Safety and Soundness: An economic history of prudential bank regulation in Australia, 1893-2008

Abstract: This thesis is an economic history of the prudential regulation of banks in Australia between the crash of 1893 and the global financial crisis (GFC) of 2008. It applies two theoretical frameworks in order to characterise the institutions of prudential regulation and identify the sources of regulatory change over the period studied. The institutional possibility frontier is used to characterise regulatory regimes. Three common models of political economy – public interest, public choice, and ideas – are used to identify the causes of changes in those regimes. The thesis uses unexamined and underused archival sources to refine and expand our understanding of regulatory change in the period studied.

As policymakers in the wake of the GFC conceive of new approaches to prudential regulation of banks, it is important to understand where and how prudential regulation has been adopted in the past. Yet no general study of the history of prudential regulation of banks in Australia exists. This thesis is an attempt to provide that study. Prudential regulation in the period covered has swung between extremes: first, from a laissez faire approach to regulatory control, where regulation was both light and poorly administered, to a system of financial repression, where prudential regulation was both heavy and thorough. As the Australian financial market has been opened to foreign entrants and global competition since the 1980s, prudential regulation has been expanded, formalised, and internationalised. Prudential regulation of banking offers a window into broader changes in the way Australian governments have controlled economic activity.

The thesis makes a number of significant contributions to knowledge. First, it finds that, contrary to later claims by the Reserve Bank of Australia, the Curtin government established a bank deposit guarantee in 1945, and was understood to have done so by the parliament and the Commonwealth Bank, which was to administer the guarantee. Second, it offers a new history of the origins of the deregulation movement in Australia, by situating the Fraser government’s 1979 Campbell committee inquiry into financial regulation in the context of a building society crisis and a contest between two visions of Australia’s economic future. Third, it offers the first account of Australia’s rapid adoption of the international Basel Capital Accords in 1988. Fourth, it provides a new interpretation of the development of prudential regulation after the introduction of foreign banks in 1985, which helps identifies the ideological drivers and economic pressures that led to the (re)creation in 2008 of the Australian bank deposit guarantee scheme by the Rudd government.

The thesis also develops a new theoretical approach to analysing changes in political economy. The ‘subjective political economy’ framework aims to integrate diverse ideological viewpoints and motivations into an institutional model of regulatory control. By characterising institutional choices as a trade-off between subjective costs, the thesis shows how changing ideas about the purposes, possibilities, and risks of prudential control drove regulatory changes. Furthermore, the framework provides a way to understand institutional innovation as changing perceived costs places pressure on the institutional choices available.

The thesis finds that the history of prudential regulation of banking in Australia was driven by changing perceptions of the relationship between the state and the economy and the responsibilities of governments to bank depositors. Australians have long seen the relationship between banking and the state as a window to understand political economy more generally. By bringing the Basel adoption and prudential regulatory changes to the front of any account of the period of financial regulatory reform, we can see how the reform movement of the 1980s was characterised less by ‘deregulation’ and more by regulatory evolution and expansion. A reassessment of the changes in prudential regulation since the crisis of 1893 should inform our understanding of the trajectories and development of Australia’s regulatory state.

Available in PDF here.