September 2015 – Page 2 – Digital Finance Analytics (DFA) Blog

Rise of cryptocurrencies like bitcoin begs question: what is money?

When you begin to delve into the question of what money really is, you must be prepared for some metaphysics. Money, currencies and other such media of exchange differ markedly in their backgrounds and means of operation, and have changed quite recently into forms that are barely understandable.

For centuries, minted coins not only represented the value and trust of banks, their depositors and eventually nation-states, but also were deemed valuable because they were made from precious metals like gold and silver. These metals are difficult to move around in large quantities, and so banknotes were invented as early as the seventh century in China and brought to Europe in the 13th century. Unlike coins, banknotes were not treated as valuable in themselves since they were simply printed on otherwise worthless paper. Rather, they served as a form of promissory note or IOU that could be presented to the banks that issued them in exchange for their face value in precious metal, coins or bullion.

In the 20th century, most central banks and governments stopped backing up their currencies with precious metals, and yet banknotes maintain fluctuating values, with some in high demand as media for exchange both domestically and internationally. Dollars and euros are highly regarded and preferred currencies for international commerce, as well as for stocking private bank accounts.

Now we have bitcoins and other digital currencies that exist entirely in blocks of zeros and ones and are even “mined” by machines running algorithms. And earlier this month, bitcoins and their ilk were officially deemed commodities by the Commodity Futures Trading Commission, which will now regulate them.

So as the greenbacks and quarters in our pockets slowly disappear, replaced by strings of digits stored on our smartphones, and money takes another step away from being tied to anything of value, a philosophical question comes to mind: does money still exist? And if so, what gives it its value?

The Guardian explains bitcoin.

What’s value without value?

Money is a “fungible” item, which means that exchange of any one portion for a portion of equal value is not a “taking” of property. That is, you don’t own a particular US$100 bill. You own the value it represents.

This is how banks have long worked, since when you deposit your money, you are not entitled to receive the same coins or bills back as you deposited. This is also how “fractional reserve” banking began (in which banks do not keep all the curency on deposit “within” the bank, just some fraction of it) and was not regarded somehow as theft. People took their money to a bank, they were given a note of deposit, which entitled them to withdraw the same amount plus some interest, but they were not entitled to the same coins or bills that they deposited.

The money on deposit in a bank is not all physically in the bank (excepting that which is in safety deposit boxes) and has not been really since banking was invented. When you deposit a sum, you no longer own the paper or other medium of exchange used for the deposit, legally. What you own is a debt and obligation by the bank to return the equivalent amount of money with interest.

John Searle has described things like money as “some special sort” of social objects. That is, X (coins, bills, strings of digits) work as Y (money) in context C (an economy, coffee shop, bank, etc). In the case of money, anything can conceivably take on the Y role even without an X (think a barter economy). Where metals, then bills and now bits in computer memory take the role of X, money might well be a “free-standing” Y, meaning it could exist without anything to represent it except the web of intentional states (the debts and obligations) that make more familiar forms of money function. It’s only physical manifestation might be a note in a ledger.

Without precious metal standards backing national currencies, and in the age of digital transactions, money is decreasingly tied to banknotes, just as its ties to metals have faded. Digital ledgers track exchanges and accounts, with digital strings in computer memories representing the trust and value we once attached to more solid things like coins, bills and notes, in more ephemeral digitally encoded, instantly accessible forms attached to cellphones, computers and chip cards.

A brave new world

New types of cryptocurrencies (where cryptography protects its integrity) like bitcoin and others take the concept one step further, distributing the banking to all its users, tying the transactions and ledgers to no particular party but to all users at once. This is similar to mirrored bank servers, but bitcoin is mirrored among all bitcoin owners.

A bitcoin is as ownable as dollars are when they are deposited in a bank. Skipping the stage of physical, fungible currencies, bitcoins exist by virtue of their representations in a ledger in cyberspace. The information encoded in a massively distributed and constantly updated blockchain is incapable of the exclusivity required for owning objects in the traditional sense. But the same is true of the information that tracks most of the money in the world. Money in nearly every denomination exists and flows in a similar state, represented by digital bits.

Bitcoins nonetheless lack some of the institutional guarantees that other types of money has due to nations and their laws.

Trading on trust

Depositors to banks are protected in their debts by states, generally, and through contracts with their banks. State insurance and the contractual guarantee that a bank will pay back what has been put into them mean that there is some force behind our trust in the continued existence of a person’s wealth while digitally stored in a bank’s servers. The blockchain exists on many servers at once, spread across the universe of bitcoin owners.

