Learning the Lessons of the Past

It has been six years since the GFC, and whilst Australia escaped the worst of the global recession, many businesses felt the pinch of the ensuing credit crunch. It seems that everyone is keen to move on and put the experience behind us, but it would be a mistake to forget the lessons we so painfully acquired.

Not least amongst them is the potential for systemic failure in the financial system, and how quickly sources of capital can dry up and become an anchor rather than a float for an economy trying to fight its way out of a recession. Arguably, Australia survived the GFC based more on the lucky timing of the Chinese driven commodities boom, than our regulators explicitly prohibiting the banking activities that led to the crisis overseas.

The near future does not look so bright for Australia. Historically, the end of a mining investment boom has been marked by a recession. It remains to be seen if we’ll manage to avoid the prevalent downside risks, or if our luck will run out. The 2012 Financial System Stability Assessment of Australia by the IMF made clear the risks of our current financial system: a combination of high household debt, elevated house prices, reliance on offshore funding, and a highly concentrated and interconnected banking system.

Australia’s four major banks hold 80% of banking assets and 88% of residential mortgages – the highest concentration of banking assets of any developed nation, and the largest exposure to systemic risk. There are major implications for competition, with the IMF noting the major banks are “enjoying a funding cost advantage derived partly from implicit government support and earning larger net interest margins than smaller banks and international peers”. No wonder the non-bank lending sector has all but collapsed in Australia, despite our booming housing market.

The near future does not look so bright for Australia. historically, the end of a mining investment boom has been marked by a recession.

APRA followed up on the IMF’s report by identifying the big four Australian banks as Domestically Systemically Important Banks (DSIBs) requiring 1% of risk weighted assets as additional capital. However, this was at the bottom of the range recommended by the IMF and APRA also allowed the banks to reduce management capital buffers to allow for this increase. The net impact was no actual capital increase for DSIBs.

The government is to be commended for instigating the Financial System Inquiry (FSI). This is an important time for actuaries to add their voices to the debate. As experts in financial risk management, predictive analysis, longevity and consumer behaviour we have a significant and useful contribution to make.

In December 2013, the Actuaries Institute recommended that the FSI terms of reference be expanded to include: additional data on the financial service industry; a debate on the balance of market efficiency and prudential security; the impact of the longevity challenge; the role of superannuation and SMSFs as providers of capital; and the role of general and life insurance. Most of these have been included in the FSI’s revised terms of reference. A working party has been set up to provide further feedback both now and after the draft report has been published. I encourage you to get involved.

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