INTERNATIONAL CONFERENCE OF BANKING SUPERVISORS

SYDNEY

WEDNESDAY 21 OCTOBER 1998

To the special guests and delegates to the 10^th International

Conference of Bank Supervisors I wish you a warm welcome to the conference

and to Australia.

Your work is important for the future of this region, indeed for the

future international financial system.

Your work is always important. We sometimes forget the importance

of financial supervisors when things are running well. Like motor

car maintenance, the mechanic is no less important because he has

the engine running well, than if it is broken down.

But at this time we are facing repair.

As we are all aware, at the moment there is a high level of volatility

on stock markets, financial markets and currency markets. We know

in this region, apart from Australia and China, practically all the

economies are in recession. We know there are economies where financial

institutions are insolvent, and it is clear that emerging markets

in Latin America and elsewhere are at risk. And the fragility in emerging

markets now has financial implications in the world’s strongest

economy, the United States.

International financial developments

These difficulties reinforce the need for sound, rigorous prudential

supervision both in emerging and developed economies. A topic, which

I know, is a central focus of your conference.

Intensive work is underway in various international forums to assist

countries facing difficulties, to strengthen the operation of the

international financial institutions, and to improve cooperation between

them.

Earlier this month, the Special Meeting of Finance Ministers and Governors,

or G-22, met in Washington at the time of the IMF and World Bank Annual

meetings. The meeting received three working party reports which made

a number of recommendations on increasing transparency and accountability;

strengthening national financial systems; and resolving international

financial crises. These reports provide a valuable roadmap for navigating

the complex issues with which we must now deal.

Addressing these issues is central to guarding against shifts in market

sentiment and contagion effects from policy weaknesses.

But we should not lose sight of some basics. Overall, capital flows

to developing countries have had enormous benefits. They enabled stronger

economic growth, rising living standards and pulled people out of

poverty.

Overall, a market is the best way of introducing a lender to a borrower

and of pricing resources between them.

Overall, price should allow for risk. And in financial transactions

risk cannot be abolished.

But clearly in recent days severe problems have occurred. There was

a mismatch between short term capital and long term investment. There

was poor pricing of risk and a systemic threat which could have arisen

from an unordered allocation of liability.

With the recent disclosure of the problems in the Long Term Capital

Management Fund, it is clear that a significant financial position,

on large financial gearings, with apparently little disclosure can

pose significant problems to established sections of the financial

system such as banks.

It illustrates one of the problems of financial supervision. With

technological developments and financial innovation new institutions

can emerge and bypass supervision. Supervision can end up looking

at institutions whose business has been passed on. Supervisors can

end up not just with new products but with new institutions offering

them.

Strong national financial systems, infrastructure and policies

In 1996 Australia recognised the need to update the financial sector

regulatory framework to keep up with the rapid pace of change in financial

markets. Even then, our prudential framework was sound and in line

with the Basle Core Banking Principles. However, the Government realised

that Australia had to aim to lead world’s best practice and ensure

that our regulatory system was flexible and responsive enough to accommodate

further rapid change in the financial sector.

In 1996 the Government established the Financial System Inquiry (known

as the Wallis Inquiry) to provide recommendations on appropriate regulatory

arrangements that would best ensure an efficient, competitive and

flexible financial system, consistent with financial stability, prudence,

integrity and fairness.

The Inquiry reported in March 1997, and the Government announced its

response to the recommendations in the same year. The changes came

into effect on 1 July 1998.

In my remarks today I want to make some observations about the key

findings of the Wallis Inquiry as I believe they pick up issues which

are relevant to discussion occurring in groups like the G22 and the

subject matter of this conference.

Australia first embarked on reform of the financial sector in the

early 1980s when the Campbell committee recommended promoting efficiency

in the financial system by deregulation of the banking sector, floating

the Australian dollar and allowing the entry of foreign trading banks.

The underlying philosophy of the approach was one of liberalising

markets.

The more recent Wallis Inquiry found that while the overall system

was sound, there was room for improvement in every area, and that

further reform was required to respond to changes occurring in financial

markets.

The main drivers of change identified by the Inquiry were technology

and innovation in products and delivery of financial services.

Technological innovation has not only fostered innovation in products

and delivery channels, but it has made global access to markets and

products easier, and is allowing consumers to pursue lower cost more

convenient means of accessing financial services. The use of electronic

transactions is already widespread but will accelerate as the ease

of use and security improves further.