Without government insurance or contractual guarantees, only mutual trust maintains the value and integrity of the system. What bitcoin owners own is the debt, just as those who own money in banks own debts that are recorded in bits. They do not own the bits that comprise the information representing that debt, nor the information itself, they own the social object – the money – that those bits represent.

Bank ledgers exist. They are tangible, even though digital, and they record the debts owed among parties. While cyberspace is ephemeral, it is still real and physically based. Digital bank ledgers now track money without the necessity for physical transfers of currencies.

Bitcoins too exist as digital records of obligations, physically encoded on servers of those who hold them, propagated and distributed for transparency and security, encrypted for privacy. Bitcoins are as real as money in banks. What’s most fascinating about these new digital cryptocurrencies is how much they reveal about the surreal nature of currencies and wealth in our digitized economy.

If bitcoins are as real as any other money, how real can money be?

Author: David Koepsell, Adjunct Associate Professor, University at Buffalo, The State University of New York

ING DIRECT Increases Rates for Property Investors

ING Direct has announced they are increasing variable rates on existing investment property loans by 0.37%pa effective 5 November 2015. They had previously tightened investment loan criteria.

Existing customers who hold both owner-occupied and residential investment loans with ING Direct will not be subject to this interest rate change.

The current rates for new investment property borrowers remain unchanged. ING Direct Orange Advantage is priced at 4.84%pa (5.03%pa comparison rate) for investors.

The bank has $38 billion in mortgages on book, of which about one third are investment loans, according to recent APRA data.

Does Trading Down Trump Trading Up?

As we continue to look over the results of the latest household surveys, as captured in the recently released Property Imperative report to September 2015, we look at households who are wanted to trade up and trade down. These are important segments of the market because they have reason to transact, and access to funding if they decide to trade. In fact they tend to underpin the market, and the balance between the two tell us something about demand and supply, and also which sectors are more likely to be on the up.

So looking first at those seeking to trade up, our survey identified about 1,077,000 households who are considering buying a larger property. Most (91%) are owner occupied. Of these households 12% are expecting to transact within the next 12 months, whilst 64% of households expect house prices to rise in this period.

The main reasons for these households to transact are as a property investment (40%), to obtain more space (33%), because of a job move (12%) and for a life-style change (12%). Many of these households will require further finance (72%) and a quarter will consider using a mortgage broker (22%), whilst 33% of these households are actively saving to facilitate a transaction. We note that prospective future capital gains rated most strongly, the view of property as an investment continues to drive behaviour. We also note that the majority of up-traders are seeking houses rather than apartments. Given the focus on owner occupied finance now, lenders and brokers would do well to consider their strategies to assist this market segment.

Turning to down-traders, more than 1.25 million households are considering selling and buying a smaller property. These households tend to be older, and with higher net worth. Of these 71% are considering an owner occupied property, and 29% an investment property. Of these 670,000 currently have no mortgage and own the property outright. Many will not need bank finance to transact. Some however may seek investment finance.

Around 24% of these households expect house prices to rise over the next year, whilst 51% expect to transact within 12 months, 9% will consider using a mortgage broker and 9% will need to borrow more. Households will transact to facilitate increased convenience (30%), to release capital for retirement (28%), because of unemployment (7%) or because of illness or death of a spouse (9%). Down traders tend to be seeking smaller more convenient property, are more likely to go for an apartment with good access to central facilities, such as shops and healthcare, and some may, as part of a wealth management strategy be seeking to release capital (as they have seen significant upside in recent times) and opt for an investment property (sometime with negative gearing).

But, if we put these two segments together, there are about 765,000 households looking to trade in the next year. Of these, nearly 80% are down traders. We think this will have an impact on the supply and demand footprint in the market, with smaller property being supported by the high number of down traders, and poor supply, whilst those with larger places, and wanting to sell may find a lack of buyers and a saturated market, so price differentials will moderate, with continue growth in the middle market, but more sluggish growth, or even a fall at the top end. This could well also distort prices in specific geographic areas. In other words, down traders may have to give a little on the price they get to sell their current place, and pay more for their next property, because of the higher level of demand. Up-traders will find good supply of property if they choose to transact, and will be able to negotiate hard on price.

Next time we look at the investment sector.

Fed Still Expecting To Lift Rates

In a wide-ranging speech, at the Philip Gamble Memorial Lecture, Fed Chair Yellen discussed inflation in the US and monetary policy. The net summary is that the more prudent strategy is to begin tightening in a timely fashion and at a gradual pace, adjusting policy as needed in light of incoming data.

