Australia’s Love of Credit Set to Continue

Australia’s love of credit isn’t likely to fade anytime soon, a conference in Sydney was told last week. But that’s no bad thing.

The Banking and Financial Stability Conference, hosted by the University of Sydney Business School, brought together senior representatives of the US Federal Reserve Bank, the Reserve Bank of Australia, the Australian Prudential Regulation Authority, the Bank for International Settlements, and The Bank of Finland.

The one-day conference also discussed:

• The current global obsession with monetary policy;
• The constant pressure banks face from new fintech players; and
• The Brexit vote and what its broader impact could be.

“Over-exuberant Lending”

The Reserve Bank of Australia’s Head of Financial Stability Department, Luci Ellis, spoke on the topic of ‘Financial Stability and the Banking Sector’.

Ellis told the conference that Australia’s ongoing need for credit can mean that the value of a well-functioning creditor sector is sometimes under-appreciated.

“Especially since the (global financial) crisis, the dangers of too much credit have become all too apparent. Over-exuberant lending and borrowing can mean that some people are getting loans that they have little prospect of being able to repay, even in good times.”

Importance of Credit

Less well appreciated are the costs of having too little credit available, Ellis added.

“The point here is simply that in recognising that too much credit can be dangerous, we should not instead fall into the trap of thinking of all borrowing as illegitimate, or somehow immoral. Less credit isn’t always better,” she said.

“The low credit levels available in regulated past decades are not the benchmark we should be evaluating ourselves against now, when trying to assess risk in the system. Some activities can and should be financed with at least some debt, even in bad times. And even thought there are plenty of others that should not.”

While Australia doesn’t have this problem, some recent examples overseas show the damage that can be done when there isn’t enough credit available, Ellis told the audience.

“Australia is one of the more bank-orientated financial systems when it comes to providing credit, but it is hardly alone. Some of the countries at the lower end of the range, such as the United States and Canada, are there partly because their governments support the securitisation market in various ways.

“These interventions allow banks to take some exposures, particularly mortgage exposures, off their balance sheets. In some cases they also allow some non-bank loan originators to operate at larger scale than might otherwise be possible,” Ellis says.

Broader Brexit Impact

Conference Co-Chair and Associate Professor in Finance at Sydney Business School, Eliza Wu, says pull-back in bank lending to Asia-Pacific by global, and in particular European, banks can be expected as a result of the Brexit. This is a major concern for the region’s investment and growth.

“This trend started with the GFC, continued into the European debt crisis, and now with Brexit,” Wu says.

Wu told the conference that, “enhancing financial stability in the face of unprecedented monetary policy regimes, and new risks that have developed, will remain a major challenge for policy makers and conference attendees alike.”

Associate Professor within the Discipline of Finance, Professor Suk-Joong Kim, added: “The most immediate concern is the increased level of uncertainty and volatility expected, and experienced, in the international financial markets due to the Brexit vote. Brexit has cast doubt over London as the world’s most important financial centre, and the future of the international banks that operate there.”

Regulation & Supervision

Luci Ellis also spoke on the role that major banks will play in the future. In a world where banks are central to financial stability, they will always need to be regulated and supervised.

“The Australian financial system has managed to weather the external shocks of the past two decades reasonably well. Strong prudential supervision has helped achieve that positive outcome.”

However, supervision goes far beyond ensuing that banks have enough capital, she added. History shows that banks can have much higher shares of capital in their liabilities than we see nowadays.

“We should remember that the policy measures that safeguard the liquidity of bank deposit liabilities, such as deposit insurance and liquidity provision by the central bank, can create incentives for banks to take those risks,” Ellis said.

“If the ultimate goal of financial stability policy is the real economy, it isn’t enough to require banks to hold enough capital to absorb losses, while disregarding the scale of those losses. The losses themselves can represent distress in the economy. The holders of capital are often part of the same economy, so absorbing the losses does not make them go away,” she says.

“Absorbing the losses, and thus avoiding a collapse of the banking system, prevents knock-on effects to other parts of the economy, which is better than nothing. But it would be irresponsible to disregard the risk profile of the banking system’s assets, as long as banks have enough capital to cover those risks,” Ellis says.