Speech

Emerging Threats to Financial Stability -

New Challenges for the Next Decade

vy RESERVE BANK OF AUSTRALIA

Brad Jones"!
Assistant Governor (Financial System)

Australian Finance Industry Association Conference
Sydney - 31 October 2023

Introduction

'May you live in interesting times' is a sardonic curse with uncertain origin!" Similarly uncertain is what the next
decade might have in store for policymakers and participants in the financial system - what new risks and
opportunities might emerge, what their impact might be and how they might interact. In the spirit of today's
conference, I will step back from the conjunctural outlook to discuss some of the emerging challenges to global
and domestic financial stability that could be with us for many years.!21

To spare any suspense, I have two punchlines.

First, the nature of the emerging risks we are likely to confront over the next decade have a different complexion
to those of recent decades (Table 1). Some of these risks could originate from within the financial system, such as
the risk of rapid-fire deposit runs in the digital age, spillovers from entities that (individually) are not systemically
important and higher interest rate volatility. Importantly, other emerging risks are emanating from outside the
system - geopolitics, operational risk and climate change - and for which there is no historical precedent to
guide us

Table 1: Emerging Financial Stability Challenges for the Next Decade

'Inside' risks 'Outside' risks

1. Rapid deposit runs in the digital age 1. Geopolitics

2. Spillovers from entities that are not : F
os A i 2. Operational risk
individually systemically important

3. Higher interest rate volatility 3. Climate change

If we are entering a decade laden with new types of risks, some of which could interact, the second main
message is that we need to rethink the concept of resilience. It's entirely possible, even likely, that regulation and
supervision will need to adapt as the threat environment evolves. But the ultimate responsibility here lies with
industry. There are limits to what even the most finely calibrated regulatory and supervisory regime can achieve

when industry governance and risk management practices fall short. We have a shared interest in getting our
collective response right.

Inside risk #1 - Rapid bank deposit runs in the digital age

Bank deposit runs are as old as banking itself. This is an artefact of liquid deposits funding less-liquid assets, like
oans. Much ink was spilled in the aftermath of the global financial crisis (GFC) to reduce this inherent
vulnerability, but international events over the past year suggest there is more work to do.

Concerns over profitability and poor risk management have long been the catalyst for deposit runs. In this sense,
he banking turmoil in the United States and Switzerland earlier this year was no different.4! What was
unprecedented was the speed of deposit runs in affected banks (Graph 1). As a case in point, Silicon Valley Bank
(SVB) lost 30 per cent of its deposit base in a matter of hours, with a further 50 per cent poised to be withdrawn
he following day.©! In our current system, any bank would struggle to survive a run of this magnitude It was
'ar beyond the provisioning required under Basel III,'7! and more severe than the fastest runs experienced during
he GFc

Graph 1

Deposit Runs
Average outflow per day; per cent of total starting deposits

% %
40 40
30 30
2023
20 20
10 10
GFC
0 0

Sovereign
Wachovia

IndyMac
Washington Mutual
DSB Bank

National City
Northern Rock
Credit Suisse

First Republic
Signature Bank
Silicon Valley Bank*

*

The lighter colour includes expected outflows based on payments that
were scheduled for the following day but did not occur as the bank
was closed by regulators.

Sources: FDIC; Federal Reserve Bank of St Louis; Federal Reserve Board
of Governors; FT; IMF; RBA; SUERF.

So why was this time different? My reading is the answer lay with the interaction of new technology and a
different set of balance sheet vulnerabilities to those prevailing in the GFC.

