Too Small to Fail: Global funding markets and the transmission of risk - E101
The onset of the global financial crisis (GFC) in 2008 prompted a funding cost shock to the Australian banking system. Banks use a mix of wholesale and deposit funds to finance lending. If a country is a net importer of wholesale funds, then a financial crisis in a foreign country can ‘infect’ the banking system by raising the cost of wholesale funds. This has further triggers a crisis in an otherwise healthy banking sector in Australia.
This research aimed to address how an external financial crisis can increase bank funding costs in countries that rely heavily on global wholesale capital markets. The research also assessed the impact of different policy choices during the GFC on the level of competition in banking. The research highlights the relationships between banking policy, banking competition, the rates paid to depositors and paid by lenders, and the likelihood of a crisis arising when there is a shock on international wholesale funds markets.
This research found that:
• Accessing wholesale funds enables the Australian banking system to increase its level of lending and enhances Australia’s economic growth. However, it also means that the Australian banking system is exposed to sudden, significant rises in the rate at which wholesale funds are available in international markets if there is a major overseas banking crisis.
• Banking policies change both the structure of financial institutions and the level of competition in the Australian banking market and that policies dealing with a crisis also alter the market structure and the rates received by both borrowers and lenders, in those times where there is no crisis.
• Considering four different approaches to banking policy: bailouts, minimum equity requirements, licensing restrictions, and restricted access to wholesale funds
markets, implicit or explicit bail outs do not stabilize the banking system but rather make a crisis more likely. Licenses and restrictions on entry into banking, or restrictions on the access of banks to international wholesale funds markets, can have ambiguous implications depending on specific design factors.
• In contrast to other policies, minimum equity requirements, can be effective tools to limit the damage of an ‘imported’ banking crisis. Even when the banking system is ‘well supervised’ and loans are sound, minimum equity requirements can still play a role in stabilizing the banking system. However, minimum equity structures are not costless and regulators must understand the link between stability in the face of a crisis and reduced competition in ‘normal’ times when designing policy.
|Professor King presenting at CIFR Symposium: Market and Regulatory Performance (Sydney, July 2014)
This research has also been presented at:
|The 12th INFINITI Conference on International Finance
Prato, Italy (June 2014)
Hobart, Tasmania (June 2014)
CIFR SYMPOSIUM: Market and Regulatory Performance
Sydney (July 2014)
Melbourne (February 2014)