Transcript of Question & Answer Session The Evolving Risk Environment

Thank you very much an excellent presentation. I was registered to attend the Basel Risk Committee last year and together we bought the capital rating requirements back down from $40 billion to $20 billion leaving money in the economy for the investors. Is the Basel Committee, which does not evaluate the effect of their requirements, a risk for the Australian economy?

Thanks for that question. The Basel Committee is doing a lot of work on a lot of different fronts and mainly what they're about is strengthening standards for banking, so that includes things like strengthening capital and liquidity standards so banks are now being required to hold more capital overall and to have better liquidity management. And there's a whole raft of things that are being done to improve the risk management framework that surrounds all of that. You did say something about evaluation of the impact of all of that and the Basel Committee does have its own Secretariat which does its own impact analysis and they've done a lot of work trying to assess the impact of all of this work and the general thrust of it and the direction of it has been to strengthen banks to make then safer, make them hold more capital.

Now what APRA's doing in Australia is we don't have to slavishly follow Basel, but it is in the interests of our banking system to show that we take the international standards seriously and APRA does take those standards very seriously and they have a very good look at them and look at how they want to apply them here. And what APRA has done has been to do a number of different things to increase the capital requirements for banks and strengthen liquidity management requirements.

Now, all of that work hasn't finished yet, we had a Financial System Inquiry over the course of the last couple of years which recommended that actually we go further in the same direction and APRA is currently looking at what they might need to do, to do that.

Thank you two brief questions. Does Australia, like Spain, face a prolonged period of low productivity following large foreign investments in housing and construction as shown in the BIS study? Secondly are you concerned by the high corporate debt growing by 80 per cent last year, you've explained 150 per cent for household debt to income but government debt as 36 per cent of GDP seems okay, last year to lower the Australian dollar as fast as you can.

I'm going to focus mainly on the second one of those questions because I haven't seen the particular study that you're referring to. But it was a question that referred to really the general economic outlook and prospects. And I think the main observation that I would want to make there is that overall even though people might express dissatisfaction about the level of growth that we're getting, overall the Australian economy has done very well in the post-crisis environment - we didn't have a recession, we didn't have a banking crisis and we've emerged from all of that in good shape. So I think that's the point that I would want to emphasise there.

Now the second part of your questions was focussing on corporate debt, and it is true that corporate borrowing now is rising faster than it had been, but that's from a position where the corporate sector had significantly deleveraged in the post-crisis environment. So if you compare it with the household sector for example, basically the way the household sector responded to the crisis was to increase their savings and to be more cautious in the way they spent money, but they didn't actually reduce debt very much relative to their incomes, they more or less held the level about the same, and now as I pointed out in the talk we've reached a stage in the cycle where they're starting to increase debt again. But corporates, actually they were quite proactive in the post-crisis environment in deleveraging and they therefore I think do have plenty of scope to borrow more to invest more. I think one of the comments that often made about the Australian economy in the current situation is that we're in an adjustment phase post the mining boom, so miners are investing less and we would actually like to see the non-mining sector investing more and that may well involve borrowing more to invest. So I don't think that's a particular area of concern at the moment.

I'd just like to ask a question about the cutting of interest rates, which of course is in the Reserve Bank's view. Obviously the interest rates have been cut quite dramatically in order to stimulate spending, however when an interest rate cut is announced and the Reserve Bank itself says it may cut again, or commentators get in and say we expect three more cuts this year, that cut becomes null and void because people are not going to invest now because they think it will be cheaper later on. I don't know what the Reserve Bank can do about this but do you have any ideas yourself?

That's a very difficult one because as you know there's no shortage of people speculating about what the next interest rate move is going to be and I often joke before I come to these talks that I hope I don't make a career-ending gaff and one of the ways that I could do that would be to make a prediction about interest rates, so I'm not going to do that.

I think the main thing I think to say about interest rates is a low interest rate environment is more supportive of spending and investment than a high interest rate environment, rates are now a lot lower than they were a few years ago and they're well below average, so I think that gross observation should be telling you that we have an environment that is supporting spending and growth. But I don't want to get into specifics about how you manage the process of predicting rate moves - there are plenty of other people that will be talking about that in due course.

But by my observation though for long periods of very low interest rates always end very badly.

I'll take that as a comment and not respond to it.

Dr Edey I gain the impression from your talk, which was fascinating, that you're quite comfortable with the way that the banks in Australia are structured at the moment. I raise this because the other day I was listening to the radio and perhaps other people were as well, and admittedly it was coming from a broker in the UK, but he was implying that the risks that the banks of default effectively I think he was sort of implying, were very similar to those in Europe, which surprised me and I just like you to comment on that.

Well I hadn't seen the specific comment that you're referring to and so it's better if I just try and comment about the strength of the banking system in the aggregate and I think the important reality is that the Australian banks are well capitalised and they have good asset quality. There are a number of different ways that you can measure that and I referred to a couple of them on the way through in the talk today - non-performing loans are low, APRA has a very proactive approach to risk management in the banking sector, and I think that was shown to have served us well during the crisis environment when we avoided the sort of crisis that occurred in other countries. So I think the main thing I can say about all of that is I'm confident that our banks are in good shape and that the supervisor is being very proactive in making sure that banks adhere to sound management practices.

I just wanted to ask, everyone's saying now that we should get into agriculture you know because we have clean food and China has not food and I see it with the A2 milk et cetera, do you think that we're going to sort of get back to that's like our new resource is going to be clean food or agriculture and of course that has other complications because if you have a drought or a flood, do you think that sector of the market's going to increase?

