michele bullock : big banks and financial stability speech by ms michele bullock, assistant governor ( financial system ) of the reserve bank of australia, at the economic and social outlook conference, melbourne, 21 july 2017. * * * thanks to david orsmond, penny smith, david norman and dilhan perera for assistance with this speech. good afternoon and thank you to the melbourne institute for the invitation to speak at this interesting conference. the theme of new directions in an uncertain world certainly has resonance at the moment in any manner of ways – political, economic, social and environmental. many of these themes have been examined during the course of the conference. the theme of this session is : are the banks too big? what i will attempt to do in the next 20 or so minutes is take the banking system structure as given and talk about the implications of this for the stability of the australian financial system. first, a bit of background. australia has always had a fairly concentrated banking system. through the 1960s and 1970s, the major banking groups, of which there were up to eight, accounted for around 80 per cent of banking assets in australia ( graph 1 ). this share declined to around 65 per cent following deregulation and the entry of foreign banks in the mid 1980s. it remained around this level until the global financial crisis when the share of the major banks, of which there were now only four, rose back to around 80 per cent. the concentration of the banking system in australia is not unique internationally but it is at the high end. there are other countries that have similar levels of concentration to australia, even a 1 / 9 bis central bankers'speeches bit higher, including canada and sweden ( graph 2 ). but there are many countries that have much lower levels of concentration including the united states, the united kingdom and a number of european countries. aside from the concentration, there are a couple of features of the australian banking system that are worth highlighting. first, if we look at cost - to - income ratios, australian banks seem to be fairly efficient ( graph 3 ). on average, the four major australian banks have a cost - to - income ratio of around 40 per cent, at the lower end of cost - to - income ratios for a selection of banks in other countries. it ’ s likely that this reflects, in part, differences in the business models of the banks. banks like the australian banks, with a greater emphasis on traditional lending activity, tend to have lower cost - to

##nometricians to test the hypothesis that the observations over the past few years were drawn from the same process as generated the observations over the 20th century. their answer, based on a battery of suitable tests for a univariate time series, was that it was too early to tell. bis central bankers ’ speeches probably change the story at some point. the lessons of history, moreover – that booms don ’ t go on indefinitely – are also too great to ignore. at this stage, the reserve bank staff are assuming that the terms of trade will fall in the latter part of the forecast horizon. the associated assumptions about key resource prices are toward the conservative end of current market forecasts, which typically assume a smaller fall in prices. even under the bank ’ s current assumptions, however, the terms of trade are still very high, by historical standards, at the end of the forecast period. but any forecast or assumption made in this area is subject to wide margins of uncertainty. we know that something very big is happening and has been for a while. we simply do not know whether it will continue like this, or not. how to respond? how, then, should we respond to our knowledge, and to the limits of our knowledge? to recap, we know that : previous commodity price and / or mining investment booms were big events that had major expansionary and inflationary effects. those booms all ended, generally with more or less a total reversal of the earlier rise in the terms of trade, though this often took some time. on some occasions, this brought on a significant economic downturn. the current boom looks bigger than any other since federation at least, in terms of the rise in the terms of trade over a period of several years. the previous episodes occurred without the benefit of a flexible exchange rate to help manage the pressures. on this occasion that particular price is adjusting, which should help to contain the pressures and help the economy to adjust more efficiently. we do not know what the terms of trade will do in future. it would be rather extreme to assume that the rise of china and india is a short - run flash - in - the - pan phenomenon. likewise it would be imprudent not to allow for a fairly significant fall in prices, even if only to still pretty attractive levels, over several years. 5 but the truth is that we will learn only gradually what the detailed shape of the new environment is. how should we handle this uncertainty? a few