Consistent with the inflation framework I have outlined, the medians of the projections provided by FOMC participants at our recent meeting show inflation gradually moving back to 2 percent, accompanied by a temporary decline in unemployment slightly below the median estimate of the rate expected to prevail in the longer run. These projections embody two key judgments regarding the projected relationship between real activity and interest rates. First, the real federal funds rate is currently somewhat below the level that would be consistent with real GDP expanding in line with potential, which implies that the unemployment rate is likely to continue to fall in the absence of some tightening. Second, participants implicitly expect that the various headwinds to economic growth that I mentioned earlier will continue to fade, thereby boosting the economy’s underlying strength. Combined, these two judgments imply that the real interest rate consistent with achieving and then maintaining full employment in the medium run should rise gradually over time. This expectation, coupled with inherent lags in the response of real activity and inflation to changes in monetary policy, are the key reasons that most of my colleagues and I anticipate that it will likely be appropriate to raise the target range for the federal funds rate sometime later this year and to continue boosting short-term rates at a gradual pace thereafter as the labor market improves further and inflation moves back to our 2 percent objective.

By itself, the precise timing of the first increase in our target for the federal funds rate should have only minor implications for financial conditions and the general economy. What matters for overall financial conditions is the entire trajectory of short-term interest rates that is anticipated by markets and the public. As I noted, most of my colleagues and I anticipate that economic conditions are likely to warrant raising short-term interest rates at a quite gradual pace over the next few years. It’s important to emphasize, however, that both the timing of the first rate increase and any subsequent adjustments to our federal funds rate target will depend on how developments in the economy influence the Committee’s outlook for progress toward maximum employment and 2 percent inflation.

The economic outlook, of course, is highly uncertain and it is conceivable, for example, that inflation could remain appreciably below our 2 percent target despite the apparent anchoring of inflation expectations. Here, Japan’s recent history may be instructive, survey measures of longer-term expected inflation in that country remained positive and stable even as that country experienced many years of persistent, mild deflation. The explanation for the persistent divergence between actual and expected inflation in Japan is not clear, but I believe that it illustrates a problem faced by all central banks: Economists’ understanding of the dynamics of inflation is far from perfect. Reflecting that limited understanding, the predictions of our models often err, sometimes significantly so. Accordingly, inflation may rise more slowly or rapidly than the Committee currently anticipates; should such a development occur, we would need to adjust the stance of policy in response.

Considerable uncertainties also surround the outlook for economic activity. For example, we cannot be certain about the pace at which the headwinds still restraining the domestic economy will continue to fade. Moreover, net exports have served as a significant drag on growth over the past year and recent global economic and financial developments highlight the risk that a slowdown in foreign growth might restrain U.S. economic activity somewhat further. The Committee is monitoring developments abroad, but we do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy. That said, in response to surprises affecting the outlook for economic activity, as with those affecting inflation, the FOMC would need to adjust the stance of policy so that our actions remain consistent with inflation returning to our 2 percent objective over the medium term in the context of maximum employment.

Given the highly uncertain nature of the outlook, one might ask: Why not hold off raising the federal funds rate until the economy has reached full employment and inflation is actually back at 2 percent? The difficulty with this strategy is that monetary policy affects real activity and inflation with a substantial lag. If the FOMC were to delay the start of the policy normalization process for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. In addition, continuing to hold short-term interest rates near zero well after real activity has returned to normal and headwinds have faded could encourage excessive leverage and other forms of inappropriate risk-taking that might undermine financial stability. For these reasons, the more prudent strategy is to begin tightening in a timely fashion and at a gradual pace, adjusting policy as needed in light of incoming data.

High Government Debt is Here to Stay – Fitch

There can be no meaningful reductions in government debt without stronger economic growth and better primary balances says Fitch Ratings in their Global Perspectives Series.

The dramatic increase in advanced economies’ government debt due to the financial crisis was quick, but its reduction in most countries will be very slow. Conditions that would facilitate rapid debt reduction appear unlikely to take hold.

In the absence of one-off factors such as privatisation receipts directed at paying down debt or – in extreme cases – agreements with creditors to reduce the debt stock, changes in government debt/GDP ratios depend on the primary balance, the effective interest rate on the debt and economic growth. These three variables form the classic government debt dynamics equation, and encompass all policy “solutions” to high debt, such as fiscal austerity (running a stronger primary position), inflating debt away (high nominal GDP growth relative to interest rates) or growing out of a debt problem (high real and nominal GDP growth relative to interest rates).

