rba warns no banks will be bailed out

RBA won't bail out banks: StevensFont Size: Decrease Increase Print Page: Print Scott Murdoch | April 15, 2008
THE Reserve Bank has warned banks not to take on too much risk on the basis the central bank would bail them out if trouble struck.

Governor Glenn Stevens, in a public lecture in Canberra, said central banks had always been regarded as the “lender of last resort” for the commercial banking system.

The regulation of financial markets, he said, had placed more emphasis on capital rather than liquidity, which he thought was more important.

“If private institutions took on additional liquidity risk, confident that the central bank would always help them out if liquidity conditions tightened, they could easily end up taking on more of these other risks as well,” Mr Stevens said.

“This would leave both them and the central bank in an awkward position at some future time should things take a turn for the worse.

“And for the central bank to act as a market maker of last resort in markets for more exotic instruments would be a very big step, potentially with many unforeseeable consequences.”

The Australian banking sector has weathered the sub-prime storm relatively well, particularly compared to international peers.

The biggest fallout has been felt in Britain with the nationalisation of Northern Rock and the rescue in the US of Bear Stearns, Wall Street's fifth-largest investment bank.

Mr Stevens said the world's largest central banks have had to manage the consequences of the sub-prime crisis as a structural issue, rather than just a one-off.

The RBA has been one of the fastest moving central banks and its policy to widen the repo agreements has been replicated by the US Federal Reserve.

“One key lesson is the importance of liquidity in markets and to institutions, something that perhaps had not been emphasised as much as it should have been in regulation, where the emphasis has been very much on capital,” Mr Stevens aid.

“ We have further learned that, under conditions of great uncertainty, liquidity pressures can erupt in markets that had seldom been affected in the past.

“Central banks have responded quickly and flexibly to such events, but it has proven difficult to contain the pressures fully.

“Some quite important questions remain for the longer run, which central banks will be considering.”