Question

Discuss the three criteria for a well-functioning system of markets( honesty, information and property rights) in terms of economic efficiency.

Answer 1

WELL-FUNCTIONING FINANCIAL MARKETS:

Well-functioning financial markets are essential to reach the objective for the management of the Fund and fulfil our mission to safeguard and buildfinancial wealth for future generations.

Well-functioning financial markets are described in standard microeconomic theory. According to theory, interventions might be warranted to correct market imperfections and failures. Interventionsthat are not soundly based risk being ineffective or could lead to unwanted and unforeseenconsequences.

(1)Fair treatment occurs where participants act with integrity, honesty, transparency and non-discrimination. A market economy operates more effectively where participants enter into transactions with confidence that they will be treated fairly.

Fair treatment does not involve shielding consumers from responsibility for their financial decisions, including for losses and gains from market movements. Some investor losses are an inevitable feature of a well-functioning market economy, which allows risk-taking in search of a return.

(2)Behavioural biases and information imbalances6 can be detrimental to both financial system participants and system efficiency. Participants, including consumers, have a responsibility to accept the outcomes of their financial decisions, but financial firms should have regard to these information imbalances in treating their customers fairly.

Financial firms need to place a high degree of importance on treating customers fairly. This includes providing consumers with clear information about risks; competent, good-quality financial advice that takes account of their circumstances; and access to timely and low-cost alternative dispute resolution and an effective judicial system.

(3)Although Australia’s experience of the global financial crisis (GFC) was not as acute as that of other countries — in part because of a strong Commonwealth fiscal position, effective monetary policy, ongoing demand for commodity exports and a prudent and well-managed financial system — Australia has not always been so well placed. Land and property speculation in the 1880s and 1890s led to an economy-wide depression, with real per capita GDP falling 20 per cent and around half of the Australian trading banks closing.3 During the 1930s depression, a number of financial institutions faced depositor runs.4 In the late 1980s and early 1990s, an unsustainable boom, primarily in the commercial property sector, combined with poor lending practices and associated loan defaults, resulted in aggregate bank losses equivalent to one-third of shareholders’ funds.5 This led to depositor runs on some institutions and was a contributing factor in Australia’s recession at that time.