Much of the contemporary policy debate surrounding high government debt in Europe centres on the desirability and effectiveness of fiscal austerity. One argument is that it is self-defeating, especially when an economy is weak and growth is fragile – as is typical after a crisis – because the contractionary measures necessary to improve the primary balance will pull growth even lower. The absence of inflation, as we are seeing now, may supplement the view that demand is simply too weak to sustain another negative knock.

A counterargument contends that a tighter fiscal position ultimately fosters growth, first by boosting confidence that post-crisis policymakers are following a more prudent path, supporting private investment, and second by allowing for an increase in the flow of financial resources to the private sector, where they can be more efficiently and effectively deployed.

The austerity debate has largely overlooked how well this approach has worked in the past, and under what conditions. The dataset accompanying Mauro, Romeu, Binder and Zaman’s A Modern History of Fiscal Prudence and Profligacy, IMF Working Paper No. 13/5, provides a useful historical overview, as it contains data on government debt, GDP growth, primary balances and real long-term interest rates for more than 50 countries since 1800, where data availability permits. The episodes of meaningful debt reduction (debt falling 10 percentage points of GDP or more over a five-year period) in advanced economies since 1970 highlight the modern debt dynamics conditions that facilitated such declines, allowing an assessment of whether they might be replicable today.

In 1970-2011 there were 22 instances in 16 countries of government debt falling by 10 percentage points of GDP or more over a five-year period. On average during these episodes, governments ran primary surpluses of 4% of GDP, real economic growth was 3.6% and real interest rates were 3%. We may consider these figures debt dynamics benchmarks.

A comparison of the current and forecast debt dynamics of highly indebted (greater than 60% of GDP) advanced economies with these benchmarks, combining Fitch estimates of effective interest rates and IMF World Economic Outlook forecasts to 2020 for growth and primary balances, reveals that interest rates align favourably with the benchmark, but economic growth and primary balances are typically too low.

The only countries in this exercise forecast to have meaningful reductions in government debt are Iceland and Ireland, both of which are projected to run primary surpluses consistently of 2%-3% of GDP. Japan and Slovenia fare the worst, with debt expected to be higher in 2020 than in 2015. Most other countries are somewhere in between, with reductions in government debt of 5-10 percentage points of GDP, predicated on stronger growth and better primary outturns.

Need for Stronger Growth and Primary Balances

The policy implications of this review are clear, if difficult to address. For better debt dynamics, the current low level of interest rates must be accompanied by larger fiscal adjustments to improve primary balances, or stronger growth, or both. Enhancing growth prospects may prove difficult. Private debt is still at historically high levels in many countries, reducing the impact of accommodative monetary policies. Advanced economies with “productivity puzzles” abound, and export-led growth, while alluring, cannot be pursued universally, particularly in the context of the profound weakness in global trade flows.

This brings us back to the austerity debate, which is unresolved as yet, but with plenty of supporters on both sides. The situation will become more urgent if neither growth nor primary balances were stronger by the time long-term interest rates eventually begin to rise, at which point all three debt dynamics variables could be working against lower government debt ratios.

If high public debt is here to stay, as seems probable, so too are the consequences. Governments will be less able to enact specific countercyclical fiscal measures, possibly amplifying the next downward shift in the economic cycle and resulting in even higher debt. Policymakers will also find themselves in unfavourable starting positions should the need arise to respond to other potential strains on public finances, such as systemic financial sector stress or a catastrophic event. For the advanced economies as a whole, the probability of debt continuing to climb over the next several years may be at least as high as that of meaningful debt reduction.

Digital Darwinism and the financial industry

In a speech entitled Digital Darwinism and the financial industry – a supervisor’s perception, Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, says in the context of digital disruption, there is an “open end” to the evolution of the digital financial sector and if banks don’t think “digitally”, they’re going to find it difficult to compete for digital customers.

Dinosaurs are an often-used means of illustrating how “Darwinism” works. We still don’t really know why those creatures – which ruled the earth for millions of years – suddenly became extinct. Some make volcanic eruptions responsible; others cite meteorites or a sharp drop in sea level as a possible explanation. In any case, the assumption is not that dinosaurs ceased to exist because they could not cope with their new environment or adapt quickly enough. Applying this diagnosis to the financial sector, where banks have reigned throughout the last few centuries, and supposing that the digital transition indeed constitutes a new environment for banks, one may pose a rather provocative question: are banks dinosaurs that will one day become extinct? You may guess that I do not share this doom scenario, so let me start out by describing my views on the evolution of the banking business.

The digital era may indeed be considered a new environment for banks. Digitalisation of the financial sector is an irrevocable change that came about due to several factors.

