Transcript of Question & Answer Session Building Financial Sector Resilience A Decade Long Transition

You are prepared to take some questions?

Yes.

I didn't advertise it I don't think, ahead of the lunch, but we do have an app and there are various questions that have come through. One of them from the audience here is, the Assistant Governor spoke about lending from non-regulated ADIs, has the RBA done work on deposit payment platforms, thinking about competition from fintech that is happening in other countries?

Sure. Let me make a point straight up. I've talked a lot about financial stability and I mentioned that profitability is good for banks, but we also mustn't forget that the competition is also good because competition delivers good outcomes to consumers. So competition from new entrants into the market I think is a very positive thing. And what the regulators really need to focus on is how do you encourage innovation, encourage competition while at the same time protecting depositors? So this is APRA's primary goal - to protect depositors. Now, I think the way we're trying to do it internationally and in Australia, there's been a number of initiatives on that. So around the world we have various regulatory sandboxes where new entrants can come in and try out their offerings, transition themselves into a position where they can meet more fully the regulatory requirements. APRA and ASIC have similar sorts of sandboxes in Australia.

I think it's a very positive thing and I think open banking is another very positive thing for competition because it's very easy for consumers to sit back and it's quite hard to move financial institutions. This makes it a little bit easier perhaps for the barriers to moving to prevail, and therefore the barriers to competition are a bit high. I think the promise of fintech and some of these new innovative platforms is to perhaps lower the barriers and make it easier for consumers to in fact move. So I think personally that the fintechs along with the open banking initiatives are going to make it a reasonably interesting time in banking land.

Another question here, there's a lot of stories in the press about housing prices, but so far the declines look quite orderly and even welcome, but they are clearly a risk factor. At what point do these price falls start to worry the RBA more and become a real threat to the economy and financial system?

Sure. The housing market, a few years ago was getting lots of attention because prices were going up too quickly. Now they're coming down, I think in a reasonably orderly fashion. I find it quite amusing in a way that there's a lot of concern that prices are coming down when a few years ago everyone was concerned that they were going up too quickly. I wouldn't put a number on it, but I would make a couple of points. The first is that the rate at which it comes down probably matters. So if you had a 10% decline over two months, that looks very different than a 10% decline over a year. So I think that the duration of it makes a difference.

From a financial stability perspective as well, what we're interested in is household and bank balance sheets. These housing loans are very well secured by the banks. Bad and doubtful debts are very low. They've risen a little bit, housing loan arrears have risen a little bit, but that's mainly due to Western Australia, which had some very challenging economic conditions. But they remain very low and they are very well secured. So I think that even if housing prices come down a bit more, historically they might come down 10% or so on average. If they come down by that much, it's not going to have a large impact on banks' balance sheets.

Households as well generally have not borrowed the maximum amounts that they were eligible to borrow, so there's good reason to think that the households are in a reasonable position to handle that. And owner occupiers really, unless you were a distressed seller and you've bought at the peak, you're probably still going to be in a reasonably good position. So we are obviously concerned about that. We're concerned about perhaps the cycle in housing prices being amplified and that leading to a domino effect if you like, but at the moment there's no signs of that happening.

Any questions from the floor?

Michele, thank you. Over here, sorry. Thank for you for your insights. I'm just interested in your thoughts about Aussie dollar funding stresses. We've seen short term funding stresses offshore in particular over the year, but pockets of Aussie dollar funding, I think largely linked to offshore holdings of assets, some of which I think might be linked to risk weighted assets being sold down in Australia where they're kind of going. Obviously, that's flowed through some of the domestic short term Australian domestic markets. We obviously see that as a commercial risk. Do you see that as a financial stability issue? How does the RBA stand on that?

It's an interesting question and we talked a little bit about it in the Financial Stability Review. I'll preface my remarks by saying I'm not a financial markets specialist and they obviously are much more involved in the detail of this than I am. There were some special factors in the initial run up which were related mainly to international factors, but Australian funding rates haven't come down. BBSW spreads for example, haven't come down by as much and part of that does seem to be associated with perhaps some of the regulatory liquidity changes. That in and of itself I don't think poses particular financial stability risks, but we do mention in the review that, to the extent that it might indicate that in periods of stress the markets might find it a little more difficult to adjust, then it's something that certainly we will be keeping our eye on.