2 RESERVE BANK OF AUSTRALIA

Herding effects associated with social media present a new challenge for financial regulators. And it is clearly
easier to withdraw deposits at the stroke of a keyboard than it is to stand for hours in the rain outside a bank
branch and bury cash in the yard. But I see the role of technology here more as an amplification mechanism, not
a root cause)

The share of deposits that were uninsured had been steadily rising in the US banking system, to the highest level
since 1947. For the three banks that failed in March, however, the share of uninsured deposits was more than
double the system-wide average, at 89-94 per cent for SVB, Silvergate and Signature Bank (Graph 2). This
might not have been an issue had these uninsured deposits been widely distributed among unconnected
parties. The problem was they were concentrated in a small number of hands that were tightly connected via
social media and industry linkages. More than half of SVB's deposit base was sourced from companies in the
technology and life sciences sectors backed by venture capital firms that were exposed to the same macro shock
(ie. higher interest rates lowering valuations), and key account holders were closely connected in socia
networks." Similarly, crypto-asset clients accounted for almost 90 per cent of the deposits of Silvergate Bank,
almost all of which were uninsured and exposed to the same risk - a 'crypto-winter' induced by higher interest
rates. The 10 largest depositors at Silvergate accounted for almost half of its deposit base.''] And part of the fear
that spread through corporate deposit holders in the failed banks was not just related to the safety of their
deposits, but also access to them - businesses needed to make payroll and other time-sensitive obligations.

Meanwhile in the case of Credit Suisse, key indicators of liquidity risk introduced under Basel Ill failed to signal
impending trouble ahead of its deposit run. This dog didn't bark, a point that is also prompting reflection among
policymakers."

Graph 2

US Banks: Uninsured Deposits
Per cent of total deposits

coy 9
' System-wide 2023 regional bank failures "
80 80
60 60
40 40
20
1 1 1

1992 2007 2022 2 2 x x

(Pre-GFC) s ® & a

o g © >

oe 5 5 2

B s $

i 2D c

" 8

=

Sources: FDIC; Rose (2023).

These events raise no shortage of policy issues:

How should deposit flight assumptions be recalibrated for the digital age?

for?

+ Should all banks be required to mark-to-market their liquid asset buffers?

would be the moral hazard implications?

If banks choose to fund themselves with a high proportion of uninsured deposits, should

pre-position collateral at the central bank so they are better placed to handle runs of any s

It is impossible to do justice to these questions here, other than to say that they are animating

among policymakers everywhere.

Before moving on, I should note that the Australian banking system did not experience the tyI
observed elsewhere (Graph 3; Graph 4). As the APRA Chair recently observed, we don't have t
concentration risk or uninsured deposits in the deposit bases of key Australian banks, and our
requirements are more onerous.!'4l That said, there is no sense of complacency here - our co

How should interaction effects between uninsured deposits and concentrated deposit bases be accounted

Should deposit insurance caps be lifted when uninsured deposits are held by so few depositors, and what

How best can continuous access to deposits be enabled in banks experiencing severe stress?

hey be required to

ize?

discussions

pes of stresses
he same level of

liquidity and capital

eagues at APRA

will soon be consulting on options for strengthening liquidity and interest rate risk management

requirements."!9

Graph 3

Australian Banks: Deposit Growth
December of previous year = 100

index System-wide Majors Non-majors index
11 11
6 Range 8
2016-2022
110 110
105 2023 105
100 a 100
2 a ee 1 a Pudi tj ij} ji tt
95 DM J S D MJ S D MJ Ss p®

Sources: APRA; RBA.

RESERVE BANK OF AUSTRALIA

Graph 4

Bank Share Price Indices
1 March 2023 = 100

index index
European banks**

Australian banks*

100 p aa Eom 100
\
90 90
80 80
Large US banks***
70 i 70
Regional US banks****

60 60
50 1 1 1 1 1 1 50
F M A M J J A Ss fe)
2023

* S&P ASX 200 Banks index.

** Stoxx Europe 600 Banks index.

***  BUBNK index of 10 largest US banks.

*"* Dow Jones Select U.S. Regional Banks index.
Sources: Bloomberg; RBA.

Inside risk #2 - Systemic risks arising from entities that individually are
not systemically important

Rapid-fire deposit runs are arguably a special case of a broader vulnerability where systemic risks arise from

entities t

hat, in the normal course, are not systemically important themselves. This means contagion risk is taking

on anew, more challenging complexion.

