Guy Debelle: Funding Australia's future
Remarks by Mr Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of
Australia, at the Launch of Funding Australia's Future, The Australia Centre for Financial
Studies, Sydney, 10 July 2013.
* * *
Thanks to Chris Stewart for his help with these remarks.
The Australian Centre for Financial Studies has put together a very interesting and timely
body of work on an important topic.1 It is a good example of a collaborative effort that
encompasses academic research with a very applied focus.
The financial sector plays a unique role in the functioning of the economy. It acts as the
intermediary between the myriad saving and spending decisions of households, businesses
and government, both domestic and foreign. In doing so, it is unlike other parts of the
economy. As I've said before, the financial sector is not at the end of a production chain
producing something which directly generates utility for society.2 Rather, it is a critical link
along the way, the oil that keeps the economy ticking over. When the oil dries up, the
economic engine starts to malfunction and can ultimately grind to a halt.
So in that sense, the set of papers that we have here tonight gets right to the heart of the
issue of how well that oil is working and whether there's any risk of it drying up in the future.
There's clearly been a lot going on in the global financial sector over the past few years. At
various times, some channels of financial intermediation have actually seized up, much more
so offshore than onshore. So the question at the heart of these set of papers is well worth
posing. It is also very timely as the financial sector is still undergoing considerable change as
it adjusts to the lessons learned from the turmoil of recent years and the regulatory changes
that have come along with that.
Today, I will try to give a quick overview of the work that has been done as part of this
project, and talk a bit about where to from here. But the main point I would like to get across
is that you should take the time to read each of these three papers. They each provide plenty
of food for thought.
Before getting to the papers individually, I'll step back and talk about the project as a whole.
The aims of the Funding Australia's Future project are to:
•
assess the future demand for and supply of finance in Australia;
•
consider the interaction between different participants in the financial system;
•
identify the potential challenges facing the system; and
•
outline institutional or regulatory changes that might improve the operation of the
system.
That's a fairly hefty agenda, as you can see.
In looking at the papers, where I think they are the most useful is in providing a clear,
wellarticulated framework to think about these issues. Such a framework has often been lacking
in the debate that has gone on at various times over the past few years.
Take one current example, which is on the G20 agenda, namely the "lack of infrastructure
funding". To answer this question appropriately, we need to know whether it is a problem for
financing different stages of a project, what type of risk is holding any financing back, what
type of institutions and instruments might help any shortfall, etc. But there needs to be a
coherent framework in mind to be able to do this, and to know what are the right questions to
be posing.
The papers commissioned for Stage 1 of the project are designed to set the scene. I will give
a brief summary of each of the main points I take away from the three papers.
Kevin Davis' paper, "Funding Australia's Future: From Where Do We Begin?" provides an
insightful overview on a number of topics. Let me give a brief disclaimer here. Kevin was my
first macroeconomics lecturer at university back in the day, so I am very much in his debt for
all he taught me about macro and monetary economics.
•
The first main point in Kevin's paper is the identification of the ways in which the
Australian financial system differs to other developed economies.
•
Second, it discusses the main consequences of the financial crisis for financial flows
in Australia as well as some of the more fundamental forces influencing the
longerterm evolution of the sector.
•
Lastly, it identifies some of the implications of these influences. For example, it links
changes in the competitive advantage of banks in raising deposits to changes in the
nature of the loan origination process, the length of the financial intermediation
"chain", and the overall cost of intermediation.
Daniel Mulino's paper, "Improving Australia's Financial Infrastructure", provides a
comprehensive overview of what the Australian financial system does well and summarises
current and prospective issues.
•
While Daniel notes that the sector performs well in supporting the economy, he
argues there are a number of issues that are worth further exploration. In doing so,
he highlights, for instance, the potential improvements to the payments system; the
financing of greenfield infrastructure and high-risk innovation projects; and the
arrangements around post-retirement savings products and the regulation around
SMSFs.
•
Dr Mulino notes that in some areas, such as the payments system, there is already
work underway by agencies including the RBA. In other areas, such as
infrastructure funding, he notes that Australia is not alone in dealing with some of
these challenges.
Rodney Maddock and Peter Munckton's paper, "The Future Demand and Supply of
Finance", considers the longer-term availability of funding for Australia's economic growth,
the composition of these funding flows, and the role of regulation in their determination.
•
As such, it sits between the other two papers in that it provides a longer-run analysis
of the flow of funds in the economy - such as the domestic savings rate back to the
1870s - as well as a broader overview of the role of regulation on these flows. It
also places a much greater emphasis on the flows within the system rather than the
balance sheet structures.
•
Overall, it concludes that the demand for and supply of finance should align over
coming years, although there are a number of factors that might alter this balance
and hence the cost of intermediation.