Michele, with respect to the committed liquidity facility, what assets can the banks repo into that and under what circumstances can they repo into that and has it been tapped?

Sure, no it hasn't. So basically, what most of them do is that they hold self-securitised mortgages. So they're not high-quality liquid assets, but most of the banks hold self-securitised mortgage assets on their balance sheets, eligible to be a repo'd with the Reserve Bank for liquidity at appropriate haircuts and so on. So there's a process every year in which the Reserve Bank looks at the stock of high-quality liquid assets out there, makes a judgement on what portion of that can be held by banks without affecting the liquidity more broadly of the market. So the idea is that if we don't have enough, and they're all held by the banks, there's no liquid market in it and that's clearly defeating the purpose. So the Bank makes a judgement on that. APRA makes a judgement on, how much high-quality liquid assets the banks require for the purposes of the LCR, and then we make up the difference basically by this committed liquidity facility.

To use it, APRA has to approve it being used and the Bank has to be happy that the bank itself is in a solvent position and a going concern. But there's a whole process around it. It's something that's able to be done in terms of the Basel III framework, particularly aimed at jurisdictions where the supply of high-quality liquid assets was not enough to meet the regulatory requirements.

[off microphone] accesses effective insurance for the banks.

It is, and they pay for it.

[off microphone] in conflict with responsible lending?

So I think we just have to make a distinction between the liquidity rules and the supervision and the capital side of things. So the liquidity is all about addressing the concerns that in stress periods, the bank may be solvent, but because of the drain on liquidity, they need enough liquid assets to meet those requirements. I think the issues about responsible lending well, if you're talking about responsible lending from a consumer perspective, typically that's an ASIC thing. But if you're talking about lending standards and banks applying appropriate lending standards, that's addressed through APRA's supervision of the financial institutions. And also ensuring that the banks in their modelling, in order to generate their risk weighted assets, that banks are taking appropriate account of the probability of default and the loss given default. So I think all those things are more combining the supervision space and the capital space, but liquidity I think is a separate thing. I don't think it contributes to them being loose.

There's another question over there on the right.

Michele, thanks for your speech. I have a question on interest-only lending. When interest-only loans convert to principal-and-interest loans, the repayment typically increases significantly, has the Reserve Bank done some research on how much of that increase in repayments is a risk to consumer spending?

Good question. So we have done a little bit of work on that. So part of the side effect, if you like, of the committed liquidity facility is that we actually have a whole lot of data on the loans that banks have securitised that would be a repo-able to us. And although it's not a full set of the market, it gives you a pretty good idea of individual loans and the conditions in which they're made, loan balances, incomes, these sorts of things. So what we know from that information and from liaison with the banks is that generally there's three categories.

There's people who when their interest-only period expires … well, let me go back a step. There's people who, when interest rates went up thought, you know what, I'm going to move to a principal-and-interest now. And the feedback we have from the data and from banks is that those people are managing things just fine. And in a way it's not surprising because from about 2014, APRA was requiring banks to measure serviceability based on those higher principal-and-interest payments. So they weren't measuring serviceability based on interest only, and they were also requiring banks to take into account and incorporate buffers into loans or interest rates on other debt so that there was actual buffers built in from about 2014.

There's a second group who have to transition when the interest-only loan expires or try and get another interest-only loan. And we think there's a reasonable portion who actually will still meet the more stringent lending standards and can just continue on with interest-only. And there's a relatively small group, it's not insignificant, but there's a chunk which might have more difficulty translating into a principal-and-interest loan.

So, to summarise, our analysis suggests that most borrowers are actually okay. They'll either be able to continue their interest-only, or they're able to transition, there is a relatively small group that might have some more difficulties. So on balance we don't think it's going to have a very big impact on credit or on consumption through that route.

We have a question here on the left, at the back.

Thanks very much for that speech. You said that changes to business models to address the risk of future misconduct could more permanently impact banks' financial performance. Could you perhaps expand on what changes specifically to business models? Maybe expand a little on that point to what you're thinking of in particular?

