Reserve Bank Governor, Glenn Stevens has warned that keeping interest rates too low doesn’t help regulate banking activity.
He said in Sydney last night that Australia’s experience of booms and busts shows that trying to regulate bank lending when rates are too low is unlikely to work.
"But as those with any recollection of Australian experience of the 1960s and 1970s will know, if the fundamental problem is actually that financial conditions are just too easy – that is, interest rates are too low – balance sheet regulation won’t ultimately constrain credit growth.
He said that bank customers and shareholders will pay for the increased regulation and safety through higher margins on loans and lower dividends.
Stevens told the annual dinner of the Australian Business Economists annual forecasting conference that "A possible outcome is that, the harder we regulate a set of institutions as a result of the last crisis, the more likely it becomes that the next crisis occurs in the hitherto unregulated part, perhaps even among institutions that do not yet exist," he said.
"If the conditions are such that people want to take risk and gear up, they will find a way."
His comments have extra force because Australia is the only economy where interest rates have been raised three times this year as the central bank prepares to return monetary policy back to a normal footing and away from the emergency setting of the cash rate of 3%.
With the Fed maintaining its rates at 0% to 0.25%, the Bank of Japan at 0.1% and the Bank Of England at 0.50% and the European Central Bank at 1%, his comments have a special resonance.
The biggest problems in the credit crunch among the banks were to be found in those economies, especially the US and the UK, and to a lesser extent in Europe.
"The most egregious behaviour was mainly that of 30 to 40 large, globally active banks, none Australian" Mr Stevens said.
"They have imposed very large costs on their own banking systems, economies and taxpayers, and on the global economy.
"But there are thousands of other banks in the world whose risk appetite did not get out of control, that have remained solvent, and that have not needed public capital injections.
"So it will be sensible to ensure, as far as we can, that the proposed measures act effectively to constrain the worst excesses of the former without unnecessarily shackling the latter."
He said it will “take a great deal of determination on the part of regulators to enforce arrangements adequately in future booms,” Stevens said, referring to global efforts to limit the emergence of lenders that are “too big to fail” and reduce risk in the financial system.
“Ultimately, the cycle of greed and fear itself cannot be regulated away,” the Reserve Bank governor said.
“To assume that unrealistic optimism will not again, at some point, overwhelm the sober instincts of investors, bankers and commentators and others would be a triumph of hope over experience.”
"In the crisis itself, the too-big-to-fail issue presented simply as an imperative for a number of governments to prevent failures.
"But as the crisis recedes, and the global financial system is gradually nursed back to health, it is this issue that is going to leave the biggest lingering challenge.
"The Financial Stability Board will be directing particular attention to it over the coming year.
"It is not likely to be amenable to simple solutions, or easy ones.
"In the mean time, enormous moral hazard, perhaps greater than ever before, exists in the global financial system as a result of the actions – albeit essential ones in the circumstances – of 2008.
But he warned that global proposals to toughen regulations, including increased capital requirements and liquidity rules, may drive up the cost of banking, Stevens said.
“Customers of financial institutions — depositors and borrowers — will also pay via higher spreads between what lenders pay for funds and what they charge for loans,” he warned.
"That is, they will pay more ex ante (before) to use a safer financial system, as opposed to taxpayers having to pay large costs ex post (after) to re-capitalise a riskier system that runs into trouble."
But there was more confidence than there was a year ago when he spoke at the same dinner.
“As 2009 draws to a close, things in the global financial system look much less worrying than they did a year ago.”
“With the sense of immediate crisis much reduced, regulators can devote more focus to the job of designing and implementing changes to regulatory frameworks."
