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How the GFC changed our approach to risk

by Matthew Smith | 17 Mar 2017

Getting in front of market risks where they appear to be building could be one of the things regulators and policy makers do differently now compared to before the global financial crisis, the Reserve Bank of Australia’s newly appointed Financial Systems assistant governor, says.

Ten years on from the event that rocked global financial markets, the GFC is still seen as a line in the sand between how market risk was and is now perceived and addressed, Michelle Bullock highlights.

Although Bullock contends the GFC has not “fundamentally” changed the way the RBA and policy makers more broadly think about financial system stability, she notes that the central bank is more sensitive to risk since the crisis.

“Prior to the GFC, there was a common, but not universal, view that the system was fairly stable. While there were some concerns about growth in credit and asset prices, there were a number of plausible explanations suggesting that the stability of the global financial system would continue,” Bullock says during a breakfast attended by finance and banking professionals in Sydney this week.

“There were alternative, more pessimistic views centred around the view that investors were seriously underestimating risk and taking on too much leverage,” Bullock notes.

“But the more prevalent view seemed to be that the diversification of risk made possible by financial innovation, and the relative strength of capital and liquidity levels, would stand the system in good stead. You could say it had a ‘this time is different’ flavour,” she says.

Now, macro prudential policy plays a more important role when it comes to addressing risks compared to 10 years ago, Bullock notes.

She admits there is not really a universal accepted definition of macro prudential policy but refers to references by her RBA colleagues defining it as: “the use of prudential actions to contain risks that, if realised, could have widespread implications for the financial system as a whole as well as the real economy.”

APRA’s tightening of mortgage loan standards was an example of this new style of macro prudential oversight, Bullock notes.

In particular, the regulator limited annual growth in a bank's investor housing lending above a benchmark of 10 per cent and set some more prescriptive guidelines for serviceability assessments and intensified its scrutiny of lending practices.

At the time, ASIC also undertook a review of lending with a focus on whether lenders were complying with responsible lending obligations, Bullock outlines.

“We are continuing to monitor their ongoing effects and are prepared to do more if needed,” Bullock says.

Amid the more tangible changes since the GFC - the creation of the Financial Stability Board (FSB), the capital requirements imposed by Basel Committee on Banking Supervision and others – it is perhaps the ability for regulators to delve into its macro prudential tool set, which most differentiates them from how they operated pre-2008.

“We are, as are policy-makers globally, more sensitive to risk,” Bullock states.

A greater willingness to respond when risks appear to be rising is a product of that sensitivity, she notes.

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