Transcript of Question & Answer Session Financial Stability and the Banking Sector

Just a quick question about lending standards. What’s your view of the strength and quality of lending standards here in Australia, taking into account what APRA has been doing over the last year or so?

Well what I’d probably do is refer you to what we’ve said in the last couple of Financial Stability Reviews, there were some things that when the regulators dug around we found were a bit unattractive. But there has been a material strengthening of lending standards over the past 12 or 18 months, that’s been welcome. But as we said in … I now forget whether it was the April one or the October one, the lending standards that we had even 18 months ago were [not] as, you know, certainly stronger then they were in the lead up to the crisis even in Australia and massively better than they were in the US in the lead up to the crisis in 2007.

But there were some things that needed to be tidied up and certainly our colleagues at APRA and ASIC have been heavily involved in that. So we’re much more comfortable with where they are now.

Yes, so at the side, and then there’s another one.

Kristie [inaudible], UC Berkeley. So we’ve seen the rise of technology companies that have been trying to do – different types of companies. Some are trying to take essentially the predictable part of the payment system out of the banking system and some of them have been trying to take the more predictable and hard information, part of the debt, out of the banking system. Presumably both of those will lead to higher volatility either in the liquidity demands or basically some sort of effect on the balance sheet of the loans that banks make. So I wonder whether or not you think that this is something that we should wait and see what happens or should it be something one should be proactive about?

Well I think we should always care about … Thank you for the question, it’s a good one. I think we should always care about the risk profile in the banking system as well as the risk profile in the other niches of the banking system. I guess, as I mentioned in my speech, we have seen this movie before, or at least its prequel. Let’s see how much of that business actually does get carved out. I mean I’m a technology optimist, I’m possibly one of the biggest nerds in the senior management at the RBA but, we also know that a lot of that technology will end up getting used by the banks. I mean that is exactly what we saw in the 90s.

Over here.

Hi Luci, I’m [inaudible] from Kaplan Professional. I have an enquiry to you at the Central Bank of Australia. The major banks or banks are having high concentration in home loans. Now given the conditions in the market, the real estate market, if something happens in the downside what would be the threat to the financial stability of Australian banking system?

Thank you for your question. It is one I’ve been asked before, unsurprisingly, and the answer I will usually give is: what alternative would you have them get into in terms of their business model? As we said in the 2014 submission into the Financial System Inquiry, the banks in Australia have coordinated on a low risk business model. Everything else they could be doing other than lending on mortgages is higher risk overall. It is true that if that particular segment of the book went bad, that would be very damaging to them because it’s very important to their business. But all of our … The stress tests that our colleagues at APRA have done have generally shown that by the time you’ve got to a position where the mortgage book is sending you out of business, you’ve already gone out of business in the other lines of business, because of the other bits of the business that you have.

So, it is very much the ballast in the banking system. You’ve got this big wodge of lower risk business in the banking system rather than somewhere else.

There was someone up here and then maybe along the side there.

Dr Ellis, thanks very much for the speech. Jonathan Shapiro from the Financial Review. I had a question about the credit rating, both the sovereign rating and the potential impact for the banks’ credit ratings. It’s something that FSI seem to emphasise the importance of, I’m just very interested in the RBA’s perspective and your perspective on the implications of a potential downgrade.

Well I don’t think I want to give the whole chapter and verse about the transmission of any particular shock. Credit rating agencies are entitled to their opinions and they will always tell you that they are just opinions. I think it’s fair to say that countries that have experienced sovereign downgrades from where we are to the next level down generally don’t see much of an effect on prices given everything else. And so that’s the thing you’ve got remember, is you’ve got to think about what else is going on. Often, the ratings downgrade is sort of a validation of what the market had already thought. So the answer is possibly not much.

Then there was someone down the side and then there’s some more in the middle. So maybe … Okay. Or maybe this lady at the far edge because I know that’s kind of a bit further away from you so I don’t want to ignore that side of the room and then there’s a whole bunch of people through there. So lady in the pink. So if the person over the far side could come down to the lady in the second row in the pink, and then there’ll be some more turns. It’s kind of hard to actually tell who’s got their hands up at the moment; it’s a big room.

