Topic: Financial Stability

Financial Stability
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Household Liquidity Buffers and Financial Stress

Lydia Wang

The ratio of household liquid assets to household income in Australia has increased substantially over recent decades, at both the aggregate and individual household levels. The increase in buffers has been most pronounced for households with mortgage debt and among indebted households – with those with the most debt typically holding the highest liquidity buffers. This is important from a financial stability perspective as liquidity buffers allow households to smooth their spending and maintain their debt payment obligations in the event of adverse shocks to their cash flows; as such, they are a key factor in reducing household financial stress. This article considers these trends and finds that, to the extent that rising liquidity buffers have increased household financial resilience, the risks associated with high and rising household indebtedness are unlikely to be as great as suggested by focusing on gross debt-to-income ratios alone.

debt, financial stability, households
Financial Stability
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Are First Home Buyer Loans More Risky?

Maia Alfonzetti

Despite the rate of home ownership in Australia drifting down over recent decades, 2020 saw a large increase in first home purchases. Given the high level of housing prices and household indebtedness, this raises the question of whether first home buyer (FHB) loans contribute disproportionately to financial stability and macroeconomic risks. FHBs appear to be riskier than other owner-occupiers, at least during the first five years of the loan. They have higher loan-to-valuation ratios and lower liquidity buffers. While this might suggest FHBs would be more vulnerable than other borrowers during a negative income or housing price shock, recent experience indicates that FHBs have been no more likely to report financial stress or be in arrears. One potential explanation is that FHBs have historically experienced better labour market outcomes than other borrowers.

debt, finance, financial stability, housing
Financial Stability
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Corporate Debt Covenants in Australia

Kim Nguyen

The economic downturn associated with the COVID-19 pandemic has raised questions about the extent to which a deterioration in the financial health of some businesses could lead to breaches of debt covenants – with potential knock-on effects on firm behaviour and loan quality. This article includes a new data set on corporate debt covenants in Australia, developed by applying text analytic techniques on the annual reports of non-financial listed companies. It reveals that the share of companies reporting debt covenants has steadily increased over time from around 10 per cent in 2002 to almost 40 per cent in 2020, although the proportion of firms with covenants that reported a breach has remained stable at roughly 13 per cent. Also, following a breach, firms try to get their financial indicators back on track quickly. This study is a first step in understanding the role of debt covenants as a point of financial friction in the economy.

business, credit, debt, finance, financial stability
Financial Stability
Photo: PM Images

Low Interest Rates and Bank Profitability – The International Experience So Far

Mark Hack and Sam Nicholls

This article discusses the effect that low interest rates may have on bank profits, and reviews the experience of banks in economies that have had very low interest rates for an extended period. In the short to medium run, low or negative interest rates appear to reduce bank profits only a little, after accounting for the positive effects of lower interest rates on loan losses and demand for credit. However, the negative effects on bank profits increase when interest rates remain very low for a prolonged period. The profits of smaller banks – which have more household deposits, limited pricing power or less capacity to adjust their activities – are more sensitive to a prolonged period of low interest rates.

banking, cash rate, interest rates, international
Financial Stability Banknotes of many countries overlay and form a kind of carpet.
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The Nature of Australian Banks' Offshore Funding

Kellie Bellrose and David Norman

Australian banks access large and deep foreign funding markets to supplement their domestic funding. Looking at the major banks’ worldwide operations, such offshore funding accounts for about one-third of their assets. This funding is raised in a variety of ways, across several countries and by various entities within the banking groups. While offshore funding can create vulnerabilities, these are appropriately mitigated by various factors. It would nonetheless be desirable for banks to continue to lengthen the maturity of their offshore debt securities.

banking, bonds
Financial Stability A puzzle showing flags of the G20 countries
Photo: KTSDesign/Science Photo Library – Getty Images

A Decade of Post-crisis G20 Financial Sector Reforms

Mustafa Yuksel

The global financial crisis resulted in significant disruption to markets, financial systems and economies. It also led to comprehensive reform of the financial sector by the G20 group of countries. After a decade of policy design and implementation, standards in the global financial system and regulatory approaches in many countries have changed substantially to improve financial system resilience. Australia, as a G20 member, has been active in implementing these reforms. This article looks at the main financial sector reforms developed in the immediate post-crisis period, their implementation in Australia and the more recent shift in international bodies' focus to assessing whether these reforms have met their intended objectives.

financial stability
Financial Stability
Photo: Kenishirotie

Financial Stability Risks and Retailing

Gabriela Araujo and Timoth de Atholia

Discretionary goods retailers are facing a challenging environment of increased competition, slow growth in consumer spending and changing consumer preferences. Despite this, these retailers generally appear to be in good financial health and there are many new shopping centres and refurbishments in the pipeline. Banks are active in funding these developments, and are increasing their exposure to retail commercial property, although they are reducing their exposure to retail businesses. If these new developments fail to attract sufficient customer spending, retailers may find themselves unable to pay rent to landlords who have taken on additional debt, and this could lead to losses at banks.

