FINANCIAL SYSTEM OF AUSTRALIA AND USA

1
Table of Contents

Graphs and charts.................................................................................................... 3

Executive summary.................................................................................................. 4

1. Introduction ......................................................................................................... 5

2. Types of financial products and services ............................................................ 5

3. Relative importance of banks versus stock exchanges ....................................... 6

4. The role and impact of regulatory bodies ............................................................ 8

5. The strengths and vulnerability of the financial system to global events. .......... 10

6. Conclusion ........................................................................................................ 10

References .............................................................................................................. 13

Appendix ................................................................................................................. 15

2
Graphs and charts

Page

Figure 1 - Economic funding: Banks versus Securities market in Australia 7

Figure 2 Economic funding: Banks versus Securities market in USA 7

Appendix C GDP Growth (%) in Australia and USA 15

Appendix D Unemployment Rate of Total Labour Force (%) in Australia

15
and USA

3
Executive summary

Purpose: The purpose of this report is to examine the differences between

Australias and USAs finacial system relating to financial products and services, the
relative importance of banks versus securities market, the role and impact of
regulatory parties and the strengths and vulnerability of these two financial systems
to the world economic activities.

Key findings: Australias and USAs financial system are highly developed, greatly
impact on the economic development of each country and the world. Both of these
two system provide variety of financial products and services which increase in
number of transactions and quality. Although Australia and USA are both market-
based economies, the relative importance of banking sector as a source of economic
funding in Australia is greater than that in USA. The triump of these two systems is
strongly contributed by the effective role of regulatory authorities monitoring all
aspects of financial activities in both countries.

Conclusion: Financial market deregulation has impacted Australia and USAs

economy drastically as it has opened it to new investment opportunities as well as
exposure to risks and instability. As economies experience growth, bank operations
become increasingly vital therefore prudential regulation must be enforced
independently by organisations separate from the government, to ensure liquidity
and capital levels in the financial market. Nonetheless, regulatory authorities and
financial market framework must experience constant reform in order to combat the
constant changes in the economy. In order for an economy to grow, growth in the
banking sector is extremely important but it must be monitored prudentially to ensure
stability, strength and reduce vulnerability.

4
 1. Introduction

Financial market deregulation has enabled open economies like Australia and USA
to develop new financial instruments such as purchasing equity in a domestic or
foreign corporation or issuing of debt via the selling of bonds. These financial
instruments facilitate the movement of funds to other open economies but also come
with risks. These risks affect the strength and stability of the domestic and
international financial markets such as the collapse of the USA economy during the
Global Financial Crisis (GFC) which had dire effects on majority of the global
economies. Thus to minimize risk, regulatory authorities must be appointed to
monitor and ensure ethical practices in the financial markets especially in the
banking sector as they are major funds holders in most economies. Financial
markets and regulatory authorities must undergo constant reform in order to
strengthen and reduce vulnerability of the financial system to global events.

2. Types of financial products and services

Over the last two decades, due to the Campbell Inquiry, Australian financial system
has a substantial change within a financial period deregulation. In the financial
development system not only the financial products but also the financial services
are important development structures in the financial system. The characteristic of
financial service is the bank that plays a main essential part in the Australian
financial system because bank is holding the most financial assets in Australia.
According to Morrison (2015), foreign savings are increasing the large number of
local investments in the Australias banking system so foreign savings benefit is
bringing higher number of investments. Consequently, it is essential to maintain the
stability to the investors and savers instead of taking the responsibility. The
characteristic for financial product is increasing the level of securitization is important
so people can reduce the chance of relying on securitization funds. According to the
Financial Stability Department (2006), from 1990-2007, financial system assets are
increased up to 7% by Australia securitization market. In Australia, financial service
is the place that is extremely develops in Australias market.