Thank you very much. Nadia Massoud from the University of Melbourne. I just witnessed like in regard to the loans that banks start to compete in different front which they find Fintech for example, and peer to peer lending. For example NAB launched recently a new product which is competing for online loans and competing directly with this type of business. What’s your view on this? Like this is more moving towards a risky space and to compete and to survive in this market?

Thank you for the question, but I would just refer you to the speech. There will always be niches for higher risk lending. But again, there is this issue about the resource cost. The economics of the disaggregation can work at smaller scale but because of the economics of intermediation and having an agent who only has to do the credit risk assessment once is actually more efficient. So it is actually very hard for disintermediated and peer to peer finance to outplay that cost advantage. So what you’ll tend to see is segmentation where the lower risk business is in the large institutions where they’re being supervised and they can fund themselves more cheaply, whereas the higher risk business will be in the peer to peer space which will be looking for a lot higher returns anyway.

So the people who need a higher return won’t be doing a lower risk business and that’s exactly what I addressed in the talk.

So there was some people up the side here and this lady did have her hand up for a while.

[Off microphone]

It isn’t on. No, there’s a little switch probably.

Okay, good it’s on. Gail Pearson, University of Sydney Business School. Luci thanks for your talk. You talked about habits and you also talked about financial stability as a matter of the whole of the system. Given developments in the Netherlands, given statements that have been made in the Australian context, do you have any comments on the culture conversation and how will APRA regulate culture within the banking system.

Well, you should ask Charles that question, not me.

I thought you might have some different comments.

But he isn’t allowed to say anything today. So certainly it is the case that culture matters and it’s hard to measure. I think there’s been some really interesting work being done recently, as you’d be aware on culture. I have to admit I wrote about good lending and borrowing habits without yet having a fully-fledged analytical framework for what that is. We do in the Reserve Bank actually have a bit of a small simple analytical framework for thinking about lending standards, but it isn’t internationally accepted. I’m happy to offer it to the world, but my suggestions have gone unanswered so far. I’m not sure exactly what you’re referring to about the Netherlands other than the fact that they’re trying to get their loan to valuation ratios down below 125, is that what you’re referring to?

Just that they think they can regulate culture.

Okay. I wasn’t aware of that and I think that is probably more one for the supervisors rather than for me. But, you know, culture matters everywhere and I think you see that across a range of different organisations whether it’s, you know, bullying behaviour in the military or whether it’s in the behaviour of fund managers, these things all matter and it is hard to do. It’s hard to make it into a tick and flick quantitative set of criteria. It’s hard to do compliance. But supervisors have soft skills. They know when an organisation has poor culture and a supervisor that’s got enough flexibility in the way it approaches supervision and isn’t having to say, oh we’re doing it according to a rule book, has got more scope to do that than perhaps one where they have to be black letter regulation.

Okay, there’s … I am not going to be able get through all these questions, I’m really sorry, but there’s a gentleman who has already got a microphone, so I think possession is nine tenths of the law and there’s another gentleman over here. So how about one and two and then there’s a lady down the front here. Okay?

Can I ask a question not about the status quo but about changing or overhauling the structure of the banking according to the new positive money movement in England and fair money in Australia or some other names in other parts of the world. Do you think it has any chance of success to give the seigniorage right back to Reserve Bank rather than giving that to the commercial banks?

Okay, so seigniorage is actually something that only happens with cash because it costs less than $20 to print a $20 note and I will tell you that the only other thing I can say about Seigniorage is I’ve spent 25 years as a central banker and seigniorage is just never one of those things that we care too much about. It is just such a second order issue nowadays.

I know, I’m talking about the credit that is used as money …

Okay, yeah. That’s okay, now I understand what you’re talking about.

Yeah.

Look, well that’s the point I made in the speech. As a society we’ve decided that private sector entities can accept deposits and give credit. So the alternative that I was discussing in the speech is, do you want that to be a government monopoly? But the two choices for the system to work are you either have private sector entities that have government regulation and backing through liquidity support and prudential supervision or you have it being a government monopoly and those are the choices because unless of course you’re willing to have lots of financial crises.

