ACST8034 in 2020

Financial Institutions Management and Regulation

Introduction and Administration
Introductions
 Shauna Ferris (lecturer in charge of this unit)

 Shauna.ferris@mq.edu.au

 Visit me at E4A – level 7

 Hong Xie – administrative assistant for this unit

 Classes 6 pm to 9 pm Wednesday

 And you (in groups and on iLearn)?

 Where are you from?
 Which degree are you enrolled in?
 Why are you doing this unit?
 Have you had any work experience in financial services?
 What sort of work would you like to do in the future?
 Objectives of ACST8034

 “You should learn from your mistakes”

 No! No! No!

 Too painful

 “You should learn from OTHER PEOPLE’s mistakes”

Air Crash Investigation
Case Study Approach
 Each week we will look at one or more case
studies of real events

 Most of these are disaster stories

◦ Financial institutions which got into serious
difficulties or failed

◦ What mistakes did they make?

◦ What could have been done to prevent the problem?
◦ How well did the regulator handle the situation?

 Maybe a few success stories too?

Case Studies are Messy & Complex

 When a company gets into trouble, there are usually

multiple causes

 Internal = poor product design, poor pricing, poor

underwriting, rapid growth, poor risk management,
poor corporate governance, dodgy accounting, etc.
etc. etc

 External = market conditions, economic conditions,

competitors’ behaviour, regulation and deregulation
Typical Lecture

 I will give an introduction to a topic

 Some weeks - we will watch a DVD of the case study and

discuss it

 Some weeks – visiting lecturers

 Course notes / overheads are on iLearn

 Required readings may be placed on iLearn

 [No textbook]
Thinking Like a Miscreant?
 After studying these disasters, you will understand
WHY we need regulations

 You will also learn about human ingenuity...

◦ As soon as there is a rule,
◦ Some clever person will work out a way to get around the rule
◦ In this unit you will learn a lot about sneaky ways of getting
around the rules
◦ e.g. “financial arbitrage” and “creative accounting”

 Please use this knowledge for good not for evil

◦ Become a better risk manager and/or a better regulator
Assessment

 Very flexible so that you can study the topics which

are most interesting and relevant to you

 3 essays 15% each = 45%

◦ April 6, May 4, June 1
◦ Topics - Less flexible than previous years (class size)
◦ Suggestion Box

 Final Exam (55%)

◦ Final Exam is based on the weekly course notes and
required readings
Assessment Due Dates
 See Unit Guide for due dates.
◦ Write due dates on your calendar

 Assignments are handed in via Turnitin

 Via iLearn DropBoxes (electronic submission)
 You must keep your Turnitin score low (avoid plagiarism)

 PLEASE put your name and student id on each page

 Grades will be posted on iLearn as well (you can look them up

using MyGrades)

 Manage your workload (don’t leave it all to the last minute)

Communication
 “Announcements” are sent to your UNI email
address (link Uni email to your usual email?)

 Announcements are also available on iLearn

 You can send me a message via iLearn or via

direct email to Shauna.Ferris@mq.edu.au

 Put you student id on the email

Unit Guide
 Please read the Unit Guide, it has useful information such as
 * Due dates for assignments
 * What to do if you have unavoidable disruption
 * rules about plagiarism (DON’T DO IT)
 * rules about referencing (DO IT)

Academic honesty – don’t take someone else’s work and

pretend that it is your own

◦ If you cut and paste your reports AND use quote marks AND
acknowledge your sources, you will get low marks
 Because you have not demonstrated understanding

◦ If you cut and paste your reports and don’t use quote marks and don’t
acknowledge your sources, you will get 0 and disciplinary action
 Because you have committed plagiarism
Any Questions?

Overview: Banking Risks
Q1: Causes of bank insolvency?

 Think back to past bank failures.

 Q. What do you think were the most common causes

of bank failures in the past?