First, the digitalisation of the financial sector has been fuelled by the development of highly effective, state-of-the-art technologies like broadband networks, advances in data processing and the ubiquity of smartphones. And there is a premise that is common to virtually all technological advances in market economies in the last few centuries: when a product becomes available, sooner or later it creates its own demand and puts market forces into action.

That means technological and social changes are intertwined. Bank customers are becoming increasingly open to digital banking. Think of innovative concepts such as online video consultation services, digital credit brokerage and the incorporation of social media into banking. Banking is still a “people business”, but it’s no longer reduced to proximate and personal relationships. So there is plenty of demand for use of the technological potential of digital banking: cheap and quick automatised processes, solutions for complex financial issues, service tailored to customers’ individual needs.

A fundamental challenge that banks now face is that in some business fields, we may expect a sudden and rapid change of the game that is being played. One rather obvious case in point is that of payment services. Service providers such as PayPal or Apple have implemented payment systems geared to consumers in a digital environment. Once customers become used to a new way of paying, competitors offering similar products will certainly have difficulties trying to convince customers to switch providers. The pioneer may have a decisive advantage.

Now, in evolutionary terms, the question is whether banks can adapt quickly enough. Banks have used IT for decades, but these fast-moving times present wholly new possibilities for its use: P2P lending becomes feasible, internet and mobile applications are sprouting up and internet giants such as Google or Facebook are cultivating “big data” methods. These enterprises have grown up with – at times – entirely new perceptions of business, work and life. And they have the appropriate staff. That may be crucial. It is one thing to build new ideas, but quite another to incorporate them into the company DNA.

Traditional banks, on the other hand, typically do not have a digital DNA. Theirs is an analogue world in which they have refined their knowledge about banking over decades and built up a customer relationship based on trust. Think of areas like investment advice and corporate finance as well as banks’ own business of generating synergies between business strands. The question now is: what part of their knowledge is still valuable and what part do banks need to reframe?

However, we cannot predict how the financial sector will look in ten years’ time. There are just too many “unknown unknowns”. Still, there is a recurring fallacy that reduces evolution to a narrow one-way street. If there are new market entrants whose businesses are well-adjusted to the digital environment, banks should be inclined to imitate their behaviour. But – to be clear – there is no one-size-fits-all strategy for digital banking. As in other industries, there will always be demand for more differentiated strategies, for example individual and personalised services as opposed to algorithm-based advice. Also, we should not be surprised to see the focus return to a key component of the banking business: establishing safety and trust.

Furthermore, the digital age does not simply redistribute market shares of a fixed revenue pie: there are also entirely new opportunities for desirable businesses.

Convenient banking is valuable. Banks could benefit from this, either through greater customer loyalty or through additional business volumes resulting from extra services. Win-win schemes are also conceivable in credit markets. “Big data” methods can generate highly informative individual risk profiles. This could enable banks to extend loans to private customers and small businesses which would otherwise not receive any financing. Even investment counselling could benefit. Video-based consulting, for example, does more than reflect modern life style of customers; it may also reduce costs for banks by rendering some branch offices unnecessary.

Other keywords of digital openings are “co-creation”, where customers participate in the development of products, and “multichannel banking”. But my aim today is not to present an all-encompassing overview on digital bank business ideas. Instead, let us move one step back and look at the bigger picture. Reshaping the financial sector doesn’t need to be left to new market entrants. This creative challenge can also be taken up by established banks. Supervisors, too, have an interest in seeing banks engage in innovation if this enhances the functionality of the financial sector and stabilises profitability in the medium and long run.

To sum up, there is an “open end” to the evolution of the digital financial sector. If you ask diehard evolutionists for a forecast of the future, they will merely point to a trial-and-error process that should eventually give us an answer. For an individual company, that is of course not helpful. As a banking supervisor, I am not inclined to attempt a market forecast. Still, there is a bottom line for banks from the line of thought I outlined earlier, namely that it is appropriate neither to blindly imitate nor to stick to old habits. The message to every player in the financial industry is simple: rather than being caught off-guard, banks have to participate actively in shaping future banking services. A new game is being played, and new strategies need to be developed and executed decisively.

3. Cyber risks – an evolutionary attachment to the digital bank

Along with the digitalisation of industries, there is another evolution that warrants our attention. It is a development that is neither intended by the visionaries and trailblazers of the digital world nor beneficial. I am referring to the evolution of cybercrime.

While we cannot predict how banking will look in ten or twenty years’ time, we can be almost certain that risks of fraud, theft and manipulation in banks through cyberspace will continue to rise. The reason is straightforward: digital channels can be used to steal a lot of assets with comparatively little effort today.

