Financial instability may be here to stay but regulators can better police it, says Philip Lowe, deputy governor of the Reserve Bank of Australia.
“Attitudes to risk can change abruptly and willingness to extend credit and to trade assets can evaporate almost instantly,” Lowe told a University of New South Wales conference in Sydney. “Over recent years we have seen too many examples of where investors seamlessly move from seeing risk nowhere to seeing it everywhere.”
The Reserve Bank, the Australian Prudential Regulation Authority and regulators around the world need to find better ways of dealing with extreme swings in financial markets, he says.
Those at investment banks must do a better job at managing their risk exposure, says Lowe. “First and foremost this is the responsibility of the managers of financial institutions. But public policy has an important role to play in designing a system that is strong enough to cope.”
A set of prudential rules is important. But rules are not enough, says Lowe.
“An understanding of how borrowers and investors are viewing risk and how their decisions are affecting the financial system as a whole is critically important,” he says. “We should not lose sight that the public sector has a balance sheet that can be used to play a stabilising role.”
But if such a balance sheet is used it must be done carefully, says Lowe. “We need to be sure that it is done in a way that promotes the welfare of the community at large, rather than the welfare of owners and managers of financial institutions.”
He acknowledged public disgust in the bailout of some banks and investment banks, especially in the US and Europe. “The decisions that were made in the 2000s by some financial institutions ended up causing very real damage to the global economy,” says Lowe. “There were serious ethical failings by some of the highly paid staff in a number of institutions. A significant amount of taxpayer dollars had to be put at risk to help solve the problems”