Martin North – Page 1002 – Digital Finance Analytics (DFA) Blog

Inequality Is Getting Worse

The latest OECD report on inequality was released today. The richest 10% of the population now earn 9.6 times the income of the poorest 10%; this ratio is up from 7:1 in the 1980s, 8:1 in the 1990s and 9:1 in the 2000s. Tight fiscal conditions have resulted in social spending cuts, including in areas targeted to the most disadvantaged. In 2012, the bottom 40% owned only 3% of total household wealth in the 18 OECD countries which have comparable data. By contrast, the top 10% controlled half of all total household wealth and the wealthiest 1% held 18%! Wealth is considerably more concentrated than income, exacerbating the overall disadvantage of low-income households.

At the launch, Angel Gurría, Secretary-General, OECD said:

For years now we have been underlining the toll that inequality takes on people’s lives. And I am proud of the contribution that the OECD has made in recent decades, putting inequality at the heart of the political and economic debate. Our 2008 report, Growing Unequal? sounded the alarm on the long-term rise in income inequality; and in 2011 Divided We Stand sought to diagnose the root causes that lay behind it.

But now we need to move the conversation forward. This is why today we are launching our new report In It Together: Why Less Inequality Benefits All in which we underline the toll that ever-rising inequality takes on people’s lives and the wider economy. But more than that, this report proposes concrete policy solutions to promote opportunities for more inclusive growth.

Where we stand: Trends in inequalities

Let me first remind you of the scale of the challenge. The latest data from In It Together make for stark reading. The richest 10% of the population now earn 9.6 times the income of the poorest 10%; this ratio is up from 7:1 in the 1980s, 8:1 in the 1990s and 9:1 in the 2000s.

During the early years of the crisis, redistribution via tax and transfer systems was reinforced in many countries. But now it is weakening again; tight fiscal conditions have resulted in social spending cuts, including in areas targeted to the most disadvantaged.

Even in those emerging economies where inequality has fallen, like Chile or Brazil, inequality remains at staggeringly high levels (26.5:1 in Chile and 50:1 in Brazil).

The story behind wealth is even worse. In 2012, the bottom 40% owned only 3% of total household wealth in the 18 OECD countries which have comparable data. By contrast, the top 10% controlled half of all total household wealth and the wealthiest 1% held 18%! Wealth is considerably more concentrated than income, exacerbating the overall disadvantage of low-income households.

The situation is economically unsustainable

In It Together finds compelling evidence that high inequality harms economic growth. The rise in inequality observed between 1985 and 2005 in 19 OECD countries knocked 4.7 percentage points off cumulative growth between 1990 and 2010. And what matters for growth is not just the poorest falling behind. In fact, it is inequality affecting lower-middle and working class families. We need to focus much more on the bottom 40%; it is their losing ground that blocks social mobility and brings down economic growth.

We have reached a tipping point. Inequality can no longer be treated as an afterthought. We need to focus the debate on how the benefits of growth are distributed. Our work on inclusive growth has clearly shown that there doesn’t have to be a trade-off between growth and equality. On the contrary, the opening up of opportunity can spur stronger economic performance and improve living standards across the board!

Policies to promote inclusive growth

In It Together identifies four key policy areas to promote opportunities for more inclusive growth.

First, to increase equality of opportunity and boost our economies it will be absolutely essential to enhance women’s participation in economic life. Overcoming gender inequalities is vital to improving long-term growth prospects and has a profound impact on inequality. If the share of households with a working woman had remained at the levels of the early 1990s, the rise in income inequality would have been almost 1 Gini point higher, on average. And the fact that more women have worked full-time and earned higher wages since 1990 has limited the rise of inequality by an additional Gini point. But we cannot be happy with the slow pace of change.

Governments should be asking themselves whether they can afford to waste the potential of the many women who are excluded from the labour market. To help women make the best use of their talents, we need to make good quality and affordable childcare available and also encourage more fathers to take parental leave.

Second, labour market policies need to address working conditions as well as wages and their distribution. Before the crisis, employment was at record highs in many OECD countries but inequality was rising. The increase in non-standard work was one of the culprits. In 2013, about a third of total OECD employment was in non-standard work, with about equal shares of temporary jobs, permanent part-time jobs and self-employment. Youth are the most affected group: 40% are in non-standard work and about half of all temporary workers are under 30.

Non-standard jobs are not always bad jobs, but work conditions are often precarious and poor. Low-skilled temporary workers, in particular, have much lower and unstable earnings than permanent workers. This would be less troubling if non-standard jobs were simply stepping stones to better and well-paying careers. But for the young, the part-time or self-employed worker this is often not the case. And among those on temporary contracts in a given year, less than half had full-time permanent contracts three years later.

