RDP 1999-05: Trends in the Australian Banking System: Implications for Financial System Stability and Monetary Policy 1. Introduction

The broad goal of monetary policy is to achieve the highest possible rate of non-inflationary economic growth. To achieve this goal, the conduct of monetary policy in the postwar period has concentrated predominantly on counteracting standard demand and supply shocks. However, recent events have demonstrated that financial shocks can have a major detrimental impact on the growth performance of an economy. A fragile financial system can greatly magnify the effect of real shocks and make it difficult for the central bank to pursue its price stability objective.^[1] Thus financial stability considerations are important for the conduct of monetary policy.

Over the past decade and a half, the Australian financial system, and the banking sector in particular, has undergone substantial changes which have influenced the stability and efficiency of the system. These changes have altered the probability of a systemic crisis occurring – some positively, some negatively – and have influenced the likely magnitude of such a crisis.

The driving forces behind these changes have been financial deregulation, technological progress and globalisation, supported by increased demand by consumers for a greater variety of sophisticated financial products and services. The influence of these forces has been manifest in three major developments in the structure of the Australian financial system. First, there is the pressure for further consolidation within the banking sector. Second, there is the trend towards the development of conglomerates which can supply a wide range of financial products within the same organisation. Third, competitive pressures on traditional banks have increased, partly from large non-bank financial firms which are offering bank-like products, and partly from smaller specialist financial firms which are able to compete successfully with banks through the increasing ability to unbundle and re-bundle financial products.

This paper draws out the implications of these developments for the stability of the financial system, and for policy. It discusses how they are likely to affect the probability of a systemic event occurring, and discusses some implications for monetary policy.

In Section 2 of this paper we present a broad definition of system stability and introduce the possibility of a trade-off between system stability and the efficiency of financial intermediation. We then discuss the interaction of standard monetary policy and policies for financial system stability, and we emphasise the importance of financial system stability for achieving monetary policy objectives.

In Section 3 we describe the four major driving forces for change in the financial system: financial deepening, globalisation, deregulation and technological advances. We discuss recent trends in both market structure and product availability in the Australian banking sector in light of these forces of change.

Section 4 of this paper focuses on the implications of consolidation for the efficiency and stability of the financial system, while Section 5 discusses the implications of conglomeration, and the rise of the competitive fringe. In Section 6 we then draw out the implications of these changes for both system stability policy and more traditional monetary policy.

Footnote

Such information is not new, as the experience of the 1930s attests. [1]