Head of Financial Stability Department
Sydney Banking and Financial Stability Conference
Sydney – 12 July 2016
I’d like to thank the University of Sydney and the organisers for the opportunity to address this conference, which is on the subject of banking and financial stability.
Over the years I’ve had the privilege of being able to speak publicly about many aspects of financial stability and its drivers. But perhaps nothing is more important to financial stability than a sound banking system. To understand why, we first need to understand what makes banks different from other players in the financial system. After discussing that question, I will explain why the unique features of banks make the banking system so important for financial stability, before turning to the implications of this for policy across a range of domains.
What Is a Bank and Why Are Banks Different?
When I was a more junior person in the Reserve Bank, I had the task of helping edit and produce the conference volume of the Bank’s 1996 conference, on the topic of ‘The Future of the Financial System’ (Edey 1996). In fact the event was almost exactly 20 years ago today. Coming back to those papers 20 years later, I was struck by how contemporary some of them seem. But the issues these papers canvassed, which seem so up-to-date, are the ones that didn’t play out as the authors anticipated. The supposition of some observers at the time was that banks were in decline (Llewellyn 1996). They would be squeezed out by niche competitors and, in particular, institutional investors (Davis 1996). That financial markets would grow in importance was also one of the underlying assumptions of the Wallis Inquiry into Australia’s financial system, which reported the following year (Financial System Inquiry 1997).
These are all arguments we hear today, as well. The challenge to banks from new entrants enabled by new technologies, the growing role of fund managers – these were issues then as now. The sequel might not turn out the same way, but we have already seen earlier episodes of this particular movie franchise.
Banks didn’t fade away two decades ago. They evolved, and if anything have become even more important than before. We can see in this chart that the share of banks in the overall financial system started rising noticeably in the 1990s. Funds management, in the form of Australia’s (compulsory) superannuation system, has also become more important. As a share of total financial sector assets, though, banks have become even more central to Australia’s financial system in the past 20 years (Graph 1). Back in the early 1980s, non-bank financial intermediaries were almost as important as banks. In contrast, nowadays the share of financial intermediation outside the prudentially regulated sectors is very small – the orange bars compared with the sum of the two blue bars.