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Thursday, September 18, 2008

We're sound. Our Governor says so.

The Reserve Bank Governor declared Australia’s financial system sound as the US yesterday bailed out the world’s biggest insurer, American International Group, with a $A107 billion loan in exchange for what amounted to nationalisation.

Speaking just hours later Glenn Stevens told company directors in Sydney that the condition of Australian banks was “light years away from what is happening in other banking systems around the world.”

Local banks had “very good profits, still ample capital and still ample access to funding” he told the directors.

However a small number of corporations were highly leveraged. “We all know who they are," he added...

The Governor's assurance was backed up by the Prime Minister who told parliament it was important to keep the challenges posed by the US financial crisis “in appropriate perspective”.

“We in this country are better prepared than most to deal with the buffeting which is being presented to other national economies,” Mr Rudd said.

On Wednesday the Reserve Bank injected money into the Australian banking system for the third successive day giving Australia's banks access to $4.285 billion in order to more than satisfy their immediate need for $2.180 billion.

In its annual report released yesterday the Bank said that long-time observers had expressed concern about the underpricing of risk in the US for years. But it had been impossible to accurately predict “how or when the process of unwinding would occur, or what its economic consequences would be”.

“No-one foresaw the sudden loss of confidence displayed in the world’s largest financial houses, manifested in a severe disruption in interbank markets,” the Governor said in the report.

“As banks all over the world became less certain of their own funding requirements and less confident of the credit profile of their counterparties, the interbank borrowing markets in countries including Australia became tight as banks were more inclined to hold onto liquid balances.”

The Reserve Bank responded by sharply increasing the level of cash it made available to the banks from an average of $750 million to a peak of $6.7 billion.

If the Bank had not done this, “the cash rate would have risen above the
target set by the Board as financial institutions bid more aggressively for funds in an attempt to increase their cash balances.”

Mr Stevens told the company directors that the government sector might have to “expand a good deal” in the future in order to support a weakened financial sector.

“The build‑up in public infrastructure in Australian cities and regions may point in the same direction, though to a lesser extent,” he said.

“If the sudden aversion to these sorts of assets by private investors continues for any length of time, governments may have to choose whether to fund the projects themselves, or defer them.”

Central banks may also have to consider whether to “lean against booms” in the future by keeping interest rates high even when inflation was under control.

“Among thoughtful people this question is up for discussion,' he said. “It will be fascinating to watch how the debate unfolds. I am not proposing to take a position today.”

The Governor would not be drawn about whether the Reserve Bank board would cut interest rates at its next monthly meeting on October 7.