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Why the negative interest rates force the banks of australia to come up with plan
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Interest Rates Force Australian Banks to Come up With a Plan

Thu Sep 16 2021 09:28
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The banking and financial system in Australia is a little different from that in many other countries. There are mainly four commercial banks that dominate the entire banking system in Australia, namely Westpac Banking Corporation, Commonwealth Bank of Australia, National Australia Bank and Australia and New Zealand Banking Group. 

However, in addition to the large banks, the Australian banking system also includes many smaller banks that are present in various locations throughout the country. 

Credit unions, mutual banks, building societies and many other financial institutions are also an important part of the Australian banking system and also provide some banking services.  

The banking sector in Australia is regulated by the Banking Act 1959. Policymakers have determined that banks need a banking licence to operate. Similarly, foreign banks must operate in Australia through a branch.  

Briefly on Australian banks 

The Australian financial and regulatory system is highly developed, profitable and competitive. In the mid-1960s, the Australian financial sector was deregulated when the separation between savings accounts and business accounts was finally abolished. 

In 1990, the Four Pillar Policy was adopted by the government.  

As a result, the government announced that it would oppose all mergers between the big four banks. This is considered the most remarkable development in the Australian banking system. This decision had its own merits and demerits. 

While some accepted the government's move without reservation. Many economists criticised the decision of the Australian legislature.  

The system is very different for foreign banks. It is mandatory for foreign banks wishing to conduct banking business in Australia to obtain a banking licence. This licence is issued by APRA under the provisions of the Banking Act. 

Once the licence is granted, the foreign bank can operate either as a wholesale bank through one of the Australian branches or through a subsidiary incorporated in Australia.  

About APRA 

APRA refers to the Australian Prudential Regulation Authority. It is a statutory authority under the Australian Government and is the regulator for the Australian financial services sector. It was established on 1 July 1998 on the recommendation of the Wallis Inquiry. Its functions and powers are set out in the Australian Prudential Regulation Authority Act, 1998.  

It was entrusted with the task of overseeing the work of Building Societies, Credit Unions, Friendly Societies, Health Insurance, General Insurance, Life Insurance and Reinsurance. 

It watches over the fact that all these institutions fulfil their duties, comply with the law and do not exploit anyone. It also ensures that these institutions are financially sound and do not default on their payments.  

APRA's recent commentary 

In 2021, APRA commented that Australian banks must have a systematic monetary policy plan for dealing with negative interest rates by 2022. It asked all banks to prepare for the possibility of negative or zero interest rates by 30 April 2022

This comment by APRA points to a future financial crisis that could have a negative impact on Australian economic growth.  

While Australia's Reserve Bank has stated that a negative cash rate is highly unlikely, the Australian Prudential Regulation Authority (APRA) has stated that interest rates set in financial markets could fall to zero or below at any time. 

APRA is therefore calling on banks to take appropriate measures to prepare for such a scenario. This includes developing tactical solutions to introduce zero and negative market interest rates and a cash rate by 30 April 2022.  

Letter to the banks 

In a letter to the banks, Therese McCarthy Hockey, Banking Officer, and an economist explained that tactical solutions are often short-term remedies that include workarounds at the edge of existing systems as well as downstream workarounds.  

The risks of a bank failing to prepare for zero and negative interest rates are severe, according to APRA, as they could have a significant impact on risk management, hedging, operational procedures, contracts, product disclosures, IT, accounting systems and other areas. 

While some banks said they were well-positioned to deal with zero and negative interest rates on financial products processed through their treasury systems during the consultation period, others claimed such rates would lead to operational problems, for example on retail loans or deposit products.

Inadequate planning for the possibility of zero and negative interest rates could thus be harmful to a bank, its customers and the markets in which it operates.  

Australia's policy rate 

Since November 2020, Australia's policy rate has been at a record low of 0.10 per cent. Last month, short-term government bond yields fell for the first time in history. 

Since November 2020, the key interest rate in Australia has been at a record low of 0.10 per cent. Last month, short-term government bond yields fell for the first time in history. 

APRA has said it will finalise its expectations by 31 October and is seeking feedback by 20 August. 

The focus on a possible world of negative interest rates comes as financial markets expect Reserve Bank to raise official interest rates sooner than the 2024 target stated by Governor Philip Lowe. 

Risks of zero and negative interest rates 

According to Prudential Standard CPS 220 Risk Management (CPS 220), and FDI must maintain a risk management framework to manage material risks. Material risks, as defined in CPS 220, are those that could have a material financial or non-financial impact on the FDI or the interests of depositors.

The risks arising from an FDI's lack of preparation for zero and negative interest rates are severe, according to APRA, as they could have a material impact on risk management, hedging, operational procedures, contracts, product disclosure, IT and accounting systems and other areas. 

According to APRA, the risks of an FDI's lack of preparation for zero and negative interest rates are serious as they could have a material impact on risk management, hedging, operational procedures, contracts, product disclosure, IT and accounting systems, among other areas. 

APRA has therefore set out below its expectations for ADIs' readiness to deal with zero and negative interest rates. In setting these expectations, APRA has taken into account ADIs' responses to its December 2020 letter and global experience. 

APRA's proposed expectation 

APRA expects ADIs to take reasonable steps to prepare for scenarios where the cash rate and/or market interest rates fall to zero or become negative to ensure that they can operate with zero and negative interest rates if required.  

Specifically, APRA requires ADIs to submit tactical solutions for the introduction of zero and negative interest rates and cash rates by 30 April 2022. Tactical solutions are typically short-term solutions that involve workarounds at the margins of current systems as well as downstream system workarounds. 

With the exception of credit products that are not linked to the spot rate or a market rate, such as business loans, mortgages, personal loans and credit cards, all products and activities fall under this expectation.

Solutions that result in an economic outcome equivalent to a negative interest rate are acceptable as long as risk management factors are taken into account. 

Final considerations 

APRA expects ADIs to assess all aspects of products and activities that fall within the scope, including client communications and disclosures when proposing tactical solutions. 

In addition, ADIs should analyse the associated operational risks and ensure that adequate controls are in place to mitigate them. 

APRA expects ADIs to consider all aspects of products and activities that fall within the scope, including client communications and disclosures, when proposing tactical solutions. 

ADIs should also assess the operational risks involved and ensure that appropriate measures are taken to mitigate them. 

Inaction could also lead to a global financial crisis. Banks would have to reduce their risk appetite. Banks need to take financial advice seriously next year.
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