In asking

1. thes

'what's different now?, my sense is that two amplification mechanisms have been dialled up:

peed of money and information flows, which can magnify herding effects

2. procyclicality in parts of the international asset management industry that have grown strongly.

spread o

confidence!

First, money can now flow out of institutions and markets with unprecedented speed in response to the rapid

information and misinformation, including that amplified through social media. In normal times, fewer

rictions in the flow of money and information should lead to better economic outcomes - few advocate for the
rictions and stale information of yesteryear. But the issue is more complex in periods of heightened stress. As
noted by the Financial Stability Board in its recent review, the ubiquity of social media, combined with

24/7 access to banking and payment services and more globally connected trading platforms, raises the
possibility that a shock somewhere in the financial system metastasizes into a broader self-fulfilling crisis of

16]

n banking, concerns about rapid-fire outflows enabled by technology have been building ever since the crisis at

Continental Illinois in 1984, which was an early adopter of the systems that enabled its large corporate clients to
engage in rapid cash transfers inside and outside the United States.!'7! Since then, money has moved within and
across borders with increasing velocity. And in recent years, social media has emerged as a new enabler of
herding behaviour, including when depositors are in close contact. Researchers have linked the unusual spike in
social media activity not only to the rapid fall of regional US banks in March, but to the stress experienced by


6

other banks."8I In Europe, Credit Suisse was immedia
deposit run in October 2022 around the time a journa
brink'; this post had more than 6,000 retweets in less

arch saw its credit spreads trade wider than during

its revenues and profitability having recently hit a multi-year high_20

nstitutions that might have little direct connection to

nerable in an environme
er than ever.

broadly similar business models, seem particularly vu

ater' - especially when the 'shooting' can happen fas

A different amplification mechanism relates to procyc
management industry. As they don't accept deposits, i

the original source of stress, but are

icality in parts of the fast-growing in

Deu

nt of 'shoot

erna

h banks. Nor do

ely caught in the cross-fire, having only narrowly survived a
ist tweeted that a major investment bank was 'on the

han 24 hours, a time when Credit Suisse was losing

CHF 12-15 billion per day in deposits.!"9! Likewise, rumours about the imminent collapse o
he peaks of the GFC and the European debt crisis, despite

tsche Bank in

perceived to have
irst, ask questions

ional asset

nvestment funds operate with less intensive regulation
and oversight of their liquidity management and use of leverage compared wi

hey benefit from

public backstops that can dampen liquidity stress, such as central bank liquidity access or deposit insurance.

Herding effects can also be amplified when funds are tied to similar benchmar'

s. Where they off

er redemption

terms to investors that cannot be easily met in stressed market conditions, asset fire sales can result. The periods

of market dysfunction in key
number of central banks respond. The use of leverage can be an accelerant of
tdown of September 2022, when an initial increa
cycle of asset sales by pension funds and required intervention by the Bank of
functioning.2" While the ma

evident in the gilt market me

these fire sale dynamics, our
(Graph 5) 22]

The wider spillovers ampli
s whether the bar for banks

should go in imposing more
regulatory design and that a
that would otherwise benefi
account for increased con

continue to play an impor

destabilise the functioning o

review.

RESERVE BANK OF AUSTRALIA

hese 'illiquidity s
se in yields set off

bond markets in early 2020 and 2021 were associated with this dynamic and saw a

pirals. This was
a self-reinforcing

England to restore market
e-up of the Australian financial system means we are not as direc

ly exposed to

unding markets have been significantly disrupted by international events

ied by small banks and investment funds in recent times raises a variety of issues. One
o be designated as systemic should be lowered. Another is how far regulators
onerous obligations on smaller banks, recognising that proportionality is central to
regime that is unduly onerous could curtail the sort of competition and innovation
society. A more general issue is how resilience and recovery planning should better
agion risk. And in the case of investment funds, an ongoing issue is how they can

ant role in intermediating savings while minimising the liquidity risks that can severely
critical financial markets. All of these issues are now under active international

