Risk Australia 2009 conference report

Senior government officials, regulators and bankers were well aware of the potential risks in the financial system presented by historically low credit spreads and volatility levels before the financial crisis started, according to speakers and delegates attending Risk Australia 2009 in Sydney on August 25. Financial models that attempted to quantify risks were not the reason for the crisis, they said, rather senior policymakers and finance executives deliberately chose to ignore the potential risks that could cause severe distress in the financial system.

Delivering a keynote address, Jim Murphy, executive director in the markets group at the Australian Treasury, warned the audience that Australia had performed well in the past two years but was not unaffected. "The top four banks in Australia are all AA-rated and this has remained unchanged. The banking system has stayed stable with no need for Government intervention," said Murphy. "But this strength and resilience has been helped by the Government guarantee of bank [debt], which has kept flows moving and helped institutions to raise capital. To-date, more than A$110 billion ($92 billion) has been raised on the wholesale markets since the introduction of the guarantee. And the Government only has a budget deficit of 4.9%, compared with the US with 13%."

Taking questions from the floor, Murphy denied Australia had avoided the worst of the crisis due to luck. "You make your own luck," said Murphy. "Australia has good macro-economic management systems in place, so this was more than serendipity."

However, he cautioned there has been a lack of attention paid to systemic risk and a lack of appreciation about credit risk in the domestic market, which needed to be addressed.

Talking on a micro level during the second keynote session, Troy Rieck, managing director of capital markets at QIC, said there was an urgent need for institutions to understand more about liquidity over different timescales and in response to certain events. He warned financial institutions to begin stress testing their demands to find out which assets can be converted quickly into cash and at what cost. "They need to communicate with stakeholders - with fiduciaries and regulators - and have an action plan," said Rieck. "Stress testing must be taken seriously. Firms are exposed to tail risk in terms of liquidity, unless they keep on top of liquidity risk."

Warren Hogan, acting chief economist at ANZ, discussed the cyclical pattern of previous global financial crises and noted the similarity in the size of the widening of credit spreads between this latest spike and that in the late 1920s. While credit spreads were worse during the 1920s, when the Great Depression was in full swing, he flagged a large spike as an aftershock of this event in the late 1930s. He said this may indicate the current crisis is unlikely to follow a smooth ‘V shaped' recovery. He commented that recovery was more likely to look like a bathtub with waves rather than a ‘V', ‘U' or ‘W'.

"The problem is with the Reserve Bank of Australia's exit strategy," said Hogan. "Interest rates are currently down at an emergency setting. They are now looking inappropriate, but the labour market is vulnerable and so is the mortgage market. The danger on the upside comes from the fact that the majority of mortgages taken out are on variable rates and not fixed."

Jonathan Pain, executive director and chief investment strategist at HFA Asset Management, pinned down four of Australia's leading economists as to their views on the exit strategy, deflation and the shape of the recovery as he chaired a chief economist roundtable debate. Pushed for his views on inflation and the timing of any recovery, Peter Jolly, head of research for global markets at National Australia Bank, said history showed there were no ‘V-shaped' recessions and the recovery would be a drawn-out process. "We must have trust in the central bankers to exit properly and not let a low interest rate environment run on and on and cause inflation," he said.

But Richard Grace, chief currency strategist at the Commonwealth Bank of Australia, said any comparison with the drawn-out Japanese recovery of recent history was misplaced as the demographics and economics are very different - Japan has a proportionately high elderly population and a lower growth trajectory compared with Australia. ANZ's Hogan agreed, saying Japan represented more of a warning for an ‘ageing Europe', which was also not forcing its financial institutions to adjust.

And Bill Evans, chief economist at Westpac, said he had concern about the human capital capacity for an economic rebound. "The recovery is about wages. Unemployment in the US is to hit 10% and yet average wages haven't fallen as it is the lower paid who have been losing their jobs," said Evans. "The concern is that the capacity may not be there for a quick recovery."

The Treasury's Murphy told delegates the global financial crisis, or GFC as it is known in Australia, had highlighted the inadequacy of cross-border co-operation between governments and regulators. At the same time, it has exposed the depths of inter-connectedness between the financial economy and the real economy. He added that Australia's prudent regulatory stance and government intervention had enhanced the country's reputation on the world stage where it is seeking to increase its role to institute greater cross-border crisis management reform.

But he noted there needs to be a balance between stability and growth. "Australian regulation is being held as a model for others to follow as it has a clear focus on prudential regulation and takes a systematic outlook on the whole financial system," Murphy said.