Nowadays, a large proportion of banks’ assets and value-generating capability is stored on hard drives and servers. The technical infrastructure facilitates the managing of bank accounts and grants access to money. But it also provides access to vast sources of data. There have been several incidents recently of truly large-scale data theft. Company secrets, too, are at stake. If, for example, the trading algorithms of your bank became known to others through illegal activities, they could be exploited in the market, causing huge losses to banks. In the same way, politically motivated acts of sabotage jeopardise trust in financial functions and integrity.

Looking at those on the other side of cybercrime, the potential attackers – they often have access to far more powerful weapons than before and convenient access through the internet. Targeted attacks on IT systems can originate from anywhere in the world. Hackers often need little more than a laptop with internet access.

Why do we have to expect a continuous evolution in this field? Attack vehicles like computer viruses differ widely and may target any chink in a bank’s defence, rather as human viruses attack biological systems. Its logic follows the arms race between criminals and law enforcers that can be traced down through human history, but is now taking place with digital weapons. What makes this evolution more dangerous still is that we now face a highly complex digital world where progress is constantly being made in technologies and innovations. But, crucially, you cannot risk a trial-and-error process here. Once an easy point of attack is identified in the IT infrastructure, the word will quickly spread and criminals from all over the world will try to exploit the weakness.

On top of this, we need to bear in mind that cyber and general IT risks are not only of a technical nature. The human factor often plays a crucial part. Employees may act in gross negligence, or they may be tricked by a Trojan horse or a phishing mail. In complex IT systems, even small system errors can quickly cause enormous damage. The error-prone human factor can only be eliminated by installing an appropriate system of controls and incentives. In today’s world, this is an important management task.

4. Adaptation as a managerial task

Before IT-related problems came to affect the very core of the digital economy, they were commonly shifted to the IT department. But this approach to IT risks is outdated. Awareness of digital risks and setting up a strategy are now a leader’s duties. If your business crucially relies on digital processing, any strategic decision at the company level requires knowledge and understanding of risks. Besides, we frequently observe that banks find it difficult to reorganise their IT systems. While a complete, “big bang” overhaul may be preferable, it often meets with resistance from many parts of the company. To avoid being locked into more and more outdated structures, banks should not just consider the expected short-term benefits when designing their IT strategy.

Furthermore, the digital world demands from banks’ managers something I would describe as unbiased attentiveness towards new technologies. If banks don’t think “digitally”, they’re going to find it difficult to compete for digital customers.

They have to reassess their client relations and even rethink different lifestyles and social trends. The individual needs and wishes of customers are more pivotal than ever before. Take a look at social networks, at online shopping or even at information research – consumers are already used to having their own needs catered for. Consequently, banks will have to get into the habit of looking at things from the customer’s perspective.

Let us also bear in mind that competition is becoming more global and more transparent, the competitors more diverse. In addition to FinTech companies, other industries with a strong IT focus are only one step away from the banking world. This means that the lines between industries are becoming blurred. Now more than ever, banks need to be aware of what the competition is doing so that they can review and refine their own strategies.

From an evolutionary perspective, adaptability is another essential attribute. The digital world welcomes experimentation, is prone to sudden trends, and is constantly changing. Although the banking industry may not always be subject to all of this constant movement, adaptability is definitely becoming more important. So a flexible IT infrastructure that supports adaptability, for example, will be vital. Business models can also be more open and flexible in structure. Just think of the “digital ecosystem” strategies banks are now deploying.

5. Towards a resilient sector

As a banking supervisor, I am wholeheartedly in favour of the goal of a stable sector. But this should not be understood as adopting a static view towards stability. For a workable financial industry, it is not decisive whether services are provided offline or online, by humans or by automated services. Our yardstick needs to measure whether the sector continues to fulfil its duty towards the real economy, which is to transform risks and provide payment and other financial services. That’s what is meant by a resilient financial sector.

To that end, we have to ensure there are no “dead ends” to the digital evolution in the financial industry. I refer to IT-related risks in particular. If we rely on computers and digitalised processes, we have to make sure that they are reliable and trustworthy. Sector-wide reputation and functionality are at stake. Nowadays, a customer’s personal payment information is stored not only at the bank but at a multitude of service providers and retailers as well. How can a bank ensure the safety of its payment services against a cyber-attack on a retailer’s network or on that of a third-party vendor? Combined efforts should be seen as insurance. You never know who will be the next victim of an attack. And attacks don’t stop at borders, so cooperation of this kind is also needed at the global level. In an interconnected and therefore interdependent financial sector, strengthening the common defence should also be in the banks’ very own interest.

