The report of the Campbell Committee* on Australias Financial System (1981) paved the way for financial deregulation of credit flows, interest rates and exchange rates. But it also recognized that a financial system could not operate effectively, let alone efficiently, unless investors at large had confidence in the underlying solvency of financial institutions and in the overall stability of financial markets. So it insisted on adequate prudential disciplines. Two subsequent Inquiries into the financial system reinforced this message. And tough prudential safeguards were implemented. As a result, we should have one of the strongest financial systems in the world. So whats going on?
We are seeing a serious breakdown in trust (even banks dont trust each other) and questions are being asked about the role played by hedge funds, margin selling and short-selling in the recent share market debacle (our share market has fallen at twice the rate of Wall Street), the adequacy of the capital backing requirements of banks and other major financial institutions, the effectiveness of the surveillance and monitoring role of the ASX, APRA and so on.
All the traditional methods of government intervention cannot work when trust has broken down. The good work being done by the Federal Reserve and other central banks, the proposed fiscal US stimulus and the ad hoc attempt to bail out insurance brokers in the USA will all help but cannot fully address a breakdown in trust.
Is it time for another comprehensive review of the functioning of capital markets in Australia? Apart from the specific concerns about margin selling etc., the Inquiry could also consider whether the financial system needs a reliable safety net for risk-averse investors and depositors (small and large) such as through a collective financial lifeboat which insures all approved financial institutions with strong balance sheets (not just banks). It could be funded by an annual levy raised from institutional members and from an initial large investment from the Future Fund. The scheme would have to be structured so as to minimize the risk of encouraging moral hazard or stifling competition in the financial system.
I am not mounting panic stations. The options are limited in a globalised capital market and an inquiry will do nothing to relieve present tensions (and may indeed alarm investors). But I do believe that once the present dust settles we will need to do something to reduce the risk of regular bouts of financial market instability.
Incidentally, in this nervous climate, and having regard for the fact that we have had three interest rate rises in the last 12 months and that the full impact of these rises have not yet been felt, I question the need for a further interest rate rise in February or March.
*I was Secretary and signatory to the report presented by Keith Campbell to John Howard in September 1981