Speaking at the Melbourne Institute on Friday, RBA assistant governor Michele Bullock explained how a concentrated banking system such as Australia’s – where the major banks share 80 per cent of the market – has its benefits and drawbacks for financial stability.
After outlining that competition and innovation “are to be encouraged”, Ms Bullock balanced her argument by saying that regulators “need to be alert” to any potential implications for financial stability.
The actions taken on housing lending in Australia over the past few years, she said, are an example of how active supervision can address risks that might arise in an environment of heightened competition.
“Over the past few years, the regulators had observed very strong growth in lending to investors for housing. Furthermore, a large share of that lending was interest-only for the first 5-10 years of the loan – that is, the loans were not being amortised for a very long time.
“And this behaviour was being fuelled by competition between the banks. Individual banks were reluctant to pull back because if they did so, the business would go to their competitors.”
Concerned about the financial stability implications of this behaviour if it continued, APRA decided to implement macroprudential measures in 2014, when the 10 per cent speed limit was introduced on investor loan books.
This has been supported by ASIC’s work on responsible lending and further action from APRA in interest-only lending earlier this year.
“As Wayne Byres (the chairman of APRA) recently highlighted, the concerns that prompted action were not about competition on interest rates or customer service standards. Rather, the concern was that competition was manifesting itself in an erosion of lending standards,” Ms Bullock said.
“Not only were the banks taking on more risk, but households were carrying a higher level of debt that they would have to service, which could be particularly concerning in the event of a shock.
“In other words, it was a financial stability issue not only because of its potential impact on banks' balance sheets, but also because it was increasing the vulnerability of the household sector,” she said
The RBA assistant governor’s comments come after last week’s announcement by APRA on new capital benchmarks for Australia’s banks. Following the basel committee’s guidance on systemically important banks, APRA has now tasked the majors with holding additional capital. The big four must now raise or release around $9 billion of capital by January 2020.
“The higher capital levels and greater intensity of supervision provide confidence that, notwithstanding the systemic importance of the major banks, the Australian financial system is more resilient to shocks than it was in the past,” Ms Bullock said. “But there is still a need to consider what might happen in the event of a bank failure.”
Ms Bullock concluded that the success of global initiatives to address the issues that arise when a bank fails “remain to be seen.”
[Related: CBA ‘has work to do’ on APRA benchmark]