Well that's a very hard one for me to answer I'm afraid because I'm not really in a position to make predictions about particular sectors, I'm not saying it's not a good question, but I'm probably not the right person to be asking that one I'll have to pass on that one.

Thank you for your talk, in a similar vein, given we've reached 24 million people and given the infrastructure audit and the plan released yesterday, is it a good time to be investing in infrastructure of which this – I think there's some quite significant infrastructure gaps in Australia in general and particularly in NSW.

Well I think I'd revert to my earlier observation just to try and keep it reasonably safe and say that we are in a post-resources boom environment and the Reserve Bank has made the comment on a number of occasions that this should be an environment where we would like to see more investment in other sorts of activities and I think that does include infrastructure. And you know one of the drivers of investment demand is population growth, because the more population you've got the more infrastructure you need, the more people you have to employ and the more demand there is for products that businesses are producing and so they need more capacity to produce more output. So logically this should be an environment where people are willing to invest in a whole range of things and the interest rate structure is low that should be supporting that, that's one of the things that we've been saying for quite a while.

So you may choose to pass on this question too, but as a person who's lived in the country for quite a part of my life, many of us are concerned about the country, in particular those who work very hard in the country; have you any comment to make on how we could, as the term goes, move forward in that area? Because we see as investors and those who watch the market an absence of real hope for those who are in the country, thank you.

That's another difficult one I'm afraid. I don't like refusing to answer questions, but sometimes things get asked that are outside my portfolio and I've got some sympathy with the Chinese Governor who I quoted earlier, saying that we're not gods and magicians who can do everything, and really the role of the Reserve Bank is to focus on the system as a whole rather than the allocation of resources within the system, and we try as much as we can to stick to that.

So you can give us no hope. We have no hope.

There may be someone out there who can give you hope, I'm just saying that I'm not that person.

So there's not a voice in the Reserve Bank that is really changes for the country, is that what you're saying?

Well there are plenty of people that are studying developments in the rural sector.

If the Greek financial crisis is over, why? And if it's not over, what might trigger the next problem?

That's another very good question, is the crisis over? It's hard to answer that because, what's your definition of crisis? The way I think I'd like to answer it is to say we're still being affected by the 08/09 crisis, that was really the theme of my speech. It's 7 to 8 years since the crisis hit and we're still grappling with the after effects of it and there are still vulnerabilities that we have to grapple with. So I think that's the answer without saying one way or the other what you call the situation is that we're in, that's what it is, and I think part of what's going on in the early part of this year is that some of those uncertainties that are still hanging over us are coming back to the surface, markets are evaluating are we really on a track that's going to resolve all of these difficulties or is there further work to be done. That kind of re-evaluation is still going on at the moment, but I think having said all of that I also want to emphasise another thing which I also tried to bring out in the speech which is that the market turmoil that we've seen this year doesn't seem to have been triggered by anything in particular in terms of observable fundamentals. If you look at the flow of economic data that's come out since the start of the year you'd be hard pressed to find something that is going to generate and explain the kind of turmoil that we're seeing. So what that suggests to me is it's too early yet to tell whether what the markets are doing is really signalling something that's really happening, or whether it's just a bit of irrational froth, or even whether it itself becomes a force that starts to affect other parts of the global economy, I think it's still too early to evaluate all of that.

Some commentators are becoming alarmed at the increasing government debt, I just wonder if you've got a comment to make on that?

Well I think the general comment to make about government debt is that for many, many years Australia has been a low debt country as far as government debt is concerned and that is still the case. If you do a league table of countries that have got high levels of government debt we don't feature in that. So when people express concern about government debt in Australia, what they're really talking about is the fact that it's rising rather than the fact that it's high, and I think the implication of that is that over time there needs to be a strategy to deal with that but it needs to be put in the perspective of the fact that the overall level is quite low.

Hi just following on from what you said a couple of answers ago. A lot of the commentary I read suggests that the turmoil that's going on in the markets at the moment is actually a reflection of a loss of investors' confidence, in central banks particularly overseas not necessarily here. Given the fact that we've got a world awash with debt, much more debt that existed back in the GFC, how do you see that situation unfolding, devolving if we use the title of your – a play on the title of your talk, do you see it happening in an orderly fashion, is it going to be chaotic? And the other instance to bring it back to why we're here, how would you recommend we position our portfolios?

I think you know I'm not going to make any portfolio recommendations, I think the best answer that I can give is really along the lines of an answer that I gave to a previous question and also to what I said in the talk, which is that there are various different interpretations that can be put on the market turmoil we've seen this year ranging from it's no big deal, to it's an irrational reaction to something that's not really real to, it's really signalling something but we haven't observed the full implications of it yet. I think that it would be conveying a false sense certainty if I made predictions or strong statements about how we should interpret that, but the main point that I tried to get across today is don't automatically swing to the most pessimistic interpretation because that's what you'll see in a lot of the media commentary. There's a kind of a knee-jerk tendency to be as pessimistic as possible and there are various things that should be kept in mind to keep this in perspective and one of those is there just hasn't been very much movement in observable fundamentals to justify the sorts of things that we've seen in the market so far this year.

Well I grant you that debt in quite a number of economies is still high and I said that earlier, but the point I'm making just now is that that hasn't changed very much just in the recent period and in fact, those debt ratios in a number of instances have been coming down and people have been repairing their balance sheets so there's no particular trigger that you can identify in the early part of this year to have generated what we've seen so far this year.

Ladies and gentlemen we've heard a very wide-ranging and well documented presentation today from Malcolm and I'll ask you to put your hands together, thank you.