Sure. Well, some of it's happening already, and I mentioned that one of the reasons why profits haven't been going up is that there's been less non-interest income as banks have started to sell their wealth businesses in particular, their life insurance businesses, those sorts of things. So there's that change in business model, the vertically–integrate-everythin-here model. I think that's changing. So that's having an impact. I highlighted the shift away from corporate lending into mortgage lending. The big banks all have very similar models now, they're very heavily weighted towards mortgage lending and that's quite profitable at the moment, but if there's more competitors coming in there, then that might have an impact as well.

As an aside, I would add that the fact that all the banks are so heavily weighted towards mortgage lending introduces a systemic component to the risk. Although housing lending itself, is relatively safe and relatively well secured, the fact that everyone is so concentrated in that adds financial stability risk. That's not quite the question you asked, but I think that's a point worth making. So I think really it's about seeing them restructure and I think they might have to make some changes to the way they sell their products as well, which might impact as well. So there's a series of things I think that as I said, at the particular business lines, the way they go about selling their business, the way they go about competing, that will impact that.

Another one from the app. The Labor Opposition Party is going to the next election with the policy of removing negative gearing and reducing capital gains tax concessions for housing. Is this contributing to current weakness in house prices? Could this be something that turns the fall in house prices into something more severe?

So the Reserve Bank is on the record of saying that negative gearing and capital gains discount on housing is something that should be examined holistically and in the context of taxation. So we're on the record as saying that. Would an introduction of that impact now? I guess what I would highlight here is that at the moment investor lending is not growing at all. So the impact of APRA's measures, the resulting increases in interest rates on investor and interest-only lending and the tightening on lending standards have resulted in fact in a situation now where investor lending is not growing at all and we haven't seen in those circumstances a complete tanking in the market. It's come off a bit, but as I said earlier, what you've seen is a bit of a switch towards owner occupiers and first-time buyers, which is actually a positive thing.

So I don't know the outcome. I'm not going to forecast what the outcome might be. I guess my point would be that we've already seen investor lending come off a long way, not growing and we haven't seen a complete rout in the housing market. So I think that's probably a positive sign for the way you can bring investor lending off and not necessarily end up with problems in the housing market.

One more over there on the right.

Thank you. Michele. Blockchain and Crypto Currencies have been part of the periphery discussions both at this conference and last week at SIBOS when all the bankers were in town. Can you share how the RBA is deliberating on this technology or phenomenon and what sort of interaction you're having with other central banks about it?

Sure. So I probably wouldn't say anything particularly new here. First point I would make is that crypto currencies from a financial stability perspective, are just a non-event, they're small. We've all seen them go up in price and down in price. People that perhaps bought them at very high levels by borrowing might now be experiencing problems, but banks aren't really exposed to them. It's quite a small market, so there's not a financial stability angle. I think a lot of the interest generated out of that has been more on the blockchain or distributed ledger technology, and there's also been a fair bit of conversation about whether central banks would in fact issue these things. Central bank digital currencies are not actually wedded to a blockchain. You can issue a central bank digital currency without involving blockchain or distributed ledger. The technology is separable from the point.

So I think mainly where central banks around the world are thinking about this at the moment, there's a lot of interest in thinking about what might be the case for a central bank issuing a digital currency, whether that be on a blockchain or not. Some banks are looking at it more seriously than others. The Swedish Central Bank you probably know is looking quite seriously at whether or not there might be a need for it and what its role might be. But I think broadly, most central banks around the world are wondering what the use case is. We haven't been convinced yet that there is a use case for a central bank digital currency.

In fact, I usually make the point, apologies for those who've heard me make it before, but in fact, we do issue a digital currency. It's exchange settlement accounts at the Reserve Bank - that is central bank digital money. So generally what people are talking about in this context is would we issue a central bank digital currency to us, you and me. I think at that point the central banks are saying pretty much around the world, we're not really convinced what the point is here, what the business case is, what problem are we trying to solve?

Okay. Well, I think we've probably exhausted questions, but certainly our time. So, just please join me in thanking Michele for a great presentation.