The challenge is therefore not only the quantity, but also the quality of jobs. Better social dialogue and improved work conditions across the income range are crucial elements of an inclusive employment strategy.

Third, we cannot afford to neglect the education and skills of any part of our societies. A focus on education in early years is essential to give all children the best start in life. This investment needs to be continued throughout the life cycle to prevent disadvantage, promote better opportunities and educational attainment.

In it Together provides new evidence that high inequality makes it harder for lower-middle and working class families to invest in education and skills. An increase in inequality of around 6 Gini points reduces the time children from poorer families spend in education by about half a year. And it also lowers the probability of poorer people graduating from university by around four percentage points. This leads to an ever widening gap in education and life-time earnings.

Last but not least, governments should not hesitate to use taxes and transfers to moderate differences in income and wealth. There has been a fear that redistribution damages growth and this has led to a long-term decline in redistribution in many countries. Our work suggests that well-designed, prudent redistribution need not harm growth. As top earners now have a greater capacity to pay taxes than before, governments should ensure that they pay their fair share of the tax burden.

We do not need new instruments, we simply need to use the ones we have: scaling back tax deductions, eliminating tax exemptions, increasing marginal tax rates, using property taxes and above all, ensuring greater tax compliance. And let’s not forget government transfers. They play an important role in guaranteeing that low-income households do not fall too far behind.

Ladies and gentlemen, ever rising inequality can be avoided. It is for us to re-imagine and create our economies anew, so that each and every citizen regardless of income, wealth, gender, race or origin is empowered to succeed.

Governments around the world need to take decisive action to promote inclusive growth. In that spirit, I urge each and every country to recognise that when it comes to economic prosperity we are not in it alone, we are “In It Together”.

Mortgage Discounts Still Running Hot

Latest data from the DFA household surveys highlights that many prospective borrowers are still able to grab significant discounts on new or refinanced home loans. The chart below shows the weighted average achieved across loans written, compared with the RBA cash rate. Despite the recent falls, discounting is still rampant.

However, we also see significant differences between players and across different customer segments and loan types. Not all households are getting the larger cuts. Discounts also varies by LVR and channel of origination, with those using a broker, on average, doing a little better.

The deep discounting flowed through to some margin compression in the recent results from the banks, and falls in deposit margins, as they continue to attempt to grab a larger share of new business. Households with a mortgage of more than a couple of years duration would do well to check their rate against those currently on offer in the highly competitive market. Even after switching costs, they may do better.

We also updated our strategic demand model, and our trend estimates for mortgage numbers out to 2020. We expect to see investment loan growth containing to run faster than owner occupation loans. Over the medium term we expect the number of owner occupied loans to grow at an average of 2.8%, and investment loans at 7.8% per annum over this period.

Behind the model we have made a number of assumptions about population growth, capital demands, house prices and economic variables, as well as the demand data from our surveys. Significantly, much of the demand is coming from those intending to trade down, buying a smaller place, AND a geared investment property. We will update the segment specific demand data in a later post.

Oil Prices And Their Economic Impact

How will lower oil prices flow through into inflation, growth and economic activity? Will monetary policy need to adjust to take account of oil price movements, or should these short term movements be isolated from inflation targetting? All important questions.

In a speech given today to the AIECE Conference in London, Martin Weale, External member of the Monetary Policy Committee, discusses two key issues for the inflation outlook in the UK: the impact of oil price moves on the UK inflation forecast, and the degree to which international prices feed through into the outlook in this country.

Weale’s arguments derive from models he believes offer a more realistic sense of the probability of relatively extreme movements in prices occurring than implied by more popular methods in economics – a lesson economists should have learned from the financial crisis. He states: “It might seem like a technical point, [but] it is in fact fundamental: if you seriously underplay the chance of relatively extreme events happening, then not only will you be more surprised when they do happen, but you may be tempted to read too much into them.”

Weale’s model for the impact of oil prices on the macroeconomy – drawing on long run data beginning in 1970 – indicates there is a risk that the impact of the oil price fall we have witnessed will be somewhat stronger in the near term than the MPC has predicted. The result, he concludes, would be that growth for 2015 would prove a little stronger, and inflation a little weaker, than expected.

However, Weale states that the risk of a slightly weaker profile for inflation has little impact on his outlook for policy, as the effect will have dissipated within two years – the relevant point for policymaking.

Turning to the international context, Weale investigates how far inflation in the UK is determined independently of what happens in other advanced economies.

