malcolm edey : competition in the deposit market speech by mr malcolm edey, assistant governor ( financial system ) of the reserve bank of australia, at the australian retail deposits conference 2010, sydney, 19 may 2010. * * * introduction the theme for this session is pricing and competition in the deposit market. it ’ s a highly topical subject, because we have been seeing some very strong competition in this area in the recent period. to give one summary indicator : the average interest rate banks have been offering on their term - deposit “ specials ” recently have been around 6 per cent, or about 100 basis points above the bill rate. a few years ago they were typically about 50 points below the bill rate – so there ’ s been a price movement, in relative terms, of around 150 basis points. that ’ s a significant shift although, to keep it in perspective, we have to remember that this is not the whole market – it ’ s just the part where competition has been most intense. other rates are not as high. nonetheless, across the board, spreads between deposit rates and wholesale rates have generally shifted in the same direction over the past couple of years. obviously this is good news for depositors. it means that, if you have funds to invest, and you ’ re prepared to shop around, now is a very good time to find a favourable rate. of course, from the point of view of deposit - takers 1 and the people they lend to, it mightn ’ t seem particularly good news, because this is one of the factors that have been adding to the relative cost of funds, and therefore adding to the cost of lending. i ’ ve been asked to talk today about what ’ s driving this competition in the deposit market, and how it might develop from here. i ’ m going to stick to that brief, but i also want to place it in a broader context by looking at how competition has evolved over a longer period. evolution of competition in the post - deregulation period i ’ ll take as a starting point a snapshot of the aggregate balance sheet of the banking system in 1980 – just before the main sweep of financial deregulation got under way ( table 1 ). banks ’ balance sheets back then looked rather different from the way they do now. roughly speaking, the liabilities side of the balance sheet consisted of close to 90 per cent deposits. on the asset side, loans were around 60 per cent of the total, and much of the

to firms or individuals as a result of government directive, rather than on a commercial basis. all these developments often take place against a background of limited transparency, where investors and depositors have difficulty monitoring the capital adequacy of individual banks. there appear to be no problems during the initial phase of rapid economic growth and rising asset prices, but doubts begin to arise when asset prices fall. the recognition that some banks ( and companies ) have become insolvent is difficult enough in sophisticated capital markets, but is harder again where there is little necessity to revalue assets and disclose the results. bank supervisors, as well as market participants, are thwarted by the lack of transparency. inevitably, insolvent entities continue to operate, and there is widespread distrust of all banks because lenders and depositors cannot distinguish between creditworthy and insolvent institutions. as a result of the presence of type ii economic crises, it is now recognised that governments require improved policies directed at financial system stability. within this general field of policy, the one that has the most direct relevance is the prudential regulation of banks. this includes both preventative measures and crisis resolution. but prudential supervision of banks is only one policy, although an extremely important one, among the range of policies that are required to achieve reasonable financial stability. other important policies are those that pertain to the payments system and, of course, the whole field of securities regulation, including disclosure provisions and the enforcement of commercial and criminal law. in fact, it is possible to consider the whole body of law relating to claims over property and accountancy standards as being part of the necessary infrastructure for system stability. 4. relevance for australia it is being increasingly recognised that, in the modern world, the most likely route to a self - inflicted economic crisis or, at its extreme, an economic collapse is through a systemic failure of the banking system. therefore, in order to get good economic outcomes in terms of sustainable economic growth, we need more than just good monetary and fiscal policies. we need good policies directed at financial system stability, including, of course, good prudential supervision of banks. there is a close inter - relationship between monetary policy and policies that affect the stability of the financial system. while the principal aim of monetary policy should be to maintain low inflation as a pre - condition for sustainable growth, it cannot be conducted in isolation from developments in the financial system. for example, how far interest rates need to be raised to bring about