Innovation in product design and distribution has blurred the boundaries

between financial instruments and institutions. The traditional categories

of banking, insurance and financial exchanges are breaking down and

the system will have a progressively greater array of participants,

products and distribution channels. The emergence of large conglomerates

offering an array of services and often operating globally is likely

to accelerate change. Changing customer needs and profiles drives

the innovation.

The Government’s reforms are aimed at providing responsive and

flexible regulatory arrangements that encourage innovation and competition,

so that the most efficient players offer the best prices and services

within the overall objectives of financial system stability.

Another frequently observed global trend to which the regulatory system

must respond is the shift from financial intermediaries. While disintermediation

in credit markets has been limited to the larger corporate players,

technological advances and lower information costs will help extend

the reach of this financing technique to other groups.

Similarly, the trend towards securitisation will change the role of

financial institutions. In Australia, securitisation has been limited

to assets which have very low risk or which represent a homogeneous

asset class, such as house mortgages, but now we are seeing securitisation

being extended to other areas.

These trends are occurring across the world and need to be addressed

by regulators and international financial institutions to ensure regulatory

frameworks adapt and take account of any new risks.

The Financial Sector Reforms

Our own reforms, designed to ensure that our national system of financial

regulation is world class for the benefit of consumers and business,

consisted of:

• a new organisational framework for the regulation of the financial

  system, based on “Twin Peaks” of regulatory focus; and

• a variety of measures to improve efficiency and contestability

  in financial markets and the payments system.

Each dedicated agency is responsible for clear regulatory objectives

across the financial system enhancing their accountability.

The Reserve Bank of Australia has been strengthened and its role focussed

on the objectives of monetary policy, overall financial system stability,

and the regulation of the payments system. The new Payments System

Board within the Bank has been established with greater powers to

ensure safety, greater competition and ease of entry into the payments

system.

The new Australian Prudential Regulation Authority, or APRA, is a

separate statutory body responsible for prudential regulation. It

provides a single licensing regime not just for banks but a broad

range of institutions, including the deposit taking institutions,

life and general insurance companies, and superannuation funds. Neutral

regulatory treatment (enhancing competition) and the maintenance of

financial safety across all providers of similar deposit products

will be achieved.

APRA will be able to assume control of financial institutions, which

fail or are likely to fail, and has a range of other tools to manage

early resolution of any failures. Existing depositor protection provisions

have been retained and extended to all licensed deposit takers. This

is the first peak of financial regulation – prudential supervision.

Secondly, the new Australian Securities and Investments Commission

focuses on market integrity, disclosure and other consumer protection

issues. This is the second peak of regulation. The Commission brings

together, under one organisation, responsibility for conduct and disclosure

regulation which previously had been provided through a variety of

agencies and which was inconsistent with the emerging structure of

markets. This will achieve more effective and efficient disclosures,

better regulation of securities and futures markets, and improve the

coordination and extension of dispute resolution schemes.

Each regulatory agency has substantial autonomy and a clear charter

of objectives. They have boards of directors or commissioners responsible

for operational and administrative policies, and are accountable through

me as Treasurer to the Parliament of Australia.

Close co-operation between the regulators is crucial and in addition

to bilateral arrangements will be formalised through a coordinating

body, the Council of Financial Regulators.

We recognise that it is not the role of regulators to eliminate financial

risk. Their role is to allow financial markets to manage, allocate

and price risk within a framework of disclosure and transparency so

that consumers of financial services can assess the level of risk

and reward they are willing to manage.

Prudential regulation should maintain safety while being sufficiently

flexible to respond to financial sector developments, and should also

be in accord with international developments and best practice. The

reforms included a range of changes to encourage new entry and competition

in the financial system by streamlining regulation, providing for

new entry to the payments system and deposit-taking market and facilitating

a wider range of corporate structures.

I have also established the Financial Sector Advisory Council, comprising

financial sector representatives, to provide advice on financial sector

developments and appropriate policies and undertake a review of the

reforms in five years time.

In implementing these financial reforms, I believe we are putting

in place not just a world class regulatory structure, but also a structure

that includes a great deal of flexibility and a capacity to evolve

as the structure of the financial sector changes over the years.

We have done this by not relying on heavy regulation, but by seeking

appropriate market-based incentives that promote a balance of efficiency,

competitiveness and stability.

Other countries are adopting a similar framework.

The underpinnings for financial system regulation

Sound prudential arrangements are not sufficient to ensure financial

stability. Other core conditions as recognised by the Basle Committee

on Banking Supervision, are: sound and sustainable macroeconomic policies;

a well developed national infrastructure; effective market discipline;

procedures for efficient resolution of problems in banks; and mechanisms

for providing an appropriate level of systemic protection.