Weale notes that the correlation between inflation in the UK and other OECD countries has been relatively high since 2008 – and more so over the past eighteen months.

However, he finds that there is relatively limited statistical evidence that the correlation is strong over the longer-run. Using data from 1993 to the present, he notes that the variability of core inflation in other rich countries can account for only about a seventh of the variability of UK core inflation.

Summing up, Weale states that the MPC must weigh the need to respond to these international factors, against the desire to provide some stability in the level of interest rates and output.

He adds: “I think the Committee is quite right to let the short-term effects of external shocks feed into inflation, even if this pushes it far from target, whether on the downside as now, or on the upside as in the crisis. To do otherwise, and tighten or loosen aggressively, would do little to help inflation in the short term, but would risk a lot with unwanted gyrations in output.”

Super Tops $2 Trillion

APRA released their quarterly superannuation stats today. Superannuation assets totalled $2.0 trillion at the end of the March 2015 quarter, up by $115 billion from December. Self Managed Super Funds continued to power ahead, both in number of funds (up by 5,911 funds) and value (up $26.6 billion), though relative share fell slightly.

Over the 12 months from March 2014 there was a 14.3 per cent increase in total superannuation assets. The total value lifted $115 billion in the last 3 months.

Total assets in MySuper products totalled $420.2 billion at the end of the March 2015 quarter. Over the 12 months from March 2014 there was a 23.1 per cent increase in total assets in MySuper products.

There were $23.7 billion of contributions in the March 2015 quarter, up 4.4 per cent from the March 2014 quarter ($22.7 billion). Total contributions for the year ending March 2015 were $101.6 billion.

Outward benefit transfers exceeded inward benefit transfers by $641 million in the March 2015 quarter.

There were $14.4 billion in total benefit payments in the March 2015 quarter, an increase of 9.2 per cent from the March 2014 quarter ($13.2 billion). Total benefit payments for the year ending March 2015 were $57.5 billion.

Net contribution flows (contributions plus net benefit transfers less benefit payments) totalled $8.7 billion in the March 2015 quarter, a decrease of 1.4 per cent from the March 2014 quarter ($8.8 billion). Net contribution flows for the year ending March 2015 were $39.3 billion.

Looking at the splits, the trend growth was strong in industry, retail and SMSF.

Looking at SMSF, both asset values and number of funds show a steady rise.

However whilst 27% of all superannuation funds are now held in SMSF, this decreased by 1% from a year ago.

The annual industry-wide rate of return (ROR) for entities with more than four members for the year ending March 2015 was 13.0 per cent. The five year average annualised ROR to March 2015 was 8.0 per cent.

As at the end of the March 2015 quarter, 52 per cent of the $1.35 trillion investments for entities with at least four members were invested in equities; with 24 per cent in Australian listed equities, 22 per cent in international listed equities and 5 per cent in unlisted equities. Fixed income and cash investments accounted for 32 per cent of investments; 19 per cent in fixed income and 13 per cent in cash. Property and infrastructure accounted for 12 per cent of investments and 4 per cent were invested in other assets, including hedge funds and commodities.

Card Payments Regulation

A speech was delivered today by Malcolm Edey, at the Cards & Payments Conference in Melbourne following on from the Murray Inquiry and the Reserve Bank Payments System Board (the PSB) own review following on from the Murray recommendations. As the PSB’s review process is still underway, Edey did not pre-empt any conclusions that might come from that. Instead he over viewed the PSB’s general approach to retail payments since it first entered the field. His comments on more recent developments does give some clues to issues ahead however, with specific reference to NPP, interchange arrangements and surcharging.

The PSB more recently undertook its Strategic Review of Innovation in the Payments System, the results of which were published in 2012. That review was conducted over a two year period and involved extensive consultations with both the payments industry and with users of payments services. It found a number of areas where there was scope for system improvements that could be achieved through coordinated action.

The key areas were:

same-day settlement of direct entry transactions;

faster payments and out-of-hours payments to be made generally available;

capacity for richer information with payments; and

an easy addressing solution for electronic payments.

The first one of these was delivered at the end of 2013 and essentially involved an acceleration of existing direct entry processes. The remaining three form a more ambitious agenda and are together being taken up as part of the industry’s New Payments Platform (the NPP project).

The NPP is a successful example of what can be done through collaboration between the industry and its regulator. It is also a good example of the catalyst role for the PSB in promoting system innovation that was envisaged by Wallis. While it is an industry-led project, it is strongly supported by the PSB, and the Board continues to encourage commitment to the project and to its timely completion.