In contrast, a United States of America (US) financial system is really wide and
complex in the world. It also consists of banking system, nonbank financial institution
and financial markets. US financial markets are highly developed and powerful in

5
world economy. Financial service is giving in expanding the economic opportunity
such as economic growth and development. Financial system include banking,
savings and investments, insurance, debt and equity financing. Financial services
give the largest amount of earnings because it is formed with largest varieties of
businesses such as merchant banks, credit card companies stock brokerages,
insurance companies and others. Financial Securities in US is offering a large
number of financial products that also increasing in the number of financial institution,
insurance companies, investment companies and money management firms.

3. Relative importance of banks versus stock exchanges

Along with the intensive development of globalization and global economy, banking
sector and stock exchanges are deemed to play vital roles for any modern economy
to function. However, there were various researches and studies arguing that the
role of markets has become more relatively important for economic activity in the
context which in the world economy has been strongly fostered by technology
(Morck & Nakamura, 1999; Song & Thakor, 2012). In particular, these studies
indicate that to developed economies, the increasing demand of projects for
customized financial arrangements and their reliance on intangible assets, which are
advantages of securities markets, relatively reduce the role of banks who have a
comparative advantage in providing standardized contracts and collateralized capital.
This means that flexible financial services provided by securities markets are more
appealing to businesses and firms, hence, have greater impact on economy
compared to those of banks. This argument is further discussed by number of
empirical researches showing the consistent results with theoretical predictions.
Demirguc-Kunt, Feyen and Levine (2012) indicate that securities markets tend to
grow faster than banks as the economies evolve. As a result, financial systems in
developed countries became more market-based as the funds of the economy were
raised more from securities market.

According to World Banks data (2014), Australia and United States of America
(USA) are two of high ranks economies in the world (rank 12 and 1 respectively in
term of GDP). Both of these economies are market-based with well-functioning
financial systems, especially banking and securities market sectors which are main
sources of industrial funding. However, there are still differences between the two
financial structures.

6
As described in Figure 1, it can be noted that in Australia, the fund of economy from
both banking sector (bank credits) and stock market (capitalization) increased with
somewhat larger proportion came from stock market. This shows that banking
system still played an important role as a source of funding for Australian economy.
Furthermore, this role of bank was especially more important for Australia in the
period of world financial recession from 2008 to 2009. During this period, while the
proportion of fund came from stock market showed the down trend (from 103.86% in
2008 to 98.12% in 2009), that from banking sector still increased (115,5% in 2008 to
128.58% in 2009).

7
In contrary, from Figure 2 it can be seen that USAs economy heavily depended on
the fund from stock market compared to banking sector even in financial downturn
period. Compared to GDP, capital raised from stock market of USA was about twice
to three times of total bank credit throughout the period of 2001 and 2011. This is
due to the fact that USA is the biggest financial central of the world with the most
dynamic and highly developed stock market that has great influence on the global
economy. Overall, although the economic fund primarily come from securities market
in both Australia and USA, the reliance on funding from banking sector is still
comparatively equal to that from market in Australia.

4. The role and impact of regulatory bodies

In Australia, three main independent regulatory bodies are responsible for monitoring
and ensuring ethical practices in the Australian financial system - Australian
Prudential Regulation Authority (APRA), Australian Securities and Investment
Commission (ASIC) and Australian Competition and Consumer Commission (ACCC).
Australias central bank, RBA, is responsible for conducting monetary policy to
establish a strong and stable financial system along with a sound payment system
(RBA 2016). APRA is a prudential supervisor who oversees banks and financial
institutions, ensuring stability in the Australian financial system (APRA 2016). ASIC
is responsible for financial market integrity by monitoring institutions that endeavour
in investments, superannuation, insurance, deposit taking and credit are operating in
accordance to ASICs requirements - a fair and transparent financial market coupled
with confident and informed investors (ASIC 2016). The ACCC is statutory authority
that promotes competition and fair trading via the competition policy (ACCC 2016).
Along with these regulatory bodies, the Australian Securities Exchange (ASX)
ensures that Australian listed companies abide with its operating rules- providing a
transparent, fair and orderly market in conjunction with effective clearing and
settlement facilities (ASX, 2016).