6. Conclusion

Let me restate my views on “digital Darwinism”. Adaptation to a digitalised financial world does not simply require banks to develop new and ground-breaking ideas. It has more to do with a well-adjusted strategy – which means that it’s not just a race between development departments, but between leaders. As a supervisor, I therefore urge that we do not interpret digital competition as a race merely for the most advanced technologies, but for the right mix. This is why I am not in favour of comparing banks to dinosaurs. Traditional banks may typically have a pre-digital DNA, but they are capable of learning, adapting to a digital landscape and cooperating with technological pioneers. And each bank needs to find its own strategy. Banking business itself is as irreplaceable as ever before.

So what will not change? Business success will continue to hinge on entrepreneurial skills. In an increasingly digital finance sector, the role of banking will still be to serve the real economy. And banking is based on trust. To keep this in mind will be key to ensuring a thriving and stable financial sector.

Australian Population Growth Is Slowing

The ABS demographic data released today to March 2015 shows that Australia’s population growth rate has slowed to a rate last seen nearly 10 years ago to 1.4% during the year ended 31 March 2015. Slowing growth, and the aging of the population are both drag anchors to future growth.

The total population was 23,714,300 people. This reflects an increase of 316,000 people since 31 March 2014, and 93,900 people since 30 December 2014. All states and territories recorded positive population growth.

Natural increase and net overseas migration (NOM) contributed 45% and 55% respectively to total population growth for the year ended 31 March 2015.

Victoria recorded the highest growth rate of all states and territories at 1.7% or 97,500 people. Victoria and Queensland were the only states recording a net gain from interstate migration

The Northern Territory a recorded the lowest growth rate at 0.2%, its lowest growth rate in 11 years. This is 80 per cent lower than that of March 2014. Net interstate migration losses were the greatest contributor to this slower growth, with the territory recording its largest ever interstate migration loss in the year to March 2015.

Western Australia also recorded slower growth. In the past two years, net overseas migration to the state has dropped by 71 per cent, while net interstate migration has dropped to the point where the state has seen a net interstate loss. This has not been seen in over 10 years in this state.

The preliminary estimate of natural increase recorded for the year ended 31 March 2015 (142,900 people) was 9.7%, or 15,400 people lower than the natural increase recorded for the year ended 31 March 2014 (158,300 people). The preliminary estimate of NOM recorded for the year ended 31 March 2015 (173,100 people) was 16.0%, or 33,000 people lower than the net overseas migration recorded for the year ended 31 March 2014 (206,100 people).

NZ’s Estimation of a Neutral Interest Rate

The Reserve Bank of New Zealand has today published a paper in its Analytical Notes series on Estimating New Zealand’s neutral interest rate. In the paper they run through a number of different methods to derive this indicator rate, and observe the mean is 4.3%. Strikingly this mean rate has been falling for a number of years, and is a further indicator of lower rates around the world.

It is important for the Reserve Bank of New Zealand to understand the extent to which current monetary policy settings are either contractionary or expansionary with respect to the macroeconomy. As a benchmark for this analysis, the Bank estimates a level of the nominal 90-day bank bill rate that it believes is neither expansionary nor contractionary. This benchmark interest rate is termed the ‘neutral interest rate’.

The neutral interest rate is unobservable and significant judgement is required to assess its current level. The Bank continually monitors the economy for possible changes in the neutral interest rate. This includes a broad assessment of consumer attitudes towards debt and risk, the economy’s potential growth rate, and international developments. Signs that the neutral rate may be changing are initially incorporated into the Bank’s risk assessment when setting policy. If the economy shows clear signs of a change in the neutral interest rate, the Bank will formally change its estimate in its various modelling frameworks.

The Bank looks at a range of model-, survey-, and market-based estimates of the neutral rate to help inform this ongoing judgement. This paper outlines the methodology the Bank uses to arrive at these model-, survey-, and market-based estimates. The Bank currently uses five key methods to help inform judgements about the neutral interest rate. These include:

• a neo-classical growth model;
• implied market expectations of long-horizon interest rates;
• analysts’ expectations of long-horizon interest rates;
• analysts’ expectations of long-horizon annual nominal economic growth; and,
• a small New Keynesian model.

These estimates suggest the nominal neutral 90-day interest rate sits between 3.8 and 4.9 percent currently. The mean of these indicators is 4.3 percent.

The Bank currently judges that the nominal neutral 90-day interest rate sits at 4.5 percent – within the range of estimates and close to the mean of these estimates. This implies that current monetary policy settings are expansionary, although these models highlight some emerging risk that the neutral interest rate is falling further. The Bank will continue to use these five methods, along with broader monitoring of the economy, to help identify any possible changes in the neutral interest rate. Furthermore, the Bank will continue to look for ways to improve its estimates, including the development of other estimation methodologies.