The project was launched in early 2013 and is now well advanced. On current scheduling the NPP will deliver a fast payments service with rich information and addressing capabilities in the second half of 2017. It will be linked to a fast settlement service provided by the Reserve Bank, which will allow transactions to be cleared and settled 24/7 in close to real time. All of this will amount to a world-class payments infrastructure.

It will also be a platform for further innovation. One of the key decisions made at an early stage of the project was to separate the basic clearing and settlement infrastructure from the commercially based overlay services that would use it. The industry is committed to an initial overlay that is intended to provide an attractive service and drive early volume growth. But it is important to note that access to the overlay space has always been intended to be open and competitive. Over time, this structure will allow new and specialist providers to make use of the rich capabilities provided by the core infrastructure.

Before moving on to some more detailed regulatory matters, I will mention one more initiative to have come out the 2012 Strategic Review, and that is the establishment of new industry coordination and consultation arrangements. In line with a recommendation from the 2012 Review, a new industry coordination body, the Australian Payments Council, was launched last year. The Council is a high-level body representing a diverse range of industry participants including banks, payment schemes and other service providers. It will have the capacity to give strategic direction to the industry as well as engaging in dialogue with the PSB. At the same time, it is important that the policy process engages with users and not just suppliers of payment services. To facilitate that, the Reserve Bank has also set up a Payments User Consultation Group which began meeting late last year.

In summary then, the policy work of the PSB has been very much consistent with the philosophy and objectives of the original Wallis reforms. A good deal of that work has been what might be termed ‘co-regulatory’ in nature, in the sense that it involved promoting industry-led solutions rather than using formal regulatory powers.

But of course the PSB does have a regulatory mandate, and it has used its powers to regulate a number of aspects of card payments where it judged that there was a public interest case to do so. Probably the aspects of this regulation that have attracted the most attention have been those related to interchange and surcharging, and I would like to make some general comments about each of these.

First, interchange. The commercial function of interchange fees is a very interesting one. They serve as a device for shifting the benefit-cost balance between issuers and acquirers in a four-party scheme and therefore, indirectly, between cardholders and merchants. Payment schemes argue that this can be an important competitive device that can promote innovation, for example by being structured to encourage network growth or the take-up of new products. Typically, interchange flows from the acquirer to the issuer, and hence the fee structure tends to encourage issuance and use of a card, but may discourage acceptance by merchants if the fee is too high. For mature schemes, however, the capacity of merchants to refuse acceptance may be quite limited. As a result, it has been frequently observed that competition between schemes can have the effect of pushing fees up rather than down, in order to maximise incentives to issuers and cardholders.

The reason that this kind of outcome is possible is that there is a misalignment between the incidence of these fees and the structure of decision-making power in a typical transaction. In a nutshell, the cardholder chooses the payment instrument but the merchant pays the fee.

In designing its card payment reforms, both for credit and debit, the PSB concluded that competition of this nature was distorting price signals in a way that inefficiently encouraged the use of high cost cards and added to merchant costs. Hence, it judged that there was a case for interchange fees to be capped by regulation. A number of other jurisdictions have since taken a similar view.

The second aspect that I want to talk about is surcharging. The PSB has consistently taken the view that merchants should not be prevented from surcharging for higher-cost payment methods. Scheme rules that prohibited surcharging had the effect of reinforcing the distortive effects of interchange fees by preventing costs from being passed on to cardholders. They also reduced the flexibility of merchants in deciding how to respond to high-cost payment instruments. The ability to surcharge improves merchants’ bargaining position by allowing them a greater range of responses, rather than just being faced with a binary decision to accept or reject a particular card.

Efficient surcharging should of course reflect the underlying payment cost. The PSB’s initial reforms to credit and debit gave merchants the right to surcharge, while effectively relying on competition to ensure that surcharging would not be excessive. This regulation was revised in 2013 in response to concerns about practices that had developed since the initial reforms, particularly about surcharging that appeared excessive or unrelated to costs. The amended regulation still prevents schemes from imposing no-surcharge rules, but it allows them to limit surcharging to the reasonable cost of acceptance. In doing so it strikes a balance, at least in principle, between the rights of merchants and schemes. Merchants cannot be prevented from recovering reasonable acceptance costs, but they can be prevented by scheme rules from going beyond that. More on that in a moment.

The PSB’s reforms to surcharging and interchange have formed part of a broader package that also included rules relating to access and transparency. I don’t have time to cover all of that today. But taken together, the effects have been beneficial. The system has continued to innovate, and merchants’ card payment costs have fallen.[³] It is also notable that these costs are significantly lower in Australia than in a jurisdiction like the United States, where reforms to card systems have been much more limited.

