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Friday, March 25, 2011

Growth-stability trade-off

I am pretty sure yours truly was the first to publicly argue that there was a post-GFC conflict between the RBA's financial stability objective of low and steady credit growth and the contrary desire of management to maximise credit growth and, given their likely inability to do so in a fully saturated banking system (ie, these institutions have become the system and therefore cannot grow more quickly than it), there was also a new financial stability risk that domestic institutions would be compelled to chase much higher risk growth in volatile offshore markets (cf. China vs. the US) despite the fact that the absence of offshore exposures was regularly proclaimed by regulators as a key strength of the financial system during the GFC. I have written on this matter too many times to count. As Banking Day reports:

"RBA sees ceiling on loan growth
25 March 2011 6:57am

The Reserve Bank of Australia has signalled that banks’ management and investors should not expect double-digit balance sheet growth in the years ahead. And it has warned that any quest for higher growth could lead to new financial instability.

In its six-monthly Financial Stability Review, delivered yesterday, the RBA warns that banks’ domestic growth opportunities “are likely to be more limited in the future”. It also cautions that Asian expansion, such as that being pursued by the ANZ, holds “challenges” (see following article).

RBA assistant governor Malcolm Edey underscored the growth point by saying, “It seems unlikely that we’ll be going back to the days of consistent double-digit growth in credit.”

The co-ordinated comments constitute the RBA’s most explicit warning yet that banks and their investors must accept the industry has entered a new, lower-growth phase.

The RBA argued that the decade of rapid growth in Australian bank balance sheets up to 2008 was the result of deregulation and then a one-off transition to low inflation. Both the Review and Edey noted yesterday that neither can be repeated.

Edey, speaking to an IIR conference in Sydney, said cautious borrowers and investors would likely need less leverage – and that would mean “our lending institutions have to get used to lower rates of expansion than were typical in the pre-crisis years”.

The Review also signalled that the RBA will now be much less relaxed about any new acceleration in credit growth than it was in the late 1990s and early 2000s.

Banks that try to get back to earlier rates of domestic credit growth “could be induced to take risks that may, subsequently, be difficult to manage”, the RBA says.

The RBA has not set out how it would react if domestic credit growth rose too fast, but prudential supervisor APRA can direct banks to reign in lending considered too risky. The Review also notes that the “counter-cyclical capital buffer” being introduced as part of the Basel III rules could be used to lean against credit growth...

Though there is little sign of banks significantly relaxing credit standards, the RBA says, “increasing competition in housing loans is starting to put pressure on lending standards”. It notes that a number of banks have raised their maximum loan-to-valuation ratios in the past nine months...

CLSA banking analyst Brian Johnson, speaking yesterday, said the lack of balance sheet growth was “the number one risk” for banks’ valuations. And, he said, although the market had partly absorbed that message, there was still scope for a further re-rating of the sector."