The GFC saw the Lehman Brothers head into bankruptcy, causing global financial
markets to come to a halt as fears arose regarding the stability of these markets as
consumer begun to question bank solvency and damaged investor confidence meant
economies worldwide saw slowed economic growth. Australias strong and sound
financial regulation meant that the effects of the GFC was considerably less compare
to other economies. As seen in Appendix C, it recorded a real GDP growth of 1.7%

8
in 2009 and growth rates remained positive with steady growth, whereas, USA
experienced major drops in real GDP growth, falling from 1.8% in 2007 to -2.8% in
2009 as the economy went into recession, this was due to lack of regulation in the
financial market and the collapse in the housing market. The recession meant USA
experienced a high unemployment rate of 9.7% as shown in Appendix D, while
Australias unemployment rate also increased but not as dramatically as USA, to
5.4%.

Post GFC, Australias financial regulation has been evolutionary, where the existing
framework will likely undergo refinement whereas USAs financial regulation has
been revolutionary with the passing of the Dodd-Frank Wall Street Reform and
Consumer Protection Act in 2010. The Dodd-Frank Act was established in response
to the failure of prudential supervision in USAs financial regulation system prior to
the GFC as major banks offered loans without following the matching principal.
Therefore, new framework for financial regulation was established where federal
agencies and self-regulatory organisations (SROs) are required coordinate on
multiple levels to monitor and regulate the financial market thus providing investor
protection, promoting effective capital markets and addressing issues that pose as a
systematic risk (Kregel, 2014).

This new framework for regulation can be split into three sectors- federal,
independent regulatory agencies and SROs. The federal branch of regulation
includes the Federal Reserve (Fed), the Central Bank of America and the U.S.
Department of the Treasury (DoT). Banks are regulated at the state and federal level.
Fed is the main regulator of banks in America in the federal level and acts as the
lender of last resort while at the state level banks are regulated by the state
government as well as the Federal Deposit Insurance Corporation (FDIC) (Murphy,
2013). DoT established the Financial Stability Oversight Council (FSOC) in response
to the GFC. FSOC identifies and responds to emerging threats to financial stability
via the continual sharing of information thus creating a transparent market (DoT,
2016).

The independent regulatory agencies include the Commodity Futures Trading

Commissions (CFTC) and Securities Exchange Commission (SEC). SEC is
responsible for protecting and providing investors with a fair, orderly and efficient
market and facilitating capital formation by enforcing federal securities laws and

9
regulating the securities industry (SEC, 2106). CFTC regulates the securities and
derivatives market. It creates an open, transparent, competitive and financially sound
market as well as promoting market integrity which helps investors avoid systematic
risk and protects their funds via the implementation of the Commodity Exchange Act
(CFTC, 2016).

SROs are non-governmental organisations that protect investors by creating rules

that promote equality and ethical practices in conjunction with enforcing industry
regulations and standards (Murphy, 2013). Several SROs in USA are Financial
Industry Regulatory Authority (FINRA) who is responsible for the securities industry
and National Futures Association (NFA) which regulates the derivative industry. The
independent regulatory agencies are responsible for overlooking the SROs and
ensuring that they are operating in the best interest of investors, where SEC
oversees FINRA and CFTC oversees NFA.

5. The strengths and vulnerability of the financial system to global events

The strength of both Australia and USAs financial system is the concentration of the
banking sector. This sector is responsible for the majority of intermediation between
savers and investors, and is highly interconnected existed among bank, non-banks,
and financial markets. Australia has four major banks while America has five largest
banks which are hold assets equal to 53 percent of US economy. Those banks are
ranking in top 25 of global safest banks and also their individual market capitalization
has listed as the one of largest banks in the world. This concentration will make less
competition in banking sector, thus the major banks are able to gain an excessive
profitability which is proved by the returns on equity of four major Australian banks
usually above 15 per cent in last 10 years (Ben et al., 2014). During global events
such as financial crisis, Australia institutions had entered crisis with relatively low
exposure to high risk assets while US institution had face huge lost and have to
transform their financial instruments to reduce credit risks. Nevertheless, despite
some losses in US finance, International Monetary Fund (IMF) stated that the
concentration of banking sector in both countries has created strong and solid which
is including capital levels, liquidity, asset and credit rating. By strength in equity
market, which allowed banks to raise large amount of equity in 2009 would help
economy to recover. Moreover, the financial system foundation is stable which is
provided by a robust stability framework. Many of regulations which reformed during