 {List 5 possible causes}

 Note that the causes of bank failure will

◦ change over time and
◦ may be different for different countries,

so different answers may be correct

Possible answers
 As a rough guide, the Basle Committee on
Banking Supervision identifies the following risks
◦ Credit Risk (related to macro economic conditions)
◦ Market Risk (related to bank trading losses)
◦ Operational Risk (fraud, rogue traders, cybercrime, etc)
◦ Liquidity Risk
◦ Securitisation Risk (new category added after GFC)

In ACST8034, we will be looking at ways of

managing all of these risks.
Q2 Causes of declining profitability
 Banks might suffer declining profitability

◦ In a well-regulated financial system, the bank probably won’t become

insolvent (i.e. will still be able to pay depositors)
◦ Instead, a weak bank is likely to be taken over by another stronger bank
(e.g. GFC in Australia) without any loss for depositors

 In Australia
◦ Banks are very profitable
◦ BUT
◦ Bank profitability has fallen over the last 10 years (see graph)

 Q. What causes changes in bank profitability?

 Q. What might make bank profitability decline in the future?

Australian Banks Declining
Profitability (Return on Equity)
Source: Reserve Bank of Australia ChartPack downloaded February 2020
KPMG comments….
 https://home.kpmg/au/en/home/insights/2019/11/major-australian-banks-ful
l-year-2019.html

 * strong competition in mortgage market

 * regulatory costs / compliance costs
 * (small) increase in bad debts (why?)
 * compensation costs to customers who were

mistreated (“remediation”)
 * increased capital requirements
Causes of Declining Profitability…
 Every year, the Center for the Study of Financial of
Financial Innovation (CSFI) asks bankers, bank
regulators, and expert observers to identify the most
serious risks facing the global banking industry.

 The survey tends to focus on problems which might

reduce the profitability of banks.

 This is called the Banana Skins survey.

 Q. What do you think might lead to reductions in the

profitability of banks in the future?
2015 CSFI Banana Skins Survey
 1. Macro-economic environment
 2. Criminality
 3. Regulation
 4. Technology Risk
 5. Political interference
 6. Weak risk management
 7. Credit Risk
 8. Conduct Practices
 9. Pricing of risk
 10. Business models
 In these notes,
we will just look at
the first 4 items on the
Banana-skins list
1. Macro-economic risk
 Q. How are banks affected by a slowdown in
the economy?

 Q. What might make the economy slow down?

 (Ask an economist)

 Q. Is there any way that banks can protect

themselves against a slowdown in the
economy?
2. Criminality
 Banks are getting more and more worried about
cyber-crime

 Q. How much will the banks need to spend on

improving security, just to protect themselves?

 Inside the bunkers and war rooms where major banks wage
nightly battle on the frontline of cyber war
 https://www.abc.net.au/news/2018-06-22/westpac-banks-and-staff-fighting-cybercrime/9895956

 Q. How much money have banks already lost

because of cyber-crime?
Reserve Bank of Australia view
 If you are interested in this topic (cybercrime)
,
you can look at this article which has comment
s from the Reserve Bank of Australia (from 201
8)

 https://www.rba.gov.au/publications/fsr/201
8/oct/box-d.html
Preventing cyber-crimes?
 In Australia, the prudential regulator for banks is
the Australian Prudential Regulation Authority
(APRA)

 APRA is now encouraging banks to take action to

prevent cyber attacks

◦ ‘APRA to introduce first prudential standard aimed at

tackling growing threat of cyber attacks’,
◦ Media Release No 18.10, 7 March. Available at
<https://www.apra.gov.au/media-centre/media-releases/apra-introduce-first-prudential-standard-aimed-tackling-growing-threat>.

 Q. Do you think this will work?

3a. Regulation – Bank Strength
 During the Global Financial Crisis (2008-2010),
many banks failed
 Governments often bailed out the banks (which

was expensive)

 -> Bank regulators tightened regulation

 Higher capital
 Better liquidity
 Better risk management
 Less risk-taking

-> All of this reduces bank profitability

Australian Banks: Stronger

From Reserve Bank of Australia website www.rba.gov.au

– Changes in Banking, Speech by Jonathan Kearns, December 2019
3b. Regulation – Unethical Conduct
 In Australia 2019: Royal Commission into Misconduct in Banking,
Superannuation, and Financial Services Industry

 Banks were making profits from unethical conduct

◦ Mistreating customers
◦ Banks were allowing money-laundering
◦ Banks were rigging markets (bank bill swap rates BBSW)

