Transcript of Question & Answer Session Banking and the COVID-19 Pandemic

Thank you very much, Jonathan, that's fantastic. And I think it's very reassuring to hear from a senior member of the Reserve Bank, that our banks are safe as well as their future is bright, despite the fact that obviously, as you acknowledged, there are short-term challenges and I'm sure it's very reassuring to hear this optimistic perspective from the Reserve Bank.

I'm just wondering whether there could be some questions that people may have. I'm just going to look at one of them. It says, thus far house prices have not fallen by anywhere near the amount some had forecasted earlier in the year. Do you expect that house prices will adversely react to COVID-19 in a lagged fashion?

Thank you. This is a very interesting observation and it's an important part of the stress testing that we do. The property price assumption is very significant in there because, as I said, 60% of loans are mortgages. Those loans are secured, and so what happens with property prices is an important determinant of losses. In our stress testing model, we can demonstrate that even if you have a given fall in GDP and increase in the unemployment rate, you really need to have large declines in property prices in order to increase the losses that banks experience. Certainly, earlier this year when we were facing the start of the pandemic, and there was a lot of uncertainty about economic outcomes, there was, I think, quite broadly expectations of price falls. I think many people were expecting price falls of some 10%, but that's not what we're seeing.

We've seen some price falls, particularly in Sydney and Melbourne. Price falls have been more significant for inner city areas, in particular for apartments, but overall, property prices have performed much better than people had expected. Some of that reflect that economic outcomes have not been as bad as was initially feared. The increase in the unemployment rate has not been as large and so for a lot of households, their financial position has not actually deteriorated and for them they're seeing the benefits of exceptionally low interest rates. And so, so far there has actually been reasonable demand for housing, but I think we're not completely out of the woods yet, when it comes to housing prices. We do have to remember that there is a significant decline in the population growth rate in Australia because of the reduction in immigration. And the housing construction industry is building for what they think the population and demand is going to be in some 18 months or whatever their construction lag is.

And so they've been building in anticipation of stronger population growth than is turning out to be the case. So I think there is still going to be some adjustment that's occurring in the housing market and there will be different outcomes for different types of housing, whether it's inner city housing or property that's on the edges of the city, which now seems more desirable when a larger share of people are working from home. So, I think there is going to be some structural change in dynamics in the housing market as well.

Okay. Thank you for that. I'm just wondering also, what is your anticipation of investment by the business community in the immediate months and years ahead, and what's the impact of business investment? Let's assume we're looking at a more positive scenario where COVID-19 hopefully will be better under control in 2021. Would that have any impact on the balance sheet of the banks as well as their activities? The volume of business might expand, even if it's a low interest environment, and what's the implication of that on the overall health of the Australian economy?

Business investment is certainly one of the more cyclical parts of economic activity and the very positive thing is that we've seen the banking system continue to support businesses. They're able to lend. The banks have sufficient capital that they're able to advance new loans. They're not having to constrain their lending. Businesses are able to borrow at exceptionally low interest rates. So that removes any constraint for businesses. Funding is available at cheap interest rates and in sufficient quantities that they need. So then all we need is the demand for businesses to want to invest and I think a lot of that comes to how confident they're feeling about the outlook. So as we see the economy starting to recover, which it already is, then hopefully that will result in businesses feeling more optimistic about the future demand for their services, and so be more willing to invest and that will certainly be an important part of the recovery.

Also, the follow-up question is, as interest rates remain low, would that create more incentives for investors to start getting into the housing market, either buying existing houses or building new one? And that in turn, could stimulate the housing market, at the same time, the volume of loans could increase, which in turn, could also benefit everyone, including banks' profits.

That's right. An important channel of transmission of monetary policy is that lower interest rates do tend to stimulate asset prices, all asset prices and that's partly that there's a substitution. So if you're receiving less money, less return on either deposits or bank bonds, there's more of an incentive to switch to other assets, and that tends to bid up those prices. So that is always an important transmission channel of monetary policy, whether we're in the current situation where interest rates are around zero and we have QE or back when we had interest rates at 5 or 7%, monetary policy is working the same way in affecting asset prices at that time.

One mechanism there is that when you do have assets such as housing, for which a lot of people do tend to fund that with debt by borrowing, then you are likely to have some increase in borrowing. Again, that's part of the transmission channel of monetary policy and it's a positive thing that the banks in Australia are well positioned to be able to support that lending and to provide ample funding.