It is difficult to overstate the importance of these preconditions,

especially in the light of events in the recent period. These preconditions

are now receiving international attention.

Macroeconomic policies

The Australian Government’s macroeconomic policy framework is

also a leader in the policies endorsed in international forums. I

note in particular that the work undertaken on transparency and accountability

does not just apply to the financial sector regulation but to government

policies in general and in this respect our approach is at the forefront

of thinking on the fiscal and monetary policy transparency.

Australia’s monetary policy is set by the Reserve Bank with its

focus on maintaining low inflation over the medium term. The Governor

and I released a joint statement on monetary policy in 1996 to strengthen

the policy framework by providing a clear statement of the nature

of the relationship between the Reserve Bank and the Government, the

objectives of monetary policy, and the independence of the Bank.

These included explicit mechanisms for ensuring transparency and accountability

in the way policy is conducted. The Government and Bank have an inflation

target and policy credibility has been enhanced by the clear recognition

of the RBA’s independent role in setting monetary policy. These initiatives

have been widely welcomed and have resulted in a more open, transparent

and accountable process.

The Government has also adopted a medium-term fiscal strategy of pursuing,

as a guiding principle, the objective of underlying budget balance

over the course of the economic cycle. Australia’s last three

budgets have been framed against this strategy. Last financial year

the Budget was in surplus. And the Government’s efforts to ensure

sound economic policies – including maintaining the budget in

underlying surplus over the medium term– have been crucial in

shielding the impact of the Asian economic crisis on the Australian

economy.

A Charter of Budget Honesty, backed by legislation, is in operation

and aims to improve fiscal outcomes by enhancing the transparency

of and accountability for fiscal policy. In particular, the Government

is required to set out its medium-term fiscal strategy in each budget,

along with its shorter term fiscal objectives and targets. Full economic

and fiscal outlook reports are required at the time of the budget,

at mid-year and prior to elections.

Australia has for some time pursued a significant degree of transparency

in the fiscal management at both the Commonwealth and State level.

The Commonwealth Budget papers provide detailed information on budget

outlays by portfolio, and provide estimates of expenditure, revenue,

fiscal outcomes for the following four financial years.

Corporate law reforms

An effective legal and institutional framework for the regulation

of financial markets and corporations is well recognised as a critical

foundation for the efficient functioning of the economy and market

confidence.

To complement the financial sector regulatory reforms, I have also

embarked upon a strategic review of the laws regulating conduct and

disclosure practices of corporations and financial institutions. The

Corporate Law Economic Reform program seeks to modernise the law regulating

fundraising, takeovers, directors’ duties, corporate governance,

financial reporting and conduct and disclosure practices in financial

markets.

The program seeks to ensure that Australia’s laws and regulation

operate at best international practice and provides an appropriately

safe and secure environment for investment. It will bring about improvements

in the transparency of financial information and the accountability

of participants in financial markets. This is a comprehensive initiative

to improve Australia’s business and company regulation. It will

modernize and harmonize our corporations law and will give it a more

economic focus, so that business will be able to operate in the framework

of much simplified and efficient regulation.

The reforms will enhance accountability and transparency as well as

allow the industry to embrace the new technology for the benefit of

business and consumers alike.

Australia’s initiatives in this area are designed to attain world

best practice and are also consistent with the policies advocated

in the G22 meeting. The philosophy behind our reforms was of minimal

regulation of markets with appropriate protections in place, while

encouraging the development of efficient and competitive markets.

While each country represented here is likely to have different priorities

and circumstances, I am sure there is broad consensus on the overall

objectives.

The future – need for flexibility and review

Your conference takes place at a critical juncture in the management

and development of financial systems throughout the world.

We need to ensure that our prudential systems attain best practice

and are vigorously applied. This conference, with its review of the

implementation of the Basle Core Principles and discussion of emerging

issues in operational risk, is very much a part of the current international

initiatives to strengthen financial systems.

However, we also need look ahead and ensure that our approaches can

encompass new trends and developments and any areas of potential risk.

This, I suspect is work that is never finished. It is important work.

It will shape our countries and the lives of our citizens.

May I urge all of you at this conference to continue your discussions

with renewed vigour, and to ensure that the quality of your supervision

continues to improve so our financial systems are strengthened in

support of the economic development so important to the living standards

of those we serve.