Graph 5

Government Bond Yields Around Stress Events
Cumulative change in yields since start of period

Ppt 5020 Dash for 12021 Bond Quake") 2022 Gilts Crisis*** I>Pt
Cash*
1.2 1.2
AUS 10 UK 10-year
0.9 year 0.9
0.6 0.6
0.3 0.3
US 10-year
Qui (PURO GHOROROGRORRRORROUE Mt IUVUUEUUUOUHTUUEROOUOUOUUOEOOUUETD itis titi ti titi 0.0

3 10 17 24 31 22 1 11 21 31 14 22 30
Mar Dec Jan Sep

* Between 9 March 2020 and 27 March 2020.

** Between 20 December 2021 and 19 January 2022.
*** Between 15 September 2022 and 30 September 2023.
Sources: Bloomberg; RBA.

Inside risk #3 - Structurally higher interest rate volatility

Much of the prior two decades saw long-term interest rate volatility either decline or languish at unusually
subdued levels (Graph 6, left panel). There are, however, a number of factors that, in the years ahead, could
contribute to a regime shift characterized by structurally higher interest rate volatility:

+ The great moderation is behind us. The global economy now appears more vulnerable to stagflationary supply
shocks, including from the rewiring of globalisation, geopolitical and political economy tensions, and energy
shocks from climate change (and related policies). This contrasts with recent decades, where developments
on the supply side of the economy were typically favourable for growth and inflation and so dampened
financial market volatility.

+ A higher and more volatile bond term premium.!22! For the better part of three decades, the term premium on

bonds declined relentlessly (Graph 6, right panel). This reflected factors that are unlikely to continue,
including declining uncertainty over future inflation outcomes and real policy rates, coupled with structural
supply--demand imbalances in bonds that meant governments were able to issue debt with little or even
negative term premia.

+ Reduced smoothing from price-insensitive buyers. To varying degrees over the past two decades, volatility in key
bond markets has been supressed by the bid from foreign exchange (FX) reserve managers and domestic
asset purchase programs by central banks. Again, this era now seems behind us. In recent years, reserve
managers have become net sellers of US Treasuries and, on current plans at least, central banks will be
reducing their domestic bond holdings for years to come. This is occurring against a backdrop where broker-
dealers have reduced ability and willingness to bid for bonds during periods of heightened volatility.


Graph 6

Interest Rate Volatility and Term Premia

10-year government bonds

bps Realised volatility* Term premia** %
Australia
10 3
5 0
United States
QUILL
1993 2008 1995 2009 2023

*

#e

Calculated as the one-year rolling standard deviation of daily

changes in yields.

Estimates based on Adrian, Crump and Moench (2013).
Sources: AOFM; Bloomberg; Federal Reserve Bank of New York; Refinitiv.

A period of structurally higher interest rate volatility would present challenges to financial system stability, a few

of which I will mention here:

+ Bank duration risk. Banks of all sizes will have to manage overall duration risk more intently. Inadequate

management of interest rate risk was an important contri

+ The interaction of interest rate and credit risk. Over much o
consistently exceeded the level of interest rates ('g> r'). This dampened credi

interest rate risk
supervisory focus in many jurisdictions.

butor to the US banking stresses in March (Graph 7).
In Australia, banks tend to have modest exposure to securities compared wit!
required to hold capital for interest rate risk in the banking book, and residua
hedged (Graph 8). Nevertheless, this is an area of ongoing

h their peers, large banks are

ends to be

he past few decades, growth in incomes
risks for lenders. But debt

servicing among borrowers with high debt levels will be more challenging - and credit risks will increase as a

result - in an environment where interest rates periodica

ly exceed the grow

hin incomes.

