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The importance of market discipline in the Reserve Bank’s prudential regime

Neroli Austin, Cavan O’Connor-Close

The Reserve Bank’s prudential framework is based on a three pillar approach that relies on self-discipline from regulated entities, market discipline provided by market participants, and regulatory discipline. Since the global financial crisis, the regulatory pillar has been bolstered in line with international regulatory developments. This article discusses the role of market discipline in the current framework and its on-going importance to the Reserve Bank’s prudential regime. It proposes that market discipline is more likely to be effective if three conditions are met:

  • market participants have useful information and the ability to process it;
  • market participants have incentives to monitor financial institutions; and
  • market participants have the right mechanisms to exercise discipline.

The article argues that the Reserve Bank encourages market discipline by supporting these conditions, and that the added emphasis on the regulatory pillar has not diminished the importance of market discipline. Market discipline remains a central and robust component of the Reserve Bank’s regulatory approach.