Reveal All, Rba Tells The Banks

Sydney Morning Herald

Friday March 28, 2008

Jacob Saulwick

THE governor of the Reserve Bank has warned that banks need to come clean on all their subprime losses before investors could regain confidence and financial markets could return to some semblance of normality.

Glenn Stevens yesterday described the local financial community as "weathering the storm well", but outlined the obstacles preventing fund managers and other investors from tipping money back into the market.

His list included the need for confidence that major financial institutions had disclosed all their losses made on subprime and associated investments, that "excess" leverage taken on by companies recently had been cleansed from the system and that slower growth in major economies such as the US was manageable.

While there is still plenty of capital around in pension funds, insurance companies and in other vehicles, those investors are now more reluctant to put it into volatile equity markets, let alone buy complex debt instruments that would reopen frozen markets.

"Increasingly, there are good quality assets at prices that would, in normal times, be very attractive," Mr Stevens told a Sydney audience.

"At some point, investors who are currently on the sidelines will need to summon enough confidence to take up the opportunities for profitable exposure to risk."

Mr Stevens defended Australia's major banks for lifting rates on mortgages and other credit beyond official moves.

"The presumption that their lending rates would and should move only in line with the cash rate, which had arisen in an earlier period when all these rates were much more closely related, has not been a realistic one in the recent environment."

Mr Stevens's speech, and with the Reserve's biannual Financial Stability Review released yesterday, was seen as painting a relatively upbeat picture of Australia's ability to withstand the worst of the financial ructions - meaning the chance of another interest rate rise in May to halt rising inflation remained alive.

For example, Rob Henderson of nabCapital assessed the Reserve's analysis as: "All going according to plan."

Mr Stevens did not mince words as he described the way innovations in financial markets in the past decade had under-priced risk, creating the conditions for the current turbulence.

"It has been remarked by others that the complexity of some new instruments meant that they were not well enough understood by investors, and perhaps even by those promoting them," he told the Euromoney Australian Financial Markets Innovation Congress.

"Complexity is also the enemy of liquidity, which proved to be much less reliable than had been assumed.

"Perhaps future innovations will need to take account of the difficulty people inevitably have in grappling with complexity, and the dangers of illiquidity."

Mr Stevens outlined the extra stress on bank balance sheets that had occurred since the subprime crisis closed some markets for debt.

"This is, in fact, a key element of the whole situation: more capital needed to be carried by the big international banks to support the risks they were taking, and that capital has to be found now," he said. "In addition, the risk capital that was available from markets is no longer there to the same extent."

The Financial Stability Review offered a relatively optimistic appraisal of the Australian banking system, in contrast to the situation in the US.

On the subprime lending that triggered the meltdown in credit markets, the Review noted that while lending criteria were relaxed in Australia in recent years, credit standards remained higher than in the US.

© 2008 Sydney Morning Herald

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