Refinancing Opportunities In The Spotlight

We continue to discuss the segmented findings from the latest edition of The DFA Property Imperative report, which was released this week. Today we look at the refinancing sector.

There are around 673,000 households considering a refinance of an existing loan of which 79% relate to an owner occupied property, and 21% to an investment property. To assist in the refinance, 75% of households will consider using a mortgage broker.

Households are looking to refinance for a number of reasons, including reducing monthly repayment (40%), to lock in a fixed rate (15%), because of a loan rollover (14%), in reaction to poor lender service (11%), for a better rate (5%) or to facilitate a capital withdrawal (15%).

In the next 12 month, 23% of these households are likely to transact (a rise from 14% last time), whilst 53% expect house prices to rise in the next 12 months.

The growth in refinancing can be expected to continue as the focus turns from investment lending to owner occupied new and refinance loans. There are a number of discounted offers for refinancing currently available. We note that a smaller proportion are refinancing to a fixed rate.

Within our data, we see that borrowers with larger loans are more likely to refinance to an interest only loan.

We also found that about 38% of loan refinance transactions were in the $250-500k range. Many potential refinancers have held their loan for more than 2 years, and may well benefit from accessing current keenly priced alternatives.

Lenders are homing in on existing owner occupied borrowers in the hope of persuading them to churn their loans. Mortgage Brokers in particular will see this as an opportunity as the growth in investment loans slows. The removal of exit fees makes it easier for households to move, and with incentives including cash-back and no fee offers in the market they are firmly in the spot light. We expect to see a rise in the proportion of refinance borrowers who leverage the capital appreciation of their property by withdrawing some additional capital.

It is worth saying that there are also more than than 808,000 households who are holding property, with 81% owner occupied and 21% investment. Whilst 431,000 of these properties are owned outright and are mortgage free, the remainder have a mortgage and may well be able to benefit from current offers. However, they will need to be enticed, as they do not plan to transact at the moment. Players may well consider some segment specific campaigns.

Of these holding households, 72% expect house prices to rise in the next year, but under 1% would consider using a mortgage broker because they are by definition not intending to transact in the next year (99%).

Next time we will look at up-traders.

APRA May Cease Point of Presence Statistics

APRA has released a discussion document on the future of the Points of Presence statistics which they currently produce. The data provides useful industry level information on channel behaviour and usage, and is highly relevant in the context of digital disruption and migration. The paper suggests modification of the reporting, or possibly a cessation. We believe the POP data is highly relevant and useful and attempts to stop reporting should be resisted.

The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the Australian financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurers, friendly societies, and most of the superannuation industry. APRA collects a broad range of financial and risk data from regulated institutions as inputs to its supervisory assessments. Data collected from regulated and unregulated institutions also assist the Reserve Bank of Australia (RBA), the Australian Bureau of Statistics (ABS) and other financial sector agencies to perform their roles. APRA also collects some data to enable APRA to publish information about regulated institutions, and in other cases, to assist the Minister to formulate financial policy. Much of the data APRA collects are used for multiple purposes to reduce the burden of reporting.

APRA publishes as much of the data collected as are considered useful and as resources permit, subject to APRA’s confidentiality obligations with respect to individual institutions’ data. Publication of industry-level statistics enhances understanding of the industries regulated by APRA, aids public discussion on policy issues, and supports well-informed decision-making by regulated institutions, policy-makers, market analysts and researchers. Publication of institution-level data, where possible, is also consistent with promoting the understanding of the financial soundness of regulated institutions.

APRA observes international statistical standards in developing, producing and managing its statistics (except in the few cases where doing so would conflict with APRA’s primary role as a prudential regulator). By doing so, APRA helps protect commercially-sensitive information provided by institutions, whilst providing statistics that are useful and reliable, and that meet the needs of users.

APRA publishes detailed banking services provided within Australia by Authorised Deposit-taking Institutions (ADI) in its ADI Points of Presence (PoP) statistics. APRA is reviewing the PoP statistics to ensure that the statistics remain relevant and useful.

This paper focuses on two options for the future of the PoP statistics and data collection:
1. streamline the PoP statistics and data collection; or
2. cease the PoP statistics and data collection.

APRA is seeking feedback on the proposed changes. Written submissions should be forwarded by 18 November 2015, preferably by email to:
Manager, Banking Statistics,
Australian Prudential Regulation Authority
GPO Box 9836
Sydney NSW 2001
Email: statistics@apra.gov.au