The Murray Report last year broadly endorsed the PSB’s reform approach while flagging a number of areas for further consideration, particularly in relation to surcharging and interchange. These have now been taken up as part of the PSB’s card payments review.

The issue of surcharging remains contentious. Instances of apparently excessive surcharging have persisted. While they acknowledge arguments for what might be called a ‘no excessive surcharge’ regime, the schemes have argued that the current formulation is too complicated and difficult for them to enforce.

The card payments review is looking at several possible mechanisms for addressing this. One option proposed by Murray is a tiered approach that would allow tougher surcharging constraints to be placed on low-cost cards. A number of other options are available to strengthen enforcement and disclosure practices, for example allowing schemes to cap surcharges that are not percentage based at some low fixed amount.

On interchange fee regulation there are a number of issues to consider. These include the overall level of the interchange cap, the complexity and proliferation of interchange categories, the phenomenon of interchange ‘drift’ with the three-year compliance cycle, and the wide disparity between interchange rates for preferred merchants and those applying to others.

While it broadly endorsed the PSB’s regulatory approach to date, the Murray Report recommended that consideration be given to tightening existing interchange regulations in some significant respects. These included lowering the overall interchange cap, and broadening its coverage to include other incentive payments that serve a similar function. It argued that this would help to prevent circumvention and, in the case of companion card arrangements, would improve competitive neutrality.

RBNZ External Stakeholder Engagement Survey

The Reserve Bank today released in its Bulletin the results of the survey, conducted by global market research company, Ipsos, as well as the Bank’s responses. Ipsos’ overall finding of the Bank’s stakeholder relationships was that “this was a positive story and one that provides a pathway to even greater levels of trust and familiarity.” The survey found that stakeholders welcome the Bank’s recent efforts to broaden its communications. The survey was conducted in the latter half of 2014, covering the general public, business, industries regulated by the Bank, financial markets, educators and researchers, and government. The survey was based on a framework to assess the Bank’s reputation, based on levels of familiarity, favourability, trust, and advocacy.

RBNZ should be congratulated for being proactive in terms of feedback from its stakeholders. RBA, please note.

The Impact of Evolving Financial Regulation

The BIS published an interesting report on how financial regulation is evolving. In short, significantly more capital will be required as the screws are tightened, or in other words capital rules have been too lax. These changes will have an impact on monetary policy; sometimes limiting credit availability; it will impact asset prices; weaken the relationship between policy rates and real-life interest rates; and make the banks reliance on the central bank stronger. It also provided a good summary of changes proposed under Basel III.

Financial regulation is evolving, as policymakers seek to strengthen the financial system in order to make it more robust and resilient. Changes in the regulatory environment are likely to have an impact on financial system structure and on the behaviour of financial intermediaries that central banks will need to take into account in how they implement monetary policy. Against this background, in February 2014, the Committee on the Global Financial System (CGFS) and Markets Committee (MC) jointly established a Working Group – co-chaired by Ulrich Bindseil (European Central Bank) and William Nelson (Federal Reserve Board) – to assess the combined impact of key new regulations on monetary policy.

The BIS has now released their report which presents the Group’s findings. It is based on information from a range of sources, including central bank case studies as well as structured interviews with private sector market participants. It argues that the likely impacts of the new financial regulations on financial institutions and markets should have only limited and manageable effects on monetary policy operations and transmission. Hence, as necessary, central banks should be able to make adjustments within their existing policy frameworks and in ways that preserve policy effectiveness. These adjustments will tend to differ across jurisdictions according to the financial systems and policy frameworks in place. Specific implications, and examples of potential policy responses, are set out and elaborated in the report.

The report’s findings can be characterised in terms of five distinct sets of implications. In addition, more general effects of the emerging regulatory environment that are independent of specific macroeconomic conditions can be differentiated from those that pertain in the context of the current environment of low policy rates. All of these, and examples of potential policy responses. In brief, they are as follows:

Safer financial systems and their implications for policymaking. The emerging regulatory environment will contribute to enhanced bank resilience, reducing the risk of spillovers from the banking sector to the real economy, and is expected to limit the extent of liquidity and maturity transformation undertaken at banks. Therefore, if the regulations are effective, bank credit will be more stable on average, because credit cycles will be less severe and less frequent. At the same time, at some points of the credit cycle, the supply of bank credit for the non-financial sector will tend to be lower than it would be in the absence of the new regulations (and with everything else unchanged). Thus, to achieve the same economic outcomes, central banks may end up adopting a policy stance that is somewhat more accommodating during some parts of the cycle than would otherwise be the case.