10
global financial crisis, have been settled. It is necessary to strengthen the financial
system to prevent collapse or reduce the cost to reinforce the system in weak period.

However, according to IMF, Australia and America financial system are still
vulnerable. Although IMF stated that both these countries financial systems are
stronger and stability than the time before global financial crisis, new threats such as
the raising in capitalisation of major banks have been bigger in pass few years. By
the way, it will contribute to systemic risk as one institution failed cause issue for
banking sector and damage to financial system as a whole. Furthermore, the low
interest rate in USA, which is promoting investors being riskier, would make bond
price become overvaluation and create an all-out bubble in the bond market. In the
other side, Corbett (1999) stated that an inadequately developed financial system
created vulnerability. The economics of Australia remains vulnerable to international
developments outside its control. After crisis, Australian did not escape without
affecting (Das, 2012). Nearly a billion Australian dollars of a major bank was lost.
Moreover, some weaknesses in financial regulation was demonstrated through the
global financial crisis. The Australia Prudential Regulation Authority banking
regulator and politicians have been reform to qualify the level of reliable to bank
assets. By that way, the preference equity and subordinated debts, which provide a
high volume of bank capital proportion, have been evaluated as low quality of capital
instruments. Also, the banks had required to hold higher minimum level of capital.
Therefore, the banks were insufficient in capital and have to pay attention to liquidity.
In some institutions, the adverse incentives of the executives encouraged the
inappropriate risk-taking. 2009 has experienced the release of proposal of the Basel
Committee on Baking Supervision for consultation which focused on tightening up
institutions capital and liquid asset holding requirement (Henry, 2010).

6. Conclusion

Financial market deregulation has impacted Australia and USAs economy drastically
as it has opened it to new investment opportunities as well as making it susceptible
to economic cycle fluctuations. New investment prospects introduced by financial
institutions has bought growth to both economies, such as the introduction of
securitised loans which has instilled confidence in individuals and corporations thus
increasing willingness to invest. As economies experience growth, banks become
increasingly important as they are the issuer of majority of financial instruments and

11
are major holders of funds in both Australia and USA. Bank operations are vital in
any economy therefore prudential regulation must be enforced independently by
organisations separate from the government, to ensure liquidity and capital levels in
the financial market. But regulatory authorities and financial market framework must
experience constant reform in order to combat the constant changes in the economy.
Such as post GFC, USAs lack of capital levels and liquidity causes collapse in the
mortgage market which meant a tightening of prudential regulation was required. In
order for an economy to grow, growth in the banking sector is extremely important
but it must be monitored prudentially to ensure stability, strength and reduce
vulnerability.

12
References

Australia Prudential Regulation Authority 2016, accessed 23 May 2016,

<http://www.apra.gov.au>

Australian Competition and Consumer Commission 2016, accessed 23 May 2016,

<https://www.accc.gov.au>

Australian Securities and Investment Commission 2016, accessed 23 May 2016,

<http://asic.gov.au>

Australian Securities Exchange 2016, accessed 23 May 2016,

<http://www.asx.com.au>

Ben, F, Adeel, K, Matthew, B, James, K, and Sarah, E 2014, Major Australian

Banks: Full Year Results 2014, KPMG, viewed 21/05/2016
<https://assets.kpmg.com/content/dam/kpmg/pdf/2014/11/major-australian-banks-
full-year-results-2014.pdf>

Commodity Futures Trading Commissions 2016, accessed 23 May 2016, <

http://www.cftc.gov>

Corbett, J 1999, Asian Currency and Financial Crises Lessons from Vulnerability,
Crisis and Collapse, Blackwell Publisher Ltd, pp.155-177.

