The Reserve Bank says “there was never any doubt about the solvency of an Australian bank” during the credit crunch, which started in August 2007. RBA Governor, Glenn Stevens made the remark in the Bank’s annual report, which was issued this morning online.

Although the timing of its release was coincidental, it emphasises the vast gulf between what’s been happening overseas, especially on Wall Street, and the local banking system.

The failure of Lehman Brothers, the bailout of Merrill Lynch, the earlier rescues of Fannie Mae and Freddie Mac and the Bear Stearns rescue in March, plus the Northern Rock debacle in Britain, all underline the difference between Australia and many larger economies and financial systems.

Many of those bigger systems are shaky, riven by doubt, illiquidity, falling asset prices, and imploding financial groups: the troubles faced by the huge American International Group, a major global insurer, is the latest, most dangerous example.

And yet down on the bottom of the globe in a little economy, we have been keeping our heads down. Australia is too small to matter much, we will be buffeted by the problems sweeping Wall Street, but according to the RBA our banks are largely immune.

That doesn’t seem to be appreciated at times by investors as they have followed US and other foreigners out of financial stocks, helped by aggressive shorting by hedge funds reduced to trying to destroy value to create value for themselves, their managers and investors.

The irony is that Lehman, Bear Stearns and Merrill Lynch and other investment banks actively funded the same hedge funds who helped drive their shares down to the point where independence was no longer an option: bailout, forced takeover and collapse were all that remained.

Australian banks, including Macquarie, as it is a “bank” in terms of the legislation and the Reserve Bank’s statement, were attacked, but haven’t been broken. Some losses have been taken, but much of that is for poor commercial lending decisions, not from dud deals in credit derivatives (with the exception of the NAB, it must be said).

Our big four are among the top 14 rated banks in the world, sitting on Double A .

That’s why the RBA Governor could write this in the annual report:

There was never any doubt about the solvency of any Australian bank. Indeed, the very sound position of the local banks was a major source of strength for the Australian financial system during this period.

It’s a comment not made lightly and couldn’t have been said about quite a few other countries, such as the US, Canada, the UK and Spain, Germany (where three banks have had to be rescued), Ireland or Denmark; or France where big banks have suffered large loses from bad investments, or poor management in the case of Societie Generale.

Mr Stevens said that the credit crunch:

.. presented some of the most demanding circumstances for the domestic market operations of central banks, including the Reserve Bank of Australia, seen for many years. Practices that had been largely settled since the mid 1980s had to be adapted quickly in the face of very unusual and fast-moving developments.

The Reserve Bank moved early to expand the scope of its daily operations, accepting a wider variety of collateral in repurchase operations, dealing at considerably longer terms than usual and, for brief periods, significantly pushing up the quantity of settlement funds in the system. The intention of this was to maintain liquidity in the domestic financial system, as local and international markets underwent the difficult and potentially disruptive process of re-pricing risk.”

Overall, the rise in term funding spreads to the official yield curve has generally been smaller in Australia than in continental Europe, the United Kingdom or the United States.

While our economy is in the black, the US economy isn’t and the latest financial worries add to the pressures forcing it into recession.

The US Federal Reserve didn’t cut overnight, has a neutral stance, but is obviously worried. it was a surprise to traders on Wall Street, but not to most economists. The central bank left its Federal Funds Rate unchanged at 2%, but left no doubt it is very, very worried about conditions in financial markets. That’s why it seems to be concentrating on making as much money available as it can, but not at a cheaper rate.

It’s not a question of price or cost right now, its quantity, and a lot of it, and support for the system as a whole. It’s also why it convened a second big meeting in as many days after trading in New York to try and sort out the mess that is American Insurance Group, the big insurer

But the Fed is pre-occupied with making sure liquidity is in the system, not its cost. It’s why $US50 billion was pumped into the US markets yesterday after $US70 billion on Monday. It’s why its lending tens of billions of dollars a day in New York to make sure the Lehman Brothers mess is resolved without escalating losses. It’s why $US200 billion or more is available for US banks each 28 days and it’s why its prepared to lend more than $US23 billion a day to the American banking system to fund their daily operations.

Here, the RBA has added around $2.6 billion on Monday and Tuesday above what the system was looking for to fund the daily deficit. It pays to be safe, boring and small.

Peter Fray

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