[Off microphone: Is there any serious consideration of, at least looking at that seriously because I even saw there was a debate in England [inaudible] about possibly what it … So I thought it maybe something that is [inaudible] in the future to point to their solution that they are suggesting but we don’t have time to discuss here …]

I don’t think we’ve got time to discuss it here I think. But there’s been so many post-crisis regulatory reforms that one’s a long way down the list.

So there was a gentleman over here and so whoever had the microphone in this section?

[Off microphone [inaudible] Bloomberg. You sounded a lot more confident on lending standards by your earlier answer. Does that mean that worries about inflating asset prices for lower rates [inaudible].]

Thanks for the question. We’ve never specified our concerns as being specifically about the level of asset prices, neither we nor APRA have done that and I think one of the interesting debates in the policy world at the moment has been whether you should have intermediate targets for financial stability policy and I think part of the drawbacks to having them is you get this kind of confusion where, what we want is a resilient banking systems and resilient non-financial sectors and that means having strong lending standards. And then what people sometimes hear us think, they think what we’re saying is something about asset prices, and that’s not what we’re saying.

I think we have time for one more question and then – so if anyone has got something really burning and is right next to the microphone, that’s probably – sorry that you missed out.

Rosalie de Gabriel, UTS Business School. I think you alluded a little earlier to maybe an answer in here, but with the inroads of Fintech and Bitcoin I’m just wondering what your concerns might be particularly as they gain prominence in overseas markets?

Well I think one of the issues around Fintech, Bitcoin and Blockchain is that everyone seems to spend all their entire time on conferences about Blockchain. So that may be a consumption of real resources that we might not otherwise choose. And I would note that Bitcoin … One of the things I talked about, free banking didn’t work precisely because it didn’t actually offer a predictable nominal value and neither does Bitcoin and so while there are some very interesting applications of Blockchain that are going on even in the mainstream financial sector and again we say, oh Fintech will disrupt. Well, no banks will use tech. So there will be some disruption but there will also be banks using tech.

So there’s some very interesting things going on, if you’re into that kind of thing but again, it’s hard to see it in the short to medium term as anything other than, well, you know, the financial sector always innovates and there’ll be some interesting things and some of them might pose risks but not all of them will.

We have to finish but just simply because Dr Loretta Mester gave the previous keynote address, she spoke about the US system when monetary policy and employment are the key functions of the US Fed but also she brought the perspective of financial stability and complementarity of these three policies. I thought it would be good for this audience because we have got some international visitors as well as our own local participants to hear from you the way in which the Reserve Bank of Australia looks at these three policies and the way we differentiate between these three or not. Thanks

Thanks Fari, well what I understood your question was really about how we get our financial stability mandate and of course, you know, the interesting thing about Australia is APRA is the one with the financial stability mandate in its legislation and the Reserve Bank doesn’t actually have the words financial stability in its Act, and there are several places where it’s implied or made progressively more explicit. So as you mentioned the Fed’s mandate is price stability and full employment. In Australia the Reserve Bank Act says stability of the currency, so price stability, full employment and the economic prosperity and welfare of the Australian people and that’s the one we derive our financial stability mandate from. I talked about this at length in a 2014 speech to the University of Adelaide which you might want to refer to, because that’s where I talk about that way that we get at financial stability is precisely the reason why we see it as being about the whole economy and not narrowly about a particular financial sector or the financial sector more broadly. And, you know, we spend a lot of time in financial stability looking at the non-financial sectors.

So it is a slightly different mandate but it has long been understood to imply financial stability but in particular again, in one of the great ironies of Australian politics, that the Reserve Bank’s financial stability mandate comes from the Second Reading Speech of the APRA Act and the Treasurer of the day said, oh of course, you know, the Reserve Bank retains its longstanding responsibility for systemic financial stability and so that’s where we derive it from. I mean Second Reading Speeches are part of the legislative framework, so we take that seriously and that has been also reflected now in the formal Statement on the Conduct of Monetary Policy that talks about financial stability explicitly. So there’s several layers – it’s not exactly in our Act, but the way that it’s indirectly in our Act is quite important for how we interpret why we’re here.