Transcript of Question & Answer Session Changes in Banking Looking Back and Looking Forward

Thank you very much, Jonathan. Any comments or questions about Australian banking system as well as global banking system?

If I could ask you just two questions. One more directly related to your remit on financial stability and the second more on the theme of the conference about climate change, if that's okay?

So the first is Deloitte forecast that super funds are going to own roughly two thirds of the share market in about 20 years. They're obviously huge holders of infrastructure and also are lending to private companies. So I'm wondering what risks to stability does that high concentration of ownership pose and whether you've thought about that in your oversight of financial stability?

And the second is on climate change. One big trend we saw this year was countries like Sweden's central bank dumping Queensland and Western Australian state government bonds over climate change concerns. I wondered whether that was a trend that you saw continuing into next year and what kind of risks that poses to the economy?

Okay, thank you. First of all, the increase in superannuation funds is something that's been happening for many years, it's a long moving trend. The important thing to note about superannuation funds is that they're not actually by and large individually leveraged and it's leverage that we typically find is the greatest contributor to risk in the financial system. But super funds do still have a role to play in financial stability. They individually have a very large share of deposits at banks. They own about a quarter of banks' equity and also fund about a quarter of banks' short-term debt. So they're certainly important and what we need to understand is how their role changes and how they respond to financial shocks.

So we can look at the financial crisis, and we've done that to an extent, and … the superannuation funds seem to actually play somewhat of a stabilising role. The important thing is that the superannuation system is actually effectively a closed system. And so, the funds can move from one super fund to another but by and large they can't leave the superannuation system and so that provides a degree of stability. That will change to an extent as the superannuation system moves from being more of a paying-in stage to a paying-out stage with the ageing in the population and so that's something that we'll need to monitor. But this comes to superannuation funds having their appropriate liquidity standards and things that they need to manage.

On climate change, this is a growing issue for financial stability. It's something that central banks and other regulators around the world are paying significant attention to. In the most recent financial stability review, which we published in October — that's a great read if you haven't looked at it — we had a box on climate change. It's a slow-moving risk that we're facing.

You pointed to one particular risk, which was of some institutions, some investors, changing their investment mandates, and so wanting to reduce their exposure to carbon intensive investments. So that's something that no doubt can happen and the market will respond to that. But the price signals that come out of market responses are something that economies are used to dealing with and that can encourage and facilitate change, so it can be a good thing.

[Off microphone] I just wanted to go back to the earlier [unclear 00:04:12] as well, whether banks should be taking a more proactive role when it comes to climate change, the central banks, and banks in general?

If you can repeat the question?

For those who didn't hear all of it, the question was whether about banks and central banks should be taking a more proactive role in responding to climate change. Central banks obviously have their mandate and that's what they're responsible for. In Australia, the Reserve Bank's mandate is for price stability, trying to ensure full employment, and the welfare of the Australian people. So to the extent that climate change is impacting these things and including in financial stability, which comes into our mandate, that's certainly something that we take into account.

Banks also have been looking at climate change quite significantly. They face potential physical risks and transition risks, the risks that Professor Engle [previous speaker] outlined. They also face potential reputational risks and I think that's one of the things that in the very short-term drives banks' responses. They know that their customers are watching them, they know that investors are watching them. And so, they're mindful about their actions and I think, again, this is one of the forces that can drive change and banks adapting.

Thanks, Dr Kearns, for a wonderful presentation. I had just one question … I'm from University of Texas. Can you comment a bit about application of blockchain and banks, both as a complement as well as challenge? Maybe the new players coming in and how they pose a challenge as well as how the technology itself can be a complement to the banking industry?

Okay. I'm trying to think of where my financial stability link for that is. So obviously a financial system is always adapting and looking at new technology. The technology changes that I discussed today are facilitating a lot of potential new entrants into the financial system and that is providing a degree of change. I think banks, like all other potential participants in the financial system, are looking for any potential uses of new technologies such as blockchain and there are some uses that are being used, in particular looking at settlements.

Any new technology potentially entails risks for the financial system so we need to monitor it and understand it. And so far what we've seen has been done in a reasonable way and the risks to the financial system haven't been that great.

I had a question and that is with regard to trust. The UNSW as a university is promoting the concept of trust and I noted there are a number of organisations like OECD is also coming and saying, "Well, if we talk about community's expectation of banks, we need to increase trust of community in our banking system and the way it's a governed." And one of the elements of this trust is the quality of governance of banking system in general, but particularly commercial banks specifically. I just wonder whether there is any interaction, if you like, between policymakers, regulators, with respect to enhancing the trust when we look at the actual governance of commercial banks? Thanks.

Thanks. That's a very important and topical question. In Australia, APRA, who's our prudential regulator, has the greatest interaction with the banks and other financial institutions with regard to their governance. And clearly, that is important in that trust in the financial system is imperative.

Now, the first point, we need trust in the banks, that customers believe that their deposits are safe and so that's delivered quite simply through the Financial Claims Scheme – depositors' first claim on deposits. But more broadly we need a community that has strong trust in the financial system in that it's able to deliver the purpose that the community sees the financial system is there for. We need banks that are intermediating financial activity and that customers are comfortable with the way that that's being done, that banks are making the right decisions in that.

So it's absolutely critical that banks do develop that trust, that the community has strong trust, and APRA is at the frontline of doing that but the Reserve Bank is still certainly watching that and taking close attention.

You mentioned that the banks have reduced their risk-taking and that they are well-capitalised. Do you feel like expanding the risk-taking would be something that would be good for the Australian economy? And do they blame their regulator for not letting them do this? This is something that I observe. When you look at banking systems that survived the financial crisis very well, they tend to have banking systems that aren't sufficiently aggressive in providing capital to small/medium enterprises that are … And I wonder if you see that here?

Okay. Thank you, Robert. You've been in the country a couple of days and already picked up on one of the most pertinent issues that we're facing, so very insightful. Australian banks are certainly still providing credit and keen to lend. So we have seen there's been an increase in mortgage lending in recent months in response to the cuts in the cash rate and the increase in demand that that's stimulated.

But we have seen that there is relatively anaemic growth, particularly to small businesses, a little bit easier access to credit for larger businesses. And that's certainly something that is a concern because small businesses can be a very dynamic part of the economy who generates significant new employment and potential productivity growth.

So there have been some efforts to ensure that banks understand their obligations and where those obligations don't apply. So in Australia we have responsible lending obligations, which apply to banks' lending to households for personal purposes, but not to businesses. And so, our regulator ASIC has been very clear in stating that responsible lending obligations do not apply for business loans. So in that regard, business loans can involve a greater degree of risk and they're always going to involve risk. If there was no risk in making business loans there'd be no payoff either to the entrepreneur or to the bank. So it is absolutely critical that banks continue to be willing to manage risk and take on risk and that's where they're adding something to the productive capacity of the economy, so it is something that we're mindful of.

The regulations have not in any regard formerly constrained banks' ability to take on those risks. Rather it comes to the banks' own internal processes and management of that and I think it's been important that banks set up their internal procedures such that their staff know where their bounds lie, know how they're able to take on risk, and are comfortable taking on risk because ultimately that's what banks do. Thank you.

Thank you very much.