 Now much more regulation relating to conduct

◦ Pay compensation to ill-treated customers
◦ Pay fines to regulators re money laundering and BBSW
◦ Stop unethical behavior (even if profitable)
◦ Sell off some subsidiaries (wealth management, financial advice)
◦ Improve systems to ensure compliance

 -> Reduces profitability of banks

4. Technology Risk
Must constantly update to new better technology
in order to remain competitive
◦ Expensive
◦ Risky – could get it wrong

Under threat from all sorts of fintech competitors

Especially from very large international companies

(Google, Amazon, Facebook, Apple, Alibaba, WeChat)
These companies have a lot of data
Will they use this data to sell financial products?
From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, Dec 2019

 While the past decade has seen substantial changes in

banking in Australia, there are several issues facing
banks that could potentially lead to even greater
change in coming years.
 The first is the general increased access to, and ability
to process, vast quantities of data.
From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, December
2019
 We are currently seeing a massive increase in the
availability of, and ability to process, data.
 This could erode, or maybe even eradicate, banks'

historical advantage in credit risk assessment.

 There are two parts to this:
 regulatory changes mean that banks' private customer

data can be made available to others and,

 second, that non-banks have some data that is useful

for banking business.

From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, December
2019
 The first part is the Consumer Data Right (CDR)
 and Open Banking.

 The CDR makes it clear that the consumer owns their own
data and Open Banking provides bank customers with the
ability to share their account data with other institutions,
including non-banks.

 Using these data, a non-bank could, for example, suggest

accounts or cards that better suit a customer's needs or use
the information for detailed credit assessment
From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, December
2019
 The second part is non-banks' data that are becoming more
valuable for ‘banking’ services.

 Much of this data is collected by ‘big tech’ firms such as Google,

Apple and Facebook.
 For example, PayPal and Amazon have substantial data on the

sales of their merchant customers, while social networking

interactions can be used to predict borrowers' commitment to repay
their loans.

 Technology firms for which collecting and analysing data is in their

DNA are a new type of competitor for banks that have historically
struggled to take full advantage of the private data they hold.
From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, December
2019
 Technological changes in payments are also challenging banks' core
role in facilitating payments. To date, this erosion has been most
apparent in emerging market economies where payments systems were
not meeting customers' needs. For example, in China and several
African countries, online marketplaces or mobile phone companies
have come to dominate payments (largely bypassing the banks).

….in Australia, and other developed economies, existing electronic

payment systems …. are already meeting customers' needs.

 Still, new payments providers engaging with banks and card

companies could reduce the banking systems' revenue from the
payments system.
From Reserve Bank of Australia website www.rba.gov.au
– Changes in Banking, Speech by Jonathan Kearns, December
2019

 Where banks have provided poor service,

 such as in cross-border transfers,
 new competitors may capture market share.
 This is already occurring with specialist firms undercutting the
banks' very wide spreads in cross-border payments.
 Cross-border payments are also a potential entry point
for‘stablecoins’ (like Facebook’s Libra) which could be used to
make low-cost payments across borders,
 completely bypassing the banking system..
Example: Digital currency
 “Pressure on RBA over Digital Currencies”
 Australian Financial Review 25/2/2020 p19

 “The Reserve Bank of Australia is being encouraged to conduct

detailed trials involving issuance of a digital version of the
Australian dollar, to ensure the country is not left behind as
dozens of global central banks seek to repel private sector
cryptocurrencies such as Facebook’s Libra with national
versions.”
Parliamentary enquiry - Fintech
 Senate Select Committee On Financial
Technology And Regulatory Technology
◦ Has issued an “Issues paper”
◦ Currently collecting submissions

◦ During this semester, we will watch for new issues

and ideas arising from this enquiry
Required Reading this week
 Read the Banana-Skins Survey – focus on the
“top ten” risks to profitability (as described on
pages 12 to 21)

 Try to understand each threat.

 Think about how the bank management

might deal with this risk.
Suggestion Box
You will have to do three essays this semester.

I would like to give you the opportunity to do

an essay on a topic which is of interest to you.

{But I can’t give TOO MUCH choice, it makes life

difficult for my markers}

 ILearn Suggestion Box (all semester)

 – tell me your preferred essay topics