ARTICLE – RECENT DEVELOPMENTS IN FINANCIAL MARKETS

This article was contributed by the Reserve Bank of Australia (February 2012).

Conditions in financial markets have improved since the acute distress in 2008, though financial markets have continued to experience bouts of increased volatility. Global growth since the financial crisis has been largely driven by emerging economies such as China and India, with the recovery of economic activity in advanced economies dependent on accommodative fiscal and monetary policies (RBA, 2010). As a result, public finances have deteriorated substantially in a number of advanced economies, particularly in Europe and the United States of America. With private sector demand slow to recover in most advanced economies, this has contributed to growing market concerns about the sustainability of sovereign finances in a number of these economies, a few of which had started from constrained positions. Sovereign finance concerns initially centred on Greece, Ireland and Portugal, but eventually spread to a wider range of countries in Europe, including the much larger economies of Italy and Spain, and a number of north Atlantic economies have had their credit rating downgraded. Growing concern over whether fiscal policy could address the large and growing level of debt in a number of European economies has resulted in increased risk aversion and volatility in global financial markets, particularly in the second half of 2011.

The effects of financial turbulence since 2008 have been less severe in Australia than in most other advanced economies. The healthy state of the Australian financial system, together with the relatively high share of variable-rate borrowing in Australia, allowed the significant easing of both monetary and fiscal policy in 2008 and 2009 to flow directly through to households, while the rapid depreciation of the exchange rate at the end of 2008 helped to offset falls in external demand. Furthermore, the resilience of Chinese economic activity, and the associated boost in Australian export income, has continued to offset the impact of softer growth in north Atlantic economies.

Nevertheless, the Australian economy has not been immune from overseas economic or financial market developments. The most obvious effect of the financial crisis on Australian households was the fall in net worth throughout the second half of 2008 and early in 2009, which was in large part driven by declines in superannuation and managed funds balances associated with the fall in equity prices over this period. The reduction in wealth is likely to have contributed to a substantial rise in the household savings rate from its pre-crisis level, with solid growth and labour market outcomes allowing this process to occur quite rapidly (graph S27.1). This sharp increase in household savings has coincided with a significant pick-up in term deposits held at Australian deposit-taking institutions. Housing credit has also grown at a more subdued pace, reflecting increased consumer caution in their borrowing behaviour (graph S27.2).

The deterioration in the financial health of the business sector in Australia was also relatively mild, with business profits as a share of GDP remaining at historically high levels. The profits of mining companies fell in late 2008, driven by falls in commodity prices, but increased rapidly from 2010 as a result of increased resource demand from China. However, business credit growth has not returned to pre-crisis levels as businesses have reduced their leverage.

Australian financial institutions were also affected by the financial crisis, but considerably less so than their international peers (graph S27.3). Australian banks’ cost of debt funding relative to the cash rate has risen since the crisis began in 2007. This reflects both an increase in the relative cost of deposits and wholesale debt, as well as a shift in the composition of bank funding to more expensive, though more stable, funding sources such as deposits and long-term debt (graph S27.4). See Deans and Stewart (2012) for more information. This is consistent with both a reassessment of funding risks by banks globally, as well as a response to regulatory and market pressures to secure more stable funding sources.



Profit growth of Australian banks was adversely affected in 2008 and 2009 by sharp increases in charges for bad and doubtful debts. However, these increases were well below those experienced in many other economies and, by 2010, charges for bad and doubtful debts had started to decline. The improvement reflects a number of factors, including tighter lending standards, a reduction in the share of low-documentation lending and more conservative debt-serviceability requirements.

More recently, Australian banks have continued to access offshore funding markets in the face of European sovereign debt concerns. This is partly because their exposures to the euro area account for only a small share of their total assets. The associated financial market turbulence has also had fewer spill-over effects on the Australian economy than in many other economies, and thus less impact on banks’ balance sheets. Increased caution by households and business has resulted in deposit growth outpacing credit growth, which has meant that Australian banks have been able to reduce their use of wholesale funding.

As a result of these developments the Australian banking sector has remained generally quite healthy, especially compared to many overseas banking sectors. The sector also has stronger capital and funding positions than prior to the crisis.


BIBLIOGRAPHY

Deans, C and Stewart, C 2012, "Banks’ Funding Costs and Lending Rates", RBA Bulletin, March, pp37-43 <back>

RBA 2010, Statement on Monetary Policy, May