financial stability, retail

Central Counterparty Margin Frameworks

Financial Stability
Louise Carter and Duke Cole

A central counterparty's (CCP's) margin framework can affect the activity of market participants and the broader functioning of the financial system. This potential impact on financial stability is an area of focus for authorities – in Australia and overseas – particularly as central clearing has grown in recent years. Additionally, the margin collected by CCPs is the first layer of financial resources held by a CCP to cover counterparty credit risk, so it is critical that a CCP's margining system is effective.

banking, credit, financial stability, risk and uncertainty

Foreign Currency Exposure and Hedging in Australia

Financial Stability
Laura Berger-Thomson and Blair Chapman

The latest Survey of Foreign Currency Exposure confirms that Australian entities' financial positions are well protected against a depreciation of the Australian dollar. Consistent with previous surveys, the net foreign currency exposures of the banking sector are fully hedged. This means that the sector's overall foreign currency liability position would not in itself be a source of vulnerability in the event of a sudden depreciation of the Australian dollar.

exchange rate, financial markets, investment

Shadow Bank Lending to the Residential Property Market

Financial Stability
Michael Gishkariany, David Norman and Tom Rosewall

Shadow bank lending can play an important role in the economy, but on a large enough scale it could damage financial system resilience. Domestic banks have tightened standards for lending to the residential property market over recent years, creating an opportunity for other lenders to expand. However, shadow banks appear to account for only a small share of total property loans in Australia. Their share of lending for property development has increased more than for housing lending.

banking, financial stability, lending standards

How Have Australian Banks Responded to Tighter Capital and Liquidity Requirements?

Financial Stability
Tim Atkin and Belinda Cheung

Australian banks have responded to tighter regulatory requirements for capital and liquidity over the past decade, which has strengthened their resilience to adverse shocks. While banks are now in a much better position to deal with these types of shocks, this strengthening has also had implications for their funding costs and some key profitability metrics. This article outlines some of the main changes to banks' activities as they have responded to the tighter capital and liquidity requirements.

financial stability, global financial crisis, liquidity, risk and uncertainty

Return on Equity, Cost of Equity and the Implications for Banks

Financial Stability
David Norman

Returns on equity for the major Australian banks have declined of late, following equity raisings in 2015. At the same time, estimates of the cost of raising new equity appear to have fallen very little, despite large declines in risk-free rates. These two developments help to explain why Australian bank stocks are now trading at a declining, but still sizeable, premium to their book value.

banking, risk and uncertainty

Macroprudential Policy Frameworks and Tools

Financial Stability
David Orsmond and Fiona Price

Over the past decade, policymakers have increasingly used macroprudential tools to address a range of financial stability concerns. International institutions have identified and offered guidance on the components of an effective macroprudential framework, while noting the need for such a framework to be sufficiently broad to reflect differences in national circumstances. This article outlines key issues faced by policymakers in identifying and mitigating systemic risk and notes the flexible approach taken by Australia's regulatory agencies. In this context, macroprudential policy is seen as just one component of an effective financial stability framework.

banking, global financial crisis, regulation, risk and uncertainty

Banks' Wealth Management Activities in Australia

Financial Stability
Theodore Golat

Wealth management activity has grown rapidly in Australia over the past 25 years and the major banks now comprise a much larger share of the industry than they did previously. The returns on these activities across the major banks have varied, being close to those on traditional banking activities in some cases but below the cost of capital in others. By undertaking this line of business, banks have increased their resilience (by diversifying their income) but also face new risks. In part reflecting these risks, as well as a greater focus on capital management, banks have begun to re-examine the nature and extent of their involvement in wealth management.

banking, financial stability

Sources of Financial Risk for Central Counterparties

Financial Stability
Jennifer Hancock, David Hughes and Suchita Mathur

Central counterparties (CCPs) play an important role in managing the risks present in financial markets and in increasing the overall stability of the financial system. This requires CCPs to be sufficiently financially resilient so that they can withstand extreme but plausible events that would pose significant stress. As use of CCPs becomes more widespread, increasing attention is being paid to how CCPs conduct stress tests to evaluate the adequacy of their financial resources. This article describes the sources of, and the circumstances in which CCPs are exposed to, financial risks and how CCPs typically manage these risks.

financial markets, financial stability, global financial crisis, risk and uncertainty

The Australian Government Guarantee Scheme:

Financial Stability
Carl Schwartz and Nicholas Tan

The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding (the Guarantee Scheme or scheme) was introduced during the global financial crisis in response to similar measures taken in other countries, and to address extreme funding pressures on authorised deposit-taking institutions (ADIs). The scheme closed to new borrowings in early 2010 and the guarantee over the few remaining liabilities ended in late 2015. This article recaps the operation of the scheme and concludes that it successfully met its objective to promote financial stability and the flow of credit to the economy during a period of extreme global funding pressures. No claims against the government were made under the scheme and the fees paid for its use generated $4½ billion in revenue.

