Veriton Investment

Australia’s Pension Funds May Amplify Stress in Liquidity Shock

(Bloomberg) -- The vast scale of Australia’s rapidly expanding pension funds means they could amplify stress in the event of a severe market-wide liquidity disruption, the Reserve Bank said in a half-yearly assessment of the nation’s financial system.

Managing a large and expanding market presence and building resilience to shocks in the superannuation sector remain priorities, the RBA said in its October Financial Stability Review released Thursday. So-called super funds now account for 160% of Australia’s annual economic output.

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“The superannuation sector has historically been a key source of support to the Australian financial system, although its size now means it has the potential to amplify stress under severe scenarios,” the RBA said. “If a severe and unexpected liquidity shock occurs, superannuation funds could raise liquidity in ways that may amplify financial market stress.”

Further strengthening of super funds’ governance, liquidity and operational risk management practices remains areas of ongoing focus for regulators, the RBA added. Australia’s prudential regulator will publish the first stress test results on super funds in coming months.

The Australian financial system collectively holds around A$14 trillion ($9.3 trillion) in assets, amounting to about 500% of gross domestic product. Non-bank financial institutions, which include super funds, insurers, non-bank lenders and investment funds collectively account for roughly half of financial system assets in Australia. And half of these assets, or around 28% of the system, are in the superannuation sector.

Overall, the report showed that Australia’s banking system remains resilient though it is vulnerable to potential global disruptions such as a sharp correction in asset prices and ongoing weakness in China’s banking and property sectors.

“Heightened risk in the international system extends beyond trade, fiscal policy and historically low risk premia in financial markets and is manifesting along multiple dimensions,” the RBA said, referring to armed conflicts, cyber-attacks and climate change. “In this environment, stress events have the potential to interact with – and amplify – existing vulnerabilities, with uncertain implications for the resilience of a global financial system that is highly integrated.”

These vulnerabilities could spill over to Australia through three main channels, the RBA said:

Global financial markets: A significant increase in risk aversion could boost financing costs, restricting Australian firms’ access to funding and liquidity which would in turn intensify financial pressures on domestic borrowers

The digital and physical infrastructure underpinning the Australian financial system: Severe operational disruptions to key financial institutions or to the wider national infrastructure on which the financial system depends could impact the economy

The real economy: A global economic downturn, particularly one that leads to a sharp slowdown in China, Australia’s top trading partner, could have a negative impact via trade channels.

If a significant downturn were to occur, Australian “banks are well positioned to absorb large loan losses while continuing to support the economy through lending to households and businesses,” the RBA reiterated.