Banking system a survivor, says IMF David Uren, Economics correspondent April 03, 2006
AUSTRALIA'S banks could withstand a recession sending the exchange rate and house prices plunging and making Australia a pariah in global capital markets.
This is the preliminary result of a comprehensive stress-testing of the banking system by the International Monetary Fund.
A team of seven IMF executives flew into Australia last week to review the results of the modelling, which has required all the major banks to apply a doomsday scenario across their balance sheets and profit-and-loss accounts.
The final results will not be published until later this year, but banking sources close to the study say the preliminary finding is that the level of home mortgage defaults would have to be many times worse than has ever been experienced in the past for bank capital adequacy to be jeopardised.
The IMF is reviewing the strength of Australia's financial system as part of a global program introduced in the wake of the Asian financial crisis of the late 1990s.
The IMF believes the ability of the financial system to withstand a sudden change in the mood of investors is more important than the size of the current account deficit.
IMF policy director Mark Allen said the current account, which measures trade in goods and services, and the flow of interest and dividends, remained a central part of macro-economic analysis. However, the IMF now paid closer attention to the ebbs and flows in the financial account, which included direct and portfolio investment, as well as cross-border lending.
"Given global financial interconnectedness, it no longer makes sense to look just at the current account," Mr Allen said.
"One must consider the financial account and the strength of financial institutions to deal with its volatility."
He said one of the lessons of the Asian crisis was that the financial account can switch direction much more rapidly than the current account.
The IMF considers that macro-economics no longer provides sufficient information about a country's financial health, and it is necessary to supplement it with detailed analysis of the strength of financial institutions and supervision standards.
The scenario developed by the IMF, in collaboration with the Reserve Bank of Australia and the Australian Prudential Regulation Authority, assumes that the financial markets become hostile to Australia.
Australia's banks would find it harder to roll over their debts to international lenders as they fell due, with the loss of confidence precipitating a fall in the exchange rate.
Although the banks would feel pain, foreign lenders only account for 28 per cent of their liabilities, and only about a quarter of these are short-term.
The balance is bonds, with an average term of four years, giving the banks some breathing space.
The stress-testing of the banks follows an analysis late last year of their systems and supervision.
In a recent speech, APRA chairman John Laker said that although the IMF's work was not yet complete, "the team has been impressed by the strength of the Australian financial system and the quality of Australia's supervisory arrangements".
A recent IMF study found that financial inflows are stronger for Australia at times when its current account is in deficit than in other developed countries.
The study's author, IMF researcher Magda Kandil, says current account deficits in Australia are usually a sign that the economy is growing strongly.
"If in the process of growing, a nation realises a higher current account deficit, this is not worrisome, because in a world in which we have globalisation and financial investors looking for good opportunities, the higher growth will provide the opportunity to sustain the inflow of external finance to sustain the deficit."
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