This last point is a particularly important one. The experience over the past few years in
Australia shows that even in the most stressed of circumstances, the financial sector can
often adapt and re-equilibrate to quite dramatic changes in circumstances. This might involve
sizeable changes in prices, but it is important to look at things from a general equilibrium
perspective, rather than analysing things in a partial manner. The financial system is very
much a system, with a high degree of interconnectedness.
A number of other general lessons can also be gathered from the papers.
1. As noted by Kevin Davis, the financial sector influences the amount of aggregate
risk-taking in the economy, it affects how that risk is distributed, and in doing so can
either amplify or moderate the effects of shocks to the system.
2. The structure and activities of the financial sector are the outcome of numerous
forces over long periods of time.
3. Looking at aggregate information, or one aspect in isolation, can often be
misleading. This is true when we are looking at the capital flows into and out of
Australia. The net flows, which are often the focus of analysis, conceal a lot of
important information that is only evident if you look at the gross flows.3
Another
example is thinking about the financing of the corporate sector, where the
preference for debt versus equity funding varies considerably depending on the
nature and size of the business. Just looking at bond and equity financing in
aggregate again conceals much of the interesting information.
4. Stocks matter at least as much as flows. Just as a disproportionate amount of
analysis is partial rather than general, stocks are very often neglected in favour of
flows, as on the price side, are levels rather than rates of change.
5. The financial system is always evolving - in both cyclical and structural senses.
- In terms of cyclical aspects, financial institutions currently have a better
appreciation of liquidity risk than they did six years ago. But if history is any
guide, at some point in the future, that appreciation is likely to wane; for
example, the lessons from the runs on some deposit-taking institutions and
trusts in the early 1990s or the concerns about liquidity in Sydney's early days
as a colony (there aren't too many around in the financial sector today who
remember that).
- The financial system is also continuously evolving in a structural sense. There
are a large array of financial products that simply didn't exist two decades ago.
In some cases, their arrival has not always been a good thing. In other cases,
such as that of asset-backed securities, or going back a bit further, junk
bonds, a new product arrived, the market grew too fast too quickly resulting in
considerable dislocation, before settling down to be an important, but much
smaller part of the financial landscape.
6. The factors driving evolution are sometimes very similar over the decades, while
some factors fade in importance and new drivers emerge.
- The increasing size of superannuation funds has played an important role in
influencing the shape of the financial sector in Australia for the past couple of
decades, and given its current size, is likely to continue to do so for the
foreseeable future.
- Likewise, government financing arrangements, banking regulations and banks'
liquid asset holdings continue to be strongly related.
- In contrast, unlike the 1990s, we no longer talk about how life insurance
offices' mortgage lending activities might return to their 1950s and 1960s
levels of importance.
7. More generally, how the system evolves to these forces is impossible to fully
comprehend ahead of time.
- Twenty years ago, for example, it would have been very hard to see exactly
how the competitive dynamics would play out in the banking sector. In the
housing loan market, discounts became increasingly common (and larger)
while in the credit card market banks initially competed through loyalty
programs rather than through lower interest rates.
- Furthermore, there was a view in the mid 1990s that a rapid expansion in the
debt market could be driven by the growth of superannuation funds, but it was
unclear whether any disintermediation would be most pronounced in the
corporate bond or mortgage markets.
- Likewise, while people understood that new distribution methods in the
banking sector were likely to evolve, few people would have appreciated the
move from ATMs and telephone banking to internet banking and banking on
our mobile phones.
- This reflects the fact that technology progresses in ways that we can't
imagine.
- Differences in incentives and the starting position of market participants matter
a lot in terms of behaviours and subsequent developments.
- Society's attitudes towards efficiency and risk evolve and are very much
shaped by the course of history. Someone born in the Depression had a
different attitude to risk than a baby boomer who in turn probably has a
different attitude to risk than someone gaining financial literacy in the current
environment.
8. A key consequence of this last point is that the industry and regulators have to
ensure that institutions are resilient to short-run shocks but are able to adjust to
longer-run secular trends with adequate consideration for both competition and
financial system stability.
With these three papers providing a sound foundation, where to now?
Just as there are differences in opinions on some of the issues raised in these papers, there
will also be different views about how to prioritise these areas for the next stage of the
review. But as I said earlier, I think one of the most useful outcomes of the work to date is the
articulation of a coherent framework with which to consider the question.
That said, I think one of the key areas that requires more work is one which is very much in a
state of flux at the moment, namely the implementation of the vast regulatory reform agenda.
A holistic view of how the Australian and global financial system is being transformed by this
would be very welcome and is much needed.
Finally, a particularly useful outcome of this project is the bringing together of many of the
key participants in the sector to discuss the issues and providing a fruitful forum with which to
do so. I thank the ACFS for the efforts in coordinating the work and wish the participants luck
in this regard as well as again commending the amount of work already accomplished. As I
said earlier, my main recommendation is that you spare the time to read these three papers.