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UWA Business School
Glenn Stevens, the Governor of the Reserve Bank of Australia, delivered the 2010 Shann Memorial Lecture at the Business School on 17 August.  The lecture, jointly hosted by the Business School and the Economics Society of Australia, is an annual event that honours the late Professor Ed Shann, Foundation Professor at UWA and the first Chair of Economics at the University.

In his lecture, Mr. Stevens warned against responding to the global financial crisis with unnecessary changes to the regulations that govern Australia's financial sector, and reminded the audience that regulatory trends, just like financial markets, move in cycles.

He reflected on the work of the late Professor Shann and traced the history of financial regulation from eighteenth century BC Babylon through to colonial Australia and then the twentieth century. Mr. Stevens noted that calls for tighter regulation generally follow periods of turmoil in the financial sector.

The RBA Governor argued that we must learn from history and impose the regulatory framework that would best allow the financial sector to fulfil its functions. These functions were not, he emphasised, solely about pursuing growth in the finance sector for its own sake.

‘For finance is not, for the community, an end in itself. It is a means to an end. Ultimately it is about mobilising and allocating resources and managing risk and so on,' said Mr. Stevens.

This allocating of resources means that the risk associated with investments should be borne by those who are most able to absorb it. Unfortunately, observed Mr. Stevens, ‘Human nature being what it is, people (or governments) are inclined to project into the future with undue confidence and insufficient assessment of risk.

‘Then, at some point, an event causes people suddenly to realise they have been too optimistic. Maybe the ‘new paradigm' disappoints in some way or the terms of trade decline again. The cycle then goes into reverse, usually painfully.'

In the lead-up to the recent financial crisis, the risk-taking of financial institutions was exacerbated by the ability of institutions to take risks with other people's money. The result was bad assets that were unable to be liquefied, investors that were unable to recover their money on demand, and a subsequent loss of confidence in the system.

In his speech, Mr. Stevens acknowledged the need for changes to the sector. ‘The finance industry, certainly at the level of the very large internationally active institutions, needs to seek to be less exciting, less ambitious for growth, less complex, more conscious of risk and more responsible about where those risks end up, than we saw for the past decade or two,' he said.

‘The objective should, rather, be to foster arrangements that preserve the genuine benefits of an efficient and dynamic financial system, but restrain, or punish, the really reckless behaviour that sows the seeds of serious instability.  Such arrangements surely have to include allowing badly run institutions to fail, which must in turn have implications for how large and complex they are allowed to become.'

It is a concept that might be difficult to accept for investors still hurting from the recent financial crisis. Yet failure remains the ultimate deterrent for excessive risk-taking.

Despite this, Mr. Stevens also emphasised the benefits of the relative strictness of Australia's existing regulations. He said that while this had caused bankers to complain about the Australian Prudential Regulatory Authority's (APRA) strict rules on definition of capital for regulatory purposes, its success was causing international regulators to consider moving in the same direction. President Obama has signed the toughest set of regulations that American banks have seen in seven decades.

However, Mr. Stevens also noted that unduly strict regulations could place Australia at a competitive disadvantage if financial institutions choose to shift their business overseas. Therefore, the imposition of regulations should be complemented by effective supervision. ‘To be effective, supervisors need support from their legislatures and executive government - in having strong legislation, adequate funding, and a high degree of operational independence from the political process in the conduct of their duties,' he said.

Mr. Stevens concluded that ‘we have to find the right balance involving regulation, supervision and financial industry practice.' Giving in to the temptation to over-regulate and suppress the finance sector, he said, would discourage investment and growth, and come at too great a cost to the economy.

Media references

Heather Merritt
Director, External Relations
UWA Business School
T: +618 6488 8171
E: [email protected]

Verity Chia
Communications Officer
UWA Business School
E: [email protected]