John Laker, Chairman - Senate Standing Committee on Economics, Canberra
Since the middle of 2007, when the global financial crisis first erupted, I have provided this Committee with regular updates on how the Australian financial system has been faring and on APRA’s supervisory activities. Looking back over this whole period, it has been nothing short of a roller coaster ride in global financial markets.
At the time of our appearance last October, the roller-coaster was gaining downhill speed, with renewed market turbulence generated by weaknesses in the public finances of the United States and a number of European countries, and in the balance sheets of European banks. By February, the roller-coaster was on an upwards climb, to a period of relative calm and improving sentiment in global financial markets. Now, we are heading downwards again and the ride is becoming ‘white knuckled’ for many.
The triggers for the recent loss in market confidence were, as we know, the election results in Greece and France, followed by further difficulties in the Spanish banking system. The integrity of the euro area and public support for austerity programs in a number of the weaker European economies are being called into question. In this highly unsettled environment, global and domestic equity markets have retreated, credit spreads in global funding markets have widened, and prospects for global growth, which were being ratcheted up a little in official forecasts, are again uncertain.
Our assessment is that the Australian banking system remains well placed to deal with this latest period of market turbulence, which may run for some time. This is the same assessment I provided the Committee last October, and it is based on the same fundamentals. To repeat these:
- authorised deposit-taking institutions (ADIs) in Australia have solid profitability and are holding historically high levels of capital;
- the larger Australian banks have only very limited direct exposures to euro area countries under the greatest strain;
- the larger banks have also significantly lengthened the maturities of their offshore wholesale funding since 2008; and
- ADIs are holding high levels of liquidity supported by continuing strong retail deposit inflows.
Despite their limited direct exposure to Europe, the market turmoil that would accompany any break-up of the euro area or a European sovereign or banking default would undoubtedly impact on the larger Australian banks, due to their reliance on global funding markets. The banks are well aware of this risk and have planned accordingly. The larger banks have been relatively successful in issuing longer-term unsecured offshore funding in recent months, and have mostly completed their planned funding programs for the immediate period ahead. Despite the market volatility of recent days, some larger banks have been able to tap offshore term funding sources.
The major banks have also all undertaken covered bond issues and this has established a market for these instruments. All retain significant ‘headroom’ between issues made and the maximum limit they are able to issue, giving them the capacity to issue more covered bonds if additional funding challenges arise.
APRA continues to monitor this situation closely. At this stage, the strengthened liquidity positions, coupled with the capacity to issue covered bonds and the unused self-securitisations that can be used in repurchase transactions with the Reserve Bank of Australia, provide APRA with comfort that ADIs could survive a period of months without access to global term debt markets, provided domestic markets continue to operate relatively normally.
Looking through these dark clouds from Europe and uncertainties about global growth, the domestic foundations for the continued strength of the Australian banking system are solid indeed. The prospects are for near-trend economic growth in 2012 and 2013, the terms of trade remain high, inflation and the unemployment rate are low and the fiscal position strong. Nonetheless, credit growth remains subdued. In this environment, strategic ambitions will be crucial in determining how ADIs maintain their financial strength and profitability in a durable way, and these ambitions are a key topic in APRA’s regular discussion with boards and senior management.
APRA is also monitoring the exposure of the insurance and superannuation industries to the volatility in global financial markets. These industries are exposed both to falls in share markets and increases in credit spreads. They have coped with volatility on this scale before and APRA expects that they will continue to do so.
A quick update on prudential policy matters. Since we last appeared before the Committee:
- APRA has released its draft prudential standards for implementing the Basel III capital reforms;
- APRA has finalised its review of capital standards for the general and life insurance industries and will be releasing revised standards in the next couple of days; and
- APRA has been consulting on its draft prudential standards for the superannuation industry.
This last point provides an appropriate segue to an opening statement on superannuation by our Deputy Chairman.