+ Financial market functioning. The post-GFC era of exceptionally low interest rate volatility gave rise to a new
generation of investment business models and strategies. This includes strategies that: (i) involve the

procyclical leveraging up of bond positions when volatili

y dips,/4] and (ii) assume a negative correlation

between bond and equity returns (as tends to occur in low and stable inflation regimes). It remains to be
seen how market functioning could be affected in a regime of higher inflation and interest rate volatility,
including where open-end fixed-income funds encounter liquidity stress, margining is more tightly enforced
than in the past,'25) and broker-dealers are unable or unwilling to supply liquidity.

RESERVE BANK OF AUSTRALIA

Graph 7
US Banks' Unrealised Gains
(Losses) on Investment Securities

US$b US$b
0 0
-200 -200

i Available-for-sale maturities
Wi Held-to-maturity securities
-400 -400
-600 -600
-800 1 1 1 1 1 1 1 1 1 1 1 1 -800
2011 2015 2019 2023
Source: FDIC.
Graph 8

Mismatch of Assets and Liabilities
Repricing maturities of ADIs operating in Australia, June 2023
$t $t

Gross assets

Net (after hedging)

Gross liabilities

- 1 1 1 1 7
4 0-1 1-3 3-6 6-12 12+ 4

Months

Sources: APRA; RBA.

Outside risk #1 - Geopolitical risk

War may well be 'the father of all things; as the philosopher Heraclitus once observed. Since 1945, however, the
absence of direct conflict between economically integrated powers meant two generations of economic
policymakers and industry participants could turn their attention elsewhere. But recent events suggest this is no
longer tenable. For a start, geoeconomic fragmentation will render the global economy more prone to supply
shocks. The International Monetary Fund (IMF) has estimated it could result in global output losses of up to

7 per cent, rising to 12 per cent for some countries'26l And as a more strained geopolitical environment could

10

also have material implications for financial stability - not limited to the cross-border allocation of capital,
international payment systems, key financial institutions, and global funding and commodity markets - a
considerable body of work is now emerging internationally to determine where financial resilience needs to be
bolstered./27]

As an organising framework, I find it useful to decipher the related risks to financial stability along two
dimensions: slow-burn fragmentation, and fast-burn kinetic risk.

Slow-burn fragmentation is arguably no longer a risk - it is already underway. Trade and financial sanctions
(including counter-sanctions) were increasing even prior to the Russian invasion of Ukraine (Graph 9). Just in
time' efficiency is being traded off for strategic resilience in supply chains. Alternative payment messaging
systems are being developed, and FX reserves are being shifted to countries and assets deemed less vulnerable
to seizure!28] 4 smaller share of foreign direct investment, portfolio investment and bank credit is flowing
between countries that are less aligned on foreign policy issues (Graph 10). It is now common to hear some
countries characterised as 'uninvestable' in a way that was not the case just a few years ago. And fraying support
for international cooperation risks hampering operation of the global financial safety net /29]

Graph 9
Worldwide Financial and Trade Restrictions
Number
125 Countries imposed with Total trade 3,250
financial sanctions restrictions
100 3,000
75 2,250
50 1,500
25 750
0
2012 2017 2012 2017 2022

Sources: Global Trade Alert; IMF.

RESERVE BANK OF AUSTRALIA

Graph 10

Geopolitical Blocs and Financial Flows*
Percentage point deviation from world portfolio

9, 9,

% Close %
M@ Neutral
Wi Distant

1 1
Direct investment Portfolio investment Banking flows

The graph shows how investment flows between countries differ from
world benchmarks based on the concept of 'geopolitical closeness',

as commonly measured by voting records at the UN General Assembly.
Based on data from 2009-2021.

Source: IMF.

