What is Financial Stability?
A stable financial system is one in which financial intermediaries, markets and market infrastructures reliably provide the financial services that households and businesses depend on, including during periods of economic and financial market stress.
This supports the economy by ensuring households and businesses have the ability and confidence to save, borrow, invest, insure, make payments, manage risk and plan for the future.
Financial stability is not simply the absence of instability: it requires a financial system that is strong, resilient and prepared for adverse conditions.
Why does it matter?
Financial stability is important because of the role that the financial system plays in the everyday lives of Australians. When the system works well, Australians can: keep their money safe, save for retirement and borrow money to make large purchases or invest in their businesses; make payments securely and efficiently, whether paying for groceries with a card or paying bills online; and insure against unexpected costs, like property damage or medical expenses.
If the financial system stops working as it should, these essential services can be disrupted. That can lead to serious economic consequences – it can make it harder to get a loan, businesses might fail and people might lose their jobs or homes.
How does the RBA assess financial stability?
To assess financial stability the RBA looks for both ‘vulnerabilities’ and ‘resilience’ in the financial system.
Vulnerabilities are weak spots in the financial system that could cause problems or make other problems worse. They might be related to how banks and other financial institutions manage risk. They can also be related to economic conditions, such as the overall health of household and business finances, or developments in credit and asset markets.
Understanding these vulnerabilities – and how they could be mitigated – is central to assessing financial stability.
Resilience refers to the ability of the financial system to keep functioning and deal with shocks, even under tough conditions. Resilience includes:
- strong banks and financial institutions that can continue to lend prudently even if they incur some losses
- healthy household and business finances that mean they are able to continue paying their bills and manage their debts even if their circumstances worsen temporarily
- well-functioning financial markets that are able to adjust smoothly in response to negative shocks.
Maintaining resilience is essential because not all risks to financial stability can be predicted or prevented at their source.
What happens when the system isn’t stable?
On rare occasions, large and unexpected events can overwhelm the financial system’s resilience, exposing vulnerabilities and potentially disrupting the financial system’s ability to meet the needs of households and businesses. The RBA works together with the other agencies of the Council of Financial Regulators to ensure they can respond effectively to instances of financial instability. This helps limit the extent of disruptions to the financial system, and keeps the financial system running during periods of stress.
Finding the right balance
Keeping the financial system stable requires finding the right balance between managing risk and supporting economic growth. Attempting to remove all risk would hold back innovation, investment and long-term growth. Maintaining a resilient financial system therefore requires managing risk in a way that enables productive risk-taking, in turn supporting economic growth and long-term financial stability.