Das, S 2012, Vulnerable to External Influences- The Economic State of Australia

(Part I), The Daily Reckoning, viewed 21/05/2016.

Demirg-Kunt, A., Feyen, E. and Levine, R., 2012. The evolving importance of
banks and securities markets. The World Bank Economic Review, p.lhs022.

Financial Stability Department, 2006, The Structure of the Australian Financial

System, viewed 23 May 2016, available at
<http://www.rba.gov.au/publications/fsr/2006/mar/struct-aus-fin-sys.html>

Henry, K 2010, The Australian financial system Emerging from The Global
Financial Crisis, Australian Government - The Treasury, issue 2, viewed 20/05/2016.

Kregel, J 2014, U.S. Financial Regulation: The Dodd-Frank Wall Street Reform and
Consumer Protection Act in current and historical perspective, Federal Reserve
Bank of St. Louis, St. Louis

13
Matt, E 2015, IMF warns U.S.: Your financial system is (still) vulnerable,
CNNMoney (New York), Viewed 21/05/2016
<http://money.cnn.com/2015/07/07/investing/imf-warns-us-financial-risks/>

Morck, R., Nakamura, M. 1999. Banks and corporate control in Japan, Journal of
Finance 54, pp. 319-340.

Morrison HS, 2015,Strength in the financial System, viewed 23 may 2016, available
at <http://fsi.gov.au/publications/final-report/chapter- 1/strength-in- the-financial-
system/>

Murphy, E.V 2013, Who regulates whom and how? An overview of U.S. financial
regulatory policy for banking and securities markets, Congressional Research
Service, Washington

Reserve Bank of Australia 2016, accessed 23 May 2016, <http://www.rba.gov.au>

Securities Exchange Commission 2016, accessed 23 May 2016,

<http://www.sec.gov>

Song, F. and Thakor, A.V., 2010. Financial System Architecture and the Co
evolution of Banks and Capital Markets. The Economic Journal, 120(547), pp.1021-
1055.

U.S. Department of the Treasury 2016, accessed 23 May 2016,

<https://www.treasury.gov>

World Bank, 2014. GDP ranking, World Bank Data, viewed 24 May 2016, available
at < http://data.worldbank.org/data-catalog/GDP-ranking-table>

14
Appendix

15
 Banks versus stock market
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Australia 61.88 63.40 65.48 68.41 69.86 73.27 81.95 92.46 96.33 93.36 96.39
BANK DEPOSITS to GDP (%)
USA 66.46 67.43 67.25 66.46 66.69 69.18 72.90 80.72 85.94 83.01 80.81

Australia 130.76 136.46 139.03 138.61 143.73 142.09 126.52 124.92 133.48 127.11 124.64
BANK CREDIT to BANK DEPOSITS (%)
USA 76.34 75.80 77.99 81.60 83.26 82.91 80.21 76.03 64.19 66.93 63.35

Australia 80.91 86.51 91.04 94.83 100.41 104.12 103.68 115.50 128.58 118.67 120.14
Bank credit to GDP (%)
USA 50.74 51.11 52.45 54.23 55.52 57.35 58.47 61.37 55.17 55.56 51.20

Australia 91.80 94.54 108.39 122.23 117.83 128.12 143.85 103.86 98.12 131.68 103.39
STOCK MARKET CAPITALIZATION to GDP (%)
USA 143.18 118.41 115.09 130.68 133.51 138.41 141.73 114.47 96.92 111.99 110.16

Australia 57.42 67.12 75.19 79.14 84.01 97.27 128.40 121.35 87.01 94.59 95.48
STOCK MARKET TOTAL VALUE TRADED to GDP (%)
USA 301.14 258.09 186.30 149.00 163.78 207.87 272.59 384.76 401.70 268.94 205.58

Source: World Bank Dataset

16