Chapter 1: Resilience
Australia’s financial sector is not invulnerable to risks to stability, and the costs of crises can be wide-ranging and severe. Financial crises can deeply damage an economy and have a lasting impact on people’s lives. Although Australia was not as acutely affected by the global financial crisis (GFC) as some countries, international experience suggests the average financial crisis could see 900,000 additional Australians out of work as well as substantially reduce the wealth of a generation.1 Financial crises tend to be protracted, with unemployment remaining high for years. The average total cost of a crisis is around 63 per cent of annual gross domestic product (GDP), and the cost of a severe crisis is around 158 per cent of annual GDP ($950 billion to $2.4 trillion in 2013 terms).2
More can be done to strengthen Australia’s economy and financial system by preventing and mitigating these costs. Although no system can ever be ‘bulletproof’, Australia should aim to cultivate financial institutions with the strength to not only withstand plausible shocks, but also to continue to provide critical economic functions, such as credit and payment services, in the face of these shocks. Australia also needs a system that minimises the costs to individuals, the economy and taxpayers when financial failure does occur. The world has learnt valuable lessons from the GFC, and Australia should look to benefit from this experience.
A more resilient financial system also has efficiency benefits. Large or frequent financial crises create volatility and uncertainty, which impede the efficient allocation of resources and harm dynamic efficiency by discouraging investment. In addition, the long periods of high unemployment following crises reflect under-utilised resources.
Government actions required to stabilise financial sectors both overseas and in Australia during the GFC reinforced perceptions that some institutions are implicitly guaranteed. The private sector accrued gains from financial activities in the run-up to the GFC, but losses and risk were shared with taxpayers when failures occurred or were threatened. These implicit guarantees create market distortions, altering the risk-reward equation and conferring a funding cost advantage on financial institutions perceived as guaranteed.
Removing perceptions of these guarantees will reduce Government’s contingent liability and improve the efficiency of the financial system and economy. This chapter recommends steps to minimise these perceptions in Australia. These steps will strengthen the resilience of banks and enhance resolution arrangements that minimise the need for taxpayer support. In the Inquiry’s view, the alternative option of charging for such guarantees is not appropriate for Australia as it does not reduce the contingent liability of Government.
1 Reinhart, C and Rogoff, K 2009, This time is different: eight centuries of financial folly, Princeton University Press, Princeton, page 224. The authors find that the average financial crisis increases unemployment by seven percentage points, which is almost 900,000 people as at October 2014.
2 Basel Committee on Banking Supervision 2010, An assessment of the long-term economic impact of stronger capital and liquidity requirements, Bank for International Settlements, Basel, page 10.