Fundamentals of Finance: Systemic Stability Essay

Systemic risk and stability

Systemic risk refers to a situation whereby the entire financial system or market in a country collapses. It is also referred to as financial system instability. This type of instability results from the instabilities that result from the financial intermediaries. It is a situation whereby the collapse of a single entity leads to the failure of an entire system. Systemic stability, therefore, refers to the measures that the government of a country implements in order to ensure that there is financial stability in the region (IMF, 2010). The government of Australia ensures that there is stability in the financial sector through the Reserve Bank of Australia (RBA).

For example, a bank may get into financial trouble while owing other banks money. Therefore, when the main bank collapses, a cascading failure in the banking sector is observed. In addition, when banks get in trouble, depositors sense trouble, and they, therefore, spread panic in the entire market. This scenario is observed in markets where many buyers and sellers of illiquid assets are present. Many policymakers, therefore, pay attention to the issue of systemic risk in order to ensure that the country’s growth remains stable (RBA, 2012). Governments and institutions which are supposed to monitor the performance of the market enforce rules in order to ensure that the entire market remains stable. Governments pay significant attention to this issue because they fear that financial markets are intertwined in a network of dependencies. This means that in case a major financial institution collapses, the entire market goes down as well.

The collapse of the financial system and market

It is, therefore, the duty of policymakers who work in the RBA to ensure that they protect the stability of the financial system. The responsibility of enhancing stability in a financial system should not be left to a single person, but it should be the responsibility of all policymakers in order to ensure that incidences of systemic instability are minimized significantly. Policymakers are regarded as more efficient and effective in terms of formulating policies that streamline the financial market. Most of the policymakers in Australia, therefore, operate in the RBA because it is the central authority that is endowed with the responsibility of monitoring all the financial operations of the country (RBA, 2012).

Financial institutions get into trouble while owing other institutions money

It is the responsibility of RBA to ensure that the financial system of Australia is stable at all times. RBA is mandated by the government to ensure that all the financial activities of the nation run smoothly and in a manner that stimulates economic growth. To ensure that RBA is capable of handling all types of financial system risks, the government of Australia made RBA the supervisor of all financial institutions. All the activities of financial institutions are therefore supposed to be regulated by the Australian Prudential Regulation Authority (APRA). In addition, RBA introduced a Payments Systems Board whose goal is to ensure that banks comply with all the payments processes in order to reduce any incidences of fraud, thus fostering transparency in the financial sector (Currie, 2010).

In order for a country to be regarded as financially stable, it is important for the financial institutions to make that the transfer of funds between investors and customers is carried out in a smooth manner. The stability of an economy is known for facilitating steady economic growth (ADBI, 2012). Therefore, RBA implements all measures possible to ensure that financial institutions and markets comply with all the rules and regulations that relate to the financial sector. In order to be effective in promoting systemic stability, RBA mitigates all the risks that are associated with financial instability and the potential systemic instabilities that are likely to occur in the country (RBA, 2012).

Policy makers should protect the stability of the financial system

There are very many mechanisms that RBA can adopt to enable it to reduce incidences of systemic stability in Australia. One of the ways in which RBA ensures that there is stability in the financial sector is by ensuring that the levels of inflation are low and stable. High rates of inflation affect the performance of institutions, thereby forcing them to engage in activities that make investors and customers refrain from associating themselves with such institutions (RBA, 2012). This makes the performance of such institutions start deteriorating, thereby bringing down the performance of the economy. With a sustainable level of inflation, the rate of economic growth also becomes sustainable. With the stable economic growth, the Australian financial environment has also managed to be stable.

It has been noted that many nations that are unable to attain systemic stability are characterized by high and uncontrollable rates of inflation. However, RBA has been effective in maintaining the levels of inflation at acceptable levels, thereby increasing the confidence of investors in the country. This has stimulated the rate of growth of the Australian economy. The health of the financial system is also a very important factor to consider for ensuring that financial institutions make a positive contribution to the performance of an economy (ADBI, 2012). Healthy institutions are able to earn significant amounts of profits, and they also pay their shareholders dividends on a timely basis. In addition, the management of such institutions is also of high caliber.

RBA ensures financial system of Australia is stable

However, unhealthy institutions tend to incur huge losses, they do not pay their shareholders a fair share of dividends, and the management of such institutions is also poor. Unhealthy organizations, therefore, make the performance of an economy lag behind because they are the ones that lead to systemic instability. As a result, RBA takes the responsibility of ensuring that all the institutions within the Australian economy are healthy so that RBA remains effective in enhancing systemic stability in the country.

To be effective in assessing the health of financial institutions, RBA evaluates various aggregate and economic data relating to all financial institutions in the country. This data is normally very effective in terms of gauging the potential vulnerabilities within the financial system. When a company is assessed, the outcomes of the review are normally published in the Financial Stability Review. This helps RBA to analyze how specific companies perform. Poorly performing institutions are given directives on the best ways in which they can operate so that they can contribute to the overall growth of the Australian economy (Benink & Llewellyn, 1995). Other institutions that are observed to deteriorate in performance are denied permission to operate while others are given financial aid in order to boost their performance.

The payment systems that are adopted by financial institutions are often subject to review by RBA in order to ensure that they are transparent and secure. There have been instances whereby financial institutions have adopted payment systems that are subject to abuse by people within the institution as well as by fraudsters from outside those institutions. There are institutions that have been observed to make huge losses as a result of using insecure payment systems. It, therefore, becomes difficult for the managers of such organizations to come up with clear explanations on how the finances in the institutions disappeared. Such institutions create panic among investors and customers, thereby leading to instability in the financial system (Benink & Llewellyn, 1995). RBA, therefore, makes sure that the payment systems that are adopted by institutions are safe and stable. RBA also stipulates that institutions should adopt payment systems that are capable of indicating how all the transactions in the institutions have been carried out. This helps to detect any incidences of fraud as well as help in detecting the possible avenues that make the institutions incur losses.

RBA plays a very important role in enhancing systematic stability

In order for RBA to devise effective measures that can help it to cope with the issue of systematic instability in the country, it normally shares its views with the relevant financial agencies. One of the bodies that RBA consults is the Council of Financial Regulators. This council joins the efforts of RBA, the Treasury, and the ASIC in order to ensure that the modes of the regulation adopted are effective and efficient in terms of enhancing systemic stability. RBA is also a member of the international financial system (Currie, 2010). This membership allows RBA to easily assess the different vulnerabilities which different countries encounter while trying to address the issue of systemic stability. This provides a mechanism through which RBA can be able to effectively address the vulnerabilities that Australian financial institutions face while conducting their activities abroad.

From the analysis, therefore, it is true that RBA has a very important role to play in terms of facilitating systemic stability in Australia. Therefore, in order for systematic stability to prevail in any region, financial institutions need to be transparent, adopt secure payment systems, and adhere to all the guidelines that RBA stipulates.

Reference List

ADBI 2012, Systemic Stability Regulation: Principles, Web.

Benink, H A & Llewellyn, D T 1995, Systemic stability and competitive neutrality issues in the international regulation of banking and securities, Journal of Financial Services Research, vol. 9, no. 4, pp. 393-407.

Currie, C 2010, Reform of the Australian Financial System: Will the Wallis Proposals Jeorpadise Systemic Stability, A Journal of Applied Economics and Policy, vol. 17, no. 3, pp. 1-17.

IMF 2010, IMF Stepping Up Focus on Global Systemic Stability, Web.

RBA 2012, About Financial Stability, Web.