The second (and even more troubling) dimension is fast-burn kinetic risk - the risk that tensions escalate into

confli

fal

con

years g

costly or uninsurable along certain routes. Global financial conditions could tighten abruptly, wi

marke
seized.

inuum in this respect, depending on the scale, location and countries involved. Events over

among countries critical to the global economy. Global financial stability risks increase a

onga
the past two

ive a sense as to the underlying stress transmission channels. Global shipping could become prohibitively

h key funding

s, risk asset prices and cross-border lending severely affected. Cross-border assets could be frozen or
Payment systems and financial market infrastructures could be affected by sanctions and counter-

sanctions. Cyber-attacks on key institutions could become more prominent. Disruptions to global commodity

marke
where

feedback loop between real and financial channels, including deteriorating asset quality for ban

The policy implications and trade-offs associated with heightened geopolitical risk are daunting

key trade routes are affected.8° More generally, the longer any conflagration persisted, t

s would be most significant where global production is concentrated in a small number of countries and

he stronger the
ks.

and complex, so

I will simply note here the importance of building financial and operational resilience along various dimensions -

at both the domestic and international level. At the international level, one key concern is to prevent the global

financial safety net from splintering into smaller liquidity pools based on geopolitical blocs. As tl

he IMF has noted,

a danger here is that the substantial benefits that come with international risk sharing are compromised at a time

when the call on international resources could increase substantially."

Outside risk #2 - Operational risk

The increasing digitalisation of financial services has been a key source of innovation. But it also means

operational risk is now a first order enterprise-wide risk that demands the highest standards of management and

governance. As some operational risks could also have systemic implications, this is emerging as a key regulatory

priority the world over.!

32]

12

I will focus here on three risks, the most immediate and challenging of which is cyber. The scope for, and
consequences of, cyber-attacks continue to increase. Challenges are building from third-party technology
dependencies, geopolitical tensions and resourcing constraints among smaller institutions that could be key
points of vulnerability for the wider system. Attacks can result in direct financial losses (from theft and ransoms)
and indirect losses arising from reputational damage. The past year alone has borne this out in Australia and
elsewhere.

A multi-faceted policy response is rolling out in response. In Australia, the Government established the role of
National Cyber Security Coordinator in May 2023 to coordinate and strengthen cybersecurity policy,
preparedness and response capability. APRA has recently conducted a cybersecurity stocktake and finalised a

new broader operational risk standard for its regulated entities, which will incorporate stronger requirements for
maintaining and testing internal controls, improved business continuity planning and enhancing institutions'
oversight of external service providers.3! Regulators are also signifying a clear intent to undertake enforcement
actions where firms fail to meet expected standards of conduct. And the Cyber Operational Resilience
Intelligence-led Exercises Framework, developed by the Council of Financial Regulators (CFR) and led by the
Reserve Bank, continues to test the resilience of key financial institutions to cyber-attacks. All that said, this is an
area where no amount of supervisory focus can substitute for robust planning and preparedness by financial
institutions.

A second operational risk relates to critical technology service providers that have been largely operating outside

the financial regulatory perimeter. Banks and financial market infrastructures are considering moving some
services to the cloud, and for sound reasons. But exposure is concentrated in a select number of service providers
and an outage could leave many institutions unable to perform critical functions. Concerns about governance,
risk management, platform concentration risk and responsiveness in a crisis have also been raised in respect to
he use of emerging technologies by financial institutions, such as distributed ledgers. And in some jurisdictions,
Australia included, Biglech has sought to move into payment services (including through digital wallets) without
he regulatory oversight typically imposed on other financial service providers.24)

A third operational risk - artificial intelligence (Al) -- seems more distant but no less challenging. Al offers
enormous opportunities for the financial system and wider economy, but managing the associated risks will not
be straightforward. As Gary Gensler (Chair of the US Securities Exchange Commission) has noted for some time,
he financial stability risks relate to the potential for shocks in the financial system to be magnified.25! Contagion
and herding risk is one potential channel, where parties could come to rely on similar models and data

aggregators that are trained on similar data and so generate similar actions - including in a crisis. And because

he underlying models are complex and typically developed outside of the financial regulatory perimeter,
system-wide vulnerabilities could be brewing in a way that is not obvious to financial institutions or supervisors.

