to meet regularly with the Australian Foreign Exchange Association to discuss market-related issues.

In recent years the Bank has implemented financial sanctions under the Banking (Foreign Exchange) Regulations in response to relevant United Nations Resolutions. No new sanctions were imposed in 1992/93 but those introduced in August 1990 against Iraq and in June 1992 against the Federal Republic of Yugoslavia (Serbia and Montenegro) have remained in place. Financial transactions which involve the governments of these countries, their agencies or nationals are prohibited without the Bank's specific approval.

The Bank's Relations with Other Supervisors

Greater complexity of financial markets, including the growth of financial conglomerates, has increased the importance of developing, and maintaining, good lines of communication among financial supervisors. One avenue for this is the Council of Financial Supervisors, a forum chaired by the Bank and with high-level representation from the Insurance and Superannuation Commission, the Australian Securities Commission and the Australian Financial Institutions Commission, the body formed in 1992 to oversee prudential supervision of building societies and credit unions. The Council, which was established late in 1992, provides an avenue for promoting discussions and information flows among supervisors, and for avoiding unintended overlaps, inconsistencies and gaps in supervision of the financial system. The Council is not a supervisor in its own right, nor does its creation alter the separate statutory responsibilities of its members, or replace other channels of communication among supervisors.

The Bank has continued to have close contact with supervisors in other countries and with the Basle Committee on Banking Supervision. During the year, senior officers of the Bank attended several conferences of bank supervisors, and visited the Federal Reserve Bank of New York and the Bank of England to discuss prudential supervision issues. An officer from the Bank was seconded for 12 months to the bank supervision areas of the Federal Reserve Board and the Federal Reserve Bank of Philadelphia.

Payments System

The Australian payments system is being transformed progressively by new technology and organisational reform, including a new framework for managing the payments clearing system. The Bank is closely involved in this process, and in initiatives for better control of risks in the payments system.

The application of more sophisticated electronic funds transfer (EFT) technology is helping to produce a safer and more efficient payments system. EFT payments can be made more quickly and at less cost than payments using paper instruments such as cheques. The process of writing, delivering, and banking cheques, and then waiting for cleared access to the funds, is both cumbersome and expensive. Increasingly, regular payments of all kinds are being made direct to bank accounts. EFT technology also effectively relocates risk in payments, away from customers towards institutions. At the same time, the technology allows better control of risk among banks by providing the means for settlement obligations to be monitored as they accumulate. Properly measuring and controlling this risk is a major objective of plans to reform the framework of the payments system in Australia, and in many other countries.

Responsibility for managing the operation of the Australian payments system now rests with the Australian Payments Clearing Association Limited (APCA), an industry body established in 1992. APCA is owned jointly by all banking institutions (including the Reserve Bank), building societies and credit unions. APCA is currently absorbing the long-established committees which previously managed the payments system, mainly under the auspices of the Australian Bankers' Association. The Trade Practices Commission is now examining both the general framework of APCA, and the rules proposed by APCA to govern the clearing of paper payment instruments; the rules proposed for the various electronic payment streams will be subject to similar scrutiny.

Apart from its role as a member of APCA, the Bank has an overriding interest in the prudent management of institutional risk in the Australian payments system. The Bank considers it essential that the payments system include mechanisms which can adequately monitor and control settlement risk and deal with any (highly unlikely) failures. To this end, the Bank has taken two important initiatives.

One is the project developed over the past two years to require earlier settlement of interbank payment obligations. Under arrangements effective from 7 July 1993, all payments cleared in the 24-hour period to 9.00 a.m. are settled before the payments system opens for new business. This change has reduced by up to 30 hours the period during which payments remained effectively unsettled.

The second initiative relates to the development of a mechanism to monitor and control settlement risk between institutions as it arises within the day. This mechanism, in the form of a settlement risk control module known as PRESS (Payment Registration and Electronic Settlement System), will be owned and operated by the Bank. It is intended that all high-value, interbank payments will need to pass through the control module, and will be approved only if the resulting net obligation of the paying institution to all other institutions remains within a preset limit. The limit granted to any institution will be covered fully by the precommitment of all other participating institutions to share the loss, should an institution be unable to meet its PRESS obligations. Low-value electronic payments will be batched periodically, and also directed through PRESS. Comparable systems to control settlement risk exist, or are being developed, in a number of countries.

The establishment of PRESS will limit the losses faced by participants in the payments system should an institution fail to settle. To be effective, the bulk of payments, especially high-value payments, will need to be made through electronic systems. At present, most high-value payments are made with paper instruments, such as cheques and bank warrants; shifting these transactions from paper to EFT will require some changes in community practices. Appropriate legislative changes are also being developed to ensure that the multilateral netting of payments between clearing institutions within PRESS is legally sound and beyond challenge.

As well as security and efficiency, the reforms in the payments area seek to enhance competitive equity. APCA is structured so that the smaller banks, and non-bank intermediaries such as building societies and credit unions, have an opportunity to participate more directly in payment clearance arrangements. The establishment of the Australian Financial Institutions Commission (AFIC), and the enhanced prudential supervision it has brought to building societies and credit unions, have facilitated their participation in the payments system. The Bank is now close to reaching agreement with both groups on the terms on which industry bodies, registered as Special Service Providers with AFIC, may have settlement account facilities with the Bank.

Consumer Issues

The Bank does not have a specific “consumer protection” role. It is, however, keen to see improvements in bank/customer relationships. It is concerned also that measures to “protect” consumers are not inimical to either the efficiency of the banking system or the best interests of the people they are intended to help.

It is clear from public debate that banks' relationships with many of their retail (and other) customers leave a good deal to be desired. The task of improving these relationships without creating unintended – even perverse – effects needs to be pursued at several levels.

Discussions are continuing on a draft Code of Banking Practice, which is potentially a significant part of the answer to these problems. The central tenet of the draft Banking Code, which was commissioned by the Treasurer in 1992, is the full disclosure by banks and other financial intermediaries of the terms and conditions governing the provision of services to their personal customers. It is premised on open, honest and fair dealing by both banking institutions and their customers. Banks will be required to have in place effective procedures to resolve complaints: disputes not resolved at that level may be referred to the Banking Industry Ombudsman, or some other suitable independent body.

Concurrently, the Commonwealth Government has decided to allocate funds to assist the establishment of a comparative financial information service which will help consumers to assess the merits of competing financial products. This initiative is, in part, a response to the debate on the merits of requiring financial institutions to disclose a so-called “comparison rate” of interest, inclusive of all fees and charges, with the aim of helping borrowers choose among alternative products. With care, such rates can be constructed and used for some products, but their value can be questionable for other products, especially loans where the right choice for individual customers will depend on their particular usage patterns.

The Australian Payments System Council (APSC), which the Bank chairs, is an important forum on the financial system for consumers. In May 1993 the Treasurer announced changes to APSC's charter and composition to give greater recognition to consumer interests. Building on its success in monitoring the EFT Code of Conduct, the Council will focus more on promoting sound customer-banker relationships, including through its monitoring of the proposed Code of Banking Practice. The number of consumer representatives on the Council has been increased from one to three, and a representative from the Trade Practices Commission has been appointed. In the interests of efficiency, and recognising that APCA now provides a more effective forum for discussion of operational aspects of payments, the number of representatives from financial institutions has been reduced.

Having a representative on the Board of the Banking Industry Ombudsman Scheme provides the Bank with another important opportunity to keep abreast of banking issues of concern to consumers, and to help in improving relationships between banks and their customers.