Shifting asset price relationships and their implications for policy targets. As markets adjust to the new regulatory requirements, the equilibrium relationships between financial asset prices and central bank policy rates will shift, adding to the existing uncertainty around these relationships – at least during the transition period. As a result, central banks may need to adjust the settings of their policy instruments to achieve the same stance of monetary policy. A complicating factor is that different regulations, considered in isolation, can have consequences that go in opposite directions. Moreover, the interaction of these regulations could add to the difficulties in predicting their overall impact. As a result, central banks will need to monitor these changes and respond to them as they manifest themselves.

Reduced arbitrage activity and its impact on policy implementation. New regulations, such as the leverage ratio, may disincentivise certain low-margin arbitrage activities, such as banks’ matched repo book business. This reduction would tend to weaken, and make more uncertain, the links between policy rates and other interest rates, weakening the transmission of monetary policy impulses along the yield curve as well as to other asset prices relevant for economic activity. More difficult reserve demand forecasting. For central banks with an operational target of steering a short-term interest rate within a corridor system, if the rate paid on reserve balances is close to the interest rate on other types of high quality liquid assets (HQLA Level 1), small changes in interest rates could result in relatively large swings in reserve demand as banks substitute freely between reserves and these other assets. Additionally, new limits on counterparty concentration may mean that forecasts of the level of reserve balances will depend more strongly than in the past on the distribution of those reserves across counterparties. Similarly, with periodic calculation of regulatory ratios (such as at year- or quarter-ends), window dressing behaviour and associated movements in short-term interest rates are likely to intensify.

More central bank intermediation. Many of the new regulations will increase the tendency of banks to take recourse to the central bank as an intermediary in financial markets – a trend that the central bank can either accommodate or resist. Weakened incentives for arbitrage and greater difficulty of forecasting the level of reserve balances, for example, may lead central banks to decide to interact with a wider set of counterparties or in a wider set of markets. In addition, in a number of instances, the regulations treat transactions with the central bank more favourably than those with private counterparties. For example, Liquidity Coverage Ratio rollover rates on a maturing loan from a central bank, depending on the collateral provided, can be much higher than those for loans from private counterparties.

Effects specific to the current low interest rate environment. In addition to these more general implications, there are a number of effects for monetary policy that are specific to the current environment of low policy rates in the major advanced economies. For example, effects that tend to lower market interest rates relative to policy rates will support monetary policy in jurisdictions at the zero lower bound, but may hinder efforts to normalise the stance of policy. Effects that tend to raise market rates relative to policy rates will have the opposite consequence. Moreover, any temporary reduction of credit supply resulting from the new regulations and their phasing-in may imply the need for additional unconventional measures for central banks operating at the zero lower bound, with the added complication that some unconventional measures may make the new regulations more binding.

The four key regulations identified by the Working Group as being the most likely ones to significantly affect monetary policy implementation:

Liquidity Coverage Ratio. The stated objective of the LCR is to ensure that banks maintain an adequate level of unencumbered, high-quality liquid assets (HQLA) that can be converted into cash to meet their liquidity needs under a 30-day scenario of severe funding stress. It is defined as the ratio of the stock of HQLA (numerator) to net cash outflows expected over the stress period (denominator). The initial minimum requirement of 60%, effective January 2015, will be increased in a stepwise fashion to 100% by 2019. The HQLA definition groups eligible assets into two discrete categories (Level 1 and Level 2). Level 1 assets, which can be included without limit, are those with 0% risk weights for Basel II capital calculations, such as cash, central bank reserves and sovereign debt (which may be subject to haircuts). Level 2 assets, which can make up no more than 40% of the buffer, include assets with low capital risk weights as well as highly rated non-financial corporate and covered bonds, subject to a 15% haircut. (Under certain conditions, supervisors may choose to include additional asset types, termed Level 2B, up to a limit of 15% of the total HQLA stock and carrying haircuts of 25% or higher.) Net cash outflows, in turn, are calculated on the basis of agreed run-off and inflow rates that are applied to different sources of cash out- and inflows (with an aggregate cap of 75% of total cash outflows).

