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This paper explores the complementary use of two instruments to manage capital-account volatility in developing countries: capital-account regulations and counter-cyclical prudential regulation of domestic financial intermediaries. Capitalaccount regulations can provide useful instruments in terms of both improving debt profiles and facilitating the adoption of (possibly temporary) counter-cyclical macroeconomic policies. Prudential regulation and supervision should take into account not only the microeconomic risks, but also the macroeconomic risks associated with boom-bust cycles. It should thus introduce counter-cyclical elements into prudential regulation and supervision, together with strict rules to prevent currency mismatches and reduce maturity mismatches. These instruments should be seen as a complement to counter-cyclical macroeconomic policies and, certainly, neither of them can nullify the risks that pro-cyclical macroeconomic policies may generate. – cycles ; capital flows ; prudential regulation ; counter-cyclical policies

Australian financial prudential supervision is still to some degree influenced by the Banking Act 1945 that restricted the Australian central bank's regulation only to 'banks'. One of the aims of the Campbell Committee Inquiry of the early 1980s was to increase competitive neutrality in the financial system so those financial intermediaries could be treated on an equal footing. The more recent Wallis Inquiry has advocated that this process should be pushed further. As the Australian government is now in the process of creating a single body, separate from the Reserve Bank, to conduct prudential supervision of all deposittaking institutions it seems an opportune time to reflect on the manner in which the Australian prudential supervision has evolved. This paper provides an historical description of the current institutional approach to regulation of deposit‐taking financial institutions and analyses the reasons behind the predominance of institutional rather than functional financial regulation in Australia to date.