Outside risk #3 - Climate change

Risks to financial stability resulting from climate change and related policies will be with us for years to come.
Physical risks from more extreme weather patterns and higher average temperatures can reduce the value of
assets and income streams in sectors and parts of the country. Transition risks, including unexpected changes to
regulations and consumer preferences, can also lower the value of assets or businesses in emissions-intensive
industries. These risks can result in unexpected losses for lenders, increased claims on insurers and write-downs
for investors - as we are now observing. Internationally, direct exposures to emissions-intensive businesses are
largest for investment funds, followed by insurers, and then banks.

As the Bank has previously set out the financial stability implications in Australia from climate change, I will briefly
recap our main takeaways to date.24 The Bank and APRA have applied complementary approaches to
examining the possible effects of physical and transition risks for the Australian banking system.87! This

preliminary analysis has found that banks would experience losses under different scenarios but not of a

RESERVE BANK OF AUSTRALIA

magnitude that would cause significant stress, as lending losses appear concentrated in specific regions and
industries that represent a small proportion of banks' overall assets. Nevertheless, these early results need to be
treated with caution as our understanding of climate-related risks to the financial system is still developing; losses
could be larger and occur faster than currently anticipated. More advanced modelling techniques and more

granular data are needed to produce more robust estimates of possible credit losses.

A particular domestic focus in the period ahead will be the household insurance sector. Payouts have been rising
in real terms for some time, and more frequent and severe weather events are expected to further increase
claims on damaged property and other assets. Insurers have the ability to reset insurance premiums quickly to
recoup climate-related losses, or they could withdraw coverage from high-risk regions. This would pass risk back
to households, businesses and governments, or to the lenders in the case of loan defaults where affected assets
are used as collateral. To better understand the risks to the financial system and broader community that could
occur due to changes in the cost and coverage of insurance, APRA, on behalf of the CFR, will soon conduct a
climate scenario analysis with insurers. More broadly, the Bank, in conjunction with other CFR agencies, is
coordinating on a set of priorities to support industry participants to manage their climate-related risks and

opportunities.

[38]

Concluding remarks

There are two common threads to the themes I have discussed today.

The first is that there are a number of emerging risks to financial stability that look quite different to those of
recent decades and that will likely be with us for some time. Some have no historical precedent, and could
interact, and so will require particularly careful attention. Governance and risk management practices that have a
strong forward-looking orientation will have a central role here - think more scenario analysis and reverse stress

testing, and less historical backtesting.

The second is that building resilience along various dimensions will be critical, recognising of course that there
are always trade-offs to be managed. Strengthened resilience was the north star for the reforms for large global
and domestic banks following the GFC. But for the financial system at large, there is more to do here. We can't
know which risks will be realised or when. But we can be better prepared for whatever might come our way.

Endnotes

"

1

Thanks to Emma Greenland and Cameron Armour for their assistance.
It is often said to have originated from China, but this has never been substantiated.

As my emphasis will be on emerging themes, I don't devote much attention to conjunctural issues like the Chinese property
market or household debt in Australia - this terrain has been well covered in various Bank speeches and publications over the
years and remains an ongoing focus of the Bank's twice-yearly Financial Stability Review.

Given we have just lived through a global pandemic, and for the sake of brevity, I will leave aside here the risk of a repeat
scenario - though this is clearly an example of a significant exogenous risk.

Unsurprisingly, the structure of compensation packages for senior leadership played a role here. At SVB, for instance,
compensation packages were tied to short-term earnings and did not include reference to risk metrics; see Basel Committee on
Banking Supervision (2023), 'Report on the 2023 Banking Turmoil, October.

See Gruenberg MJ (2023), 'Successfully Managing Systemic Risk: Deposit Insurance in a Turbulent World; Speech at the
International Association of Deposit Insurers 2023 Annual Conference, Boston, 28 September.

Two options might conceivably deal with this issue: (