Net Stable Funding Ratio. The aim of the NSFR, which will be introduced as of January 2018, is to (i) limit overreliance on short-term wholesale funding, (ii) encourage better assessment of funding risk across all on-and offbalance sheet items, and (iii) promote funding from stable sources on a structural basis. The NSFR is defined as the ratio of available stable funding (ASF) to required stable funding (RSF), which needs to be equal to at least 100% on an ongoing basis. The numerator is determined by applying ASF factors to a bank’s liability positions, with higher factors assigned for longer maturities (according to pre-defined buckets: less than six months, between six and 12 months, and higher), and more stable funding sources. The denominator reflects the product of RSF factors and the bank’s assets, differentiated according to HQLA/non-HQLA definitions and by counterparty (financial/non-financial). Asset encumbrance generally results in higher RSF factors, especially for longer encumbrance periods (eg assets encumbered for a period of one year or more receive the maximum RSF factor of 100%, while central bank reserves have a factor of 0% (with discretion to apply a higher rate) and other Level 1 assets a factor of 5%). Differentiated RSF factors also apply according to whether assets are secured against Level 1 assets or not.

Leverage ratio. The Basel III minimum leverage ratio is intended to restrict the build-up of leverage in the banking sector, and to backstop the risk-based capital requirements with a simple, non-risk-based measure. Public disclosure of the regulatory LR by banks commenced on 1 January 2015. The final calibration and any further adjustments to the definition will be completed by 2017 with a view to migrating to a binding Pillar 1 requirement on 1 January 2018. The LR is defined as the ratio of Tier 1 capital to total exposures. The denominator consists of the sum of all onbalance sheet exposures, derivative positions, securities financing transactions and off-balance sheet items. As such, the total exposure measure includes central bank reserves and repo positions. Netting of cash legs (ie of receivables and payables) of repo exposures (with the same counterparty) is permitted under certain conditions, but netting across counterparties or of cash positions against collateral is not.

Large exposure limits. The large exposures (LE) framework of the Basel Committee on Banking Supervision (BCBS) is a set of rules for internationally active banks aimed at reducing system-wide contagion risk. It imposes limits on banks’ exposures to single counterparties in order to constrain the maximum loss a bank could face in the event of sudden counterparty failure. The framework is due to be fully implemented on 1 January 2019. Under the LE framework, a bank’s exposure to any single counterparty or group of connected counterparties cannot exceed 25% of the bank’s Tier 1 capital. A tighter limit of 15% is set for exposures between banks that have been designated as globally systemically important. While exposure measurement is aligned with the standardised approach under risk-based capital rules, exposures to sovereigns and central banks, as well as intraday interbankexposures, are exempt from the limit.

Basel III capital regulation includes a number of new elements to boost banks’ capital base. First, it incorporates a significant expansion in risk coverage, which increases risk-weighted assets. Specifically, it targets the instruments and markets that were deemed most problematic during the crisis – that is, trading book exposures, counterparty credit risk and securitised assets. This builds on the earlier approach under Basel II, which introduced differentiated risk weights (which are either internal model-based or set by regulation). A key differentiation from the perspective of monetary policy is that central bank reserves carry a zero risk weight under the risk-weighted standard, whereas the leverage ratio introduces an implied capital charge that is equal for all assets. Riskweighted capital charges also differ according to whether a transaction is secured or unsecured. Second, and critically, Basel III tightens the definition of eligible capital, with a strong focus on common equity. This represents a
move away from complex hybrid capital instruments that proved incapable of absorbing losses in periods of stress. A unique feature of Basel III is the introduction of capital buffers that banks can use without compromising their solvency, and surcharges, which counter individual banks’ contribution to systemic risk.

First, a conservation buffer is designed to help preserve a bank as a going concern by restricting discretionary distributions (such as dividends and bonus payments) when the bank’s capital ratio deteriorates. Second, a countercyclical buffer – capital that accumulates in good times and that can be drawn down in periods of stress – will help protect banks against risks that evolve over the financial cycle. Finally, a capital surcharge will be applied to global systemically important banks (G-SIBs), or banks with large, highly interconnected and complex operations, in order to discourage the concentration of risk. These international standards impose lower bounds on regulators: countries may choose to implement higher standards to address particular risks in their national contexts. Combining these elements will significantly increase banks’ capital requirements.

Federal Reserve Minutes From April Suggest Rates US Rates Will Be Lower For Longer

From the Fed: Information received since the Federal Open Market Committee met in March suggests that economic growth slowed during the winter months, in part reflecting transitory factors. The pace of job gains moderated, and the unemployment rate remained steady. A range of labor market indicators suggests that underutilization of labor resources was little changed. Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment re-mains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined. Inflation continued to run below the Committee’s longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Although growth in output and employment slowed during the first quarter, the Committee continues to expect that, with appropriate policy accommo-dation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual man-date. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 per-cent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissi-pate. The Committee continues to monitor inflation developments closely.

