Holding firm

The Australian market, in many ways, is more strongly linked to the US and Europe than the rest of Asia. Technology is at a highly advanced level and the Australian financial markets have a healthy mix of institutional and retail investors - both of which are turning to capital-protected structured products as equity markets have fallen (Capital protected, pages 10-12).

Banks in the country are at the leading edge of developments in financial services, whether it is linked to the deployment of electronic trading platforms or through to the implementation of advanced economic capital risk management techniques.

This very level of sophistication, however, has caused the financial services sector more than a few problems. As our cover story explains on pages 4-6, Australia has not been immune to the fallout from the subprime debacle in the US that has resulted in a seizing up of global credit and funding markets since August last year.

Initially, it looked like the non-conforming mortgage lenders lacking the strong deposit base of banks would be the biggest losers. Rams Home Loans became the first casualty when it was forced to sell its 91 branches and all its future business to Westpac Banking Corporation in October for A$140 million. Banks, meanwhile, were shoring up their capital by raising interest rates more quickly than the Reserve Bank of Australia, which, unlike its counterparts in Europe and the US, has hiked the country's benchmark rate 100 basis points since August last year to 7.25%.

Yet, the persistence of illiquidity in the funding market and credit-related writedowns - not to mention lost future revenue streams - has also put significant pressure on the major banks and credit unions. As Risk Australia was going to press, Westpac was plotting a takeover of St George Bank for $14 billion. St George's five-year subordinate debt credit default swaps were trading wider than 100bp over Libor in early May.

The Australian Prudential Regulation Authority may feel somewhat vindicated for introducing a controversial Basel II capital charge under Australian Prudential Standard 117. This rule - unique to Australia - forces banks to reserve capital for interest rate risk associated with their banking books. Cynics say charges for non-traded market risk were devised to ensure a capital status quo between Basel I and Basel II, which came into full effect on January 1. But prudent regulation, along with the commodities boom in the country - primarily due to demand from China - means the Australian economy looks set to do far better than its Western peers. It's holding firm.

Christopher Jeffery, Editor, Asia Risk.