financial markets, financial stability, funding, regulation

Total Loss-absorbing Capacity

Financial Stability
Penelope Smith and Nicholas Tan

Total loss-absorbing capacity (TLAC) is a key part of the G20's regulatory reform agenda to address the problems associated with financial institutions that are ‘too big to fail’. By strengthening the loss-absorbing and recapitalisation capacity of global systemically important banks (G-SIBs), the TLAC standard is intended to help ensure that these large, interconnected and complex financial institutions can be resolved in an orderly manner if they fail, without the need for financial support using public funds.

balance sheet, banking, regulation

Default Risk Among Australian Listed Corporations

Financial Stability
Michael Robson

Market-based information can help detect deteriorating corporate health because it incorporates more forward-looking information than other data sources such as financial statements. With this in mind, the Reserve Bank has developed an indicator of financial health based on a contingent claims framework developed by Merton (1974), which is sometimes called a distance-to-default model. The Bank will primarily use the model to assess trends in financial health for the corporate sector as a whole and, in aggregate, the model is able to broadly match the dynamics of the corporate failures data, suggesting that it will be a useful addition to the Bank's existing suite of monitoring tools. The results from the model suggest that corporate financial conditions remain robust, despite some deterioration more recently, which partly reflects the headwinds faced by listed resource companies.

business, financial stability, risk and uncertainty

Structural Features of Australian Residential Mortgage-backed Securities

Financial Stability
Ivailo Arsov, In Song Kim and Karl Stacey

This article provides a summary of structural features typically found in Australian residential mortgage-backed securities and their evolution over the past decade. Understanding the structural features of the securities is essential to the effective risk management and valuation of the securities because these features determine how the risks of the securitised mortgages are borne by the different investors in the securities.

bonds, financial markets, housing

Recent Developments in Asset Management

Financial Stability
Fiona Price and Carl Schwartz

The global asset management industry has grown rapidly following the global financial crisis. International standard-setting bodies and national regulators are working to better understand and, if necessary, address potential financial stability risks from this industry. A particular concern is that, in the event of a significant negative shock to current favourable conditions, some funds may experience substantial redemptions, and so be forced to engage in asset ‘fire sales’ that could be destabilising for the financial system. This article provides background on international developments, as well as some Australian context.

financial stability, funding, risk and uncertainty

Shadow Banking – International and Domestic Developments

Financial Stability
Josef Manalo, Kate McLoughlin and Carl Schwartz

One of the lessons from the global financial crisis is that systemic risk to the financial system can arise from outside the regular banking system, in so-called ‘shadow banking’. This article reviews post-crisis international and domestic trends in shadow banking, and regulatory efforts to better understand and address potential risks that may arise. In Australia, systemic risks arising from shadow banking appear limited given its relatively small size and minimal links to the banking system, but it remains an area for regulators to monitor and better understand.

banking, financial stability, global financial crisis, risk and uncertainty

A Model for Stress Testing Household Lending in Australia

Financial Stability
Tom Bilston and David Rodgers

Stress testing can be a useful tool for authorities to assess the resilience of their banking systems to various shocks, including those that result in more borrowers being unable to repay their debts. This article outlines a model that simulates household loan defaults and losses using data from a survey of Australian households. The model generates plausible results in response to shocks to interest rates, the unemployment rate and asset prices. It also provides a useful starting point for the Bank's development of a more holistic stress-testing framework for the Australian banking system.

banking, debt, households, risk and uncertainty

The Use of Trade Credit by Businesses

Financial Stability
Amy Fitzpatrick and Bobby Lien

Trade credit is an important source of funding for some businesses, particularly those in the unlisted business sector. Nonetheless, little is known about the use of trade credit owing to the paucity of data. This article explores the use of trade credit, as well as the terms and conditions of trade credit contracts. It also examines the relationship between trade and bank credit. Understanding the nature of this relationship provides useful insights into how changes in financial conditions will affect the overall funding of businesses.

business, credit, trade

G20 Financial Regulatory Reforms and Australia

Financial Stability
Carl Schwartz

The global financial crisis prompted a comprehensive international regulatory response, directed through the Group of Twenty (G20). The Reserve Bank and other Council of Financial Regulators (CFR) agencies have been heavily involved in the reform process, including engaging with international bodies on policy development, and implementing agreed reforms domestically. While the reforms have achieved a great deal, the Bank and other CFR agencies are mindful that the pace and volume of change are challenging for the financial system and regulators, and raise the potential for unintended consequences. Five years after the peak of the crisis, and with substantial policy development completed, there is an opportunity to focus the financial regulatory agenda on implementing reforms already agreed, with a close eye on their effectiveness.

credit, finance, funding, trade

Mapping the Australian Banking System Network

Financial Stability
Eduardo Tellez

An important aspect of the banking system is the network of exposures between individual financial institutions. Using regulatory data, this article maps the network of large bilateral exposures between Australian financial institutions and then analyses its basic features using the tools of network theory. Many of the features of the Australian network are consistent with those of financial networks in other countries. In particular, most institutions in the network are only linked to a small number of other institutions, while a few, typically larger, institutions are linked to a large number of other institutions. An understanding of the banking system network can assist in identifying contagion risks and assessing financial stability.

banking, debt, securities

The graphs in the Bulletin were generated using Mathematica.

ISSN 1837-7211 (Online)