To support continued progress toward maxi-mum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In de-termining how long to maintain this target range, the Committee will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation. This assessment will take into ac-count a wide range of information, including measures of labor market conditions, indica-tors of inflation pressures and inflation expec-tations, and readings on financial and interna-tional developments. The Committee antici-pates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that infla-tion will move back to its 2 percent objective over the medium term.

The Committee is maintaining its existing pol-icy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. When the Committee decides to begin to re-move policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run

Federal Reserve Fines Six Major Banking Organisations $1.8 billion For Rigging FX Markets

The Federal Reserve on Wednesday announced it will impose fines totaling more than $1.8 billion against six major banking organizations for their unsafe and unsound practices in the foreign exchange (FX) markets. The fines, among the largest ever assessed by the Federal Reserve, include: $342 million each for UBS AG, Barclays Bank PLC, Citigroup Inc., and JPMorgan Chase & Co.; $274 million for Royal Bank of Scotland PLC (RBS); and $205 million for Bank of America Corporation. The Federal Reserve also issued cease and desist orders requiring the firms to improve their policies and procedures for oversight and controls over activities in the wholesale FX and similar types of markets.

The Federal Reserve is requiring the firms to correct deficiencies in their oversight and internal controls over traders who buy and sell U.S. dollars and foreign currencies for the organizations’ own accounts and for customers. As a result of these deficient policies and procedures, the organizations engaged in unsafe and unsound conduct by failing to detect and address improper actions by their traders. These actions included the disclosure in electronic chatrooms of confidential customer information to traders at other organizations. Five of the banks failed to detect and address illegal agreements among traders to manipulate benchmark currency prices. Bank of America failed to detect and address conduct by traders who discussed the possibility of entering into similar agreements to manipulate prices. In addition, the Federal Reserve found UBS, Citigroup, JPMorgan Chase, and Barclays engaged in unsafe and unsound conduct in FX sales, including conduct relating to how the organizations disclosed to customers the methods for determining price quotes.

The Federal Reserve is requiring the six organizations to improve their senior management oversight, internal controls, risk management, and internal audit policies and procedures for their FX activities and for similar kinds of trading activities and is requiring four of the organizations to improve controls over their sales practices. The Federal Reserve is also requiring all six organizations to cooperate in its investigation of the individuals involved in the conduct underlying these enforcement actions and is prohibiting the organizations from re-employing or otherwise engaging individuals who were involved in unsafe and unsound conduct.

The Federal Reserve is taking action against UBS, Barclays, Citigroup, JPMorgan Chase, and RBS concurrently with the Department of Justice’s criminal charges against these five organizations related to misconduct in the FX markets. Bank of America was not part of the actions taken by the Department of Justice and has not been charged by the Department of Justice in this matter.

The Connecticut Department of Banking has joined the cease and desist provisions of the Federal Reserve’s action against UBS, which has a branch located in Stamford, Connecticut. The New York Department of Financial Services has taken a separate action against Barclays and its New York branch based on FX-related conduct.

Treasury Consults on Proposed Financial Institutions Supervisory Levies for 2015-16

The financial institutions supervisory levies are set to recover the operational costs of APRA and other specific costs incurred by certain Commonwealth agencies and departments, including the Australian Securities and Investments Commission, the Australian Taxation Office, and the Department of Human Services.

By way of background, in December 2002, the Government adopted a formal cost recovery policy to improve the consistency, transparency and accountability of cost recovered activities and promote the efficient allocation of resources. Cost recovery involves government entities charging individuals or non-government organisations some or all of the efficient costs of a specific government activity.

On 16 April 2014, Treasury released a paper responding to the submissions received on the methodology review and its conclusions informed last year’s discussion paper on the levies to be imposed in 2014-15. In the 2014-15 discussion paper, industry was further asked to provide Government with their views in relation to whether: The 2014-15 levies should be calculated in the same way as the 2013-14 levies (Option 1), or; For the 2014-15 levies, the costs of all activities, except for APRA’s prudential supervision, should be allocated to the unrestricted levy component with the maximum cap for superannuation funds lowered to reflect the cost of SuperStream being met from the unrestricted component, and Pooled Superannuation Trusts to be levied at a lower rate to reflect the lower intensity of regulation required (Option 2).

Industry was also asked to provide Government with their views on whether the SuperStream levy payable should continue to be calculated on a net assets basis or with reference to the number of superannuation fund members. Following industry consultation, the Government elected to determine the levies payable in 2014-15 using the methodology outlined in Option 2. This methodology will be used to determine the levies payable in 2015-16.

APRA’s net funding requirements under the levies for 2015-16 is $125.1 million, a $2.7 million (2.2 per cent) increase relative to budget for 2014-15. $6.6 million of these costs will be