It's important, obviously that banks do continue to have strong lending standards. And in Australia, there has been a significant improvement in lending standards over the past five or so years and that's an important consideration in this environment. Think of the work that APRA did, in improving the lending standards of the banks; in recognising back in 2014, 2015, that there was a larger share of what we might think of being riskier types of lending. Lending of a large share, some 40% of loans, being interest only, a larger share of high LVR loan lending, not high internationally, but high relative to Australian history.

And so it was an important consideration to improve the quality of that lending in Australia across those metrics. It's positive that both in housing lending and business lending, standards across the board on average seem to be very good. And so that's more positive, that when you do have exceptionally low interest rates, which will stimulate lending, that we can be more confident that that lending will be of a good standard, high quality, and that reduces the financial stability risks, that otherwise we could be concerned about.

Another question is with regard to the composition of the liabilities of banks, only one third, for large banks, are dependent on wholesale market. How do you see this composition evolving? We know that it was more than that earlier on. And they would like to hear a little bit of elaboration on [audio cuts out] the question of dependence on wholesale market. Thanks.

Absolutely. So it has been a very significant change in Australia over the past decade or more. Prior to the GFC, banks were funding a very large share through wholesale markets and following the GFC, there was a recognition of the benefits of funding a larger share from deposits. Bank regulation favoured that, investors clearly had a preference for that. And so the Australian banks did shift a large share of their funding to deposits, and that's continued to increase. In the most recent episode, we've again seen a fairly significant shift, where partly as a result of fiscal policy, which has provided a lot of funding to households and also to businesses, that has helped to boost deposits of households and businesses and increase the flow into banks. The other important factor has been one part of the stimulus package of the Reserve Bank of Australia, the TFF.

And so that's providing banks with up to 5% or even more, depending on their lending activities, of their credit outstanding, as funding from the Reserve Bank and that's three-year funding that's coming at the cash rate. So that's another form of important funding that's changing the composition of the liabilities of the Australian banks and the consequence of that is that Australian banks haven't been borrowing as much in wholesale markets. So there's a reduced supply of Australian bank bonds, which then actually also works to reduce the cost of bank bonds, because there are still investors that want those assets, and so they bid up their prices and that in effect also makes the funding cheaper for Australian banks. So all of these things are contributing to changing the structure of Australian banks' funding, and also reducing the cost of their funding as well.

Thank you for that. There is another question and that is with regard to the loan deferral. How do we ensure that those proportion of population, which have been more negatively affected as a result of COVID-19, will be in a position to come back to the workforce, have more sustainable jobs, and contribute at the same time, if you like, assist a stronger and healthier economy, as well as the banking system? What are the measures on the way?

The loan repayment deferrals have been a really important way of how banking systems globally have dealt with this pandemic. In effect, what we had was part of economic activity had to be curtailed in order to achieve acceptable health outcomes here and elsewhere. And so that meant that there were some businesses that had a very significant reduction in their income, and households as well, and so couldn't make their loan repayments for a period of time. The alternative is, banks could have forced those people to try to make their repayments. They wouldn't have been able to, they would have defaulted. And then you would have had large asset sales, fire sales of assets, a lot of households and businesses with impaired balance sheets, and that would have been a significant problem. So, loan repayment deferrals have been a really important way of how we've dealt with this. But what we want to make sure is that those deferrals are not used to hide problem loans.

And so that's why it's important that APRA has a cut-off date for when the more favourable regulatory treatment on capital comes to an end, and so 31st of March. And then banks will have to recognise, they can still provide various forms of hardship assistance to borrowers, but they need to do that in a way that they're recognising the potential impact and taking into account the capital costs. So I think the mechanisms to do that, are switching from a more favourable capital treatment to a more sustainable long run position, where banks do have to recognise any losses.

Wonderful. Thank you so much. I think you have covered a lot of ground, and I think it's wonderful to see that people show interest, but also, I think it's wonderful to see, towards the end of this year, we are having one of the last statements from one of the officials of the Reserve Bank, which is reassuring us. I think building confidence in the minds of people, as well as those who are the decision-makers, households, investors, and others is very important, and I'm sure they all benefited from this reassuring, but also very cautious approach that we all should take as we move towards 2021.

Thank you so much for this presentation and also answering all these great questions. Thank you again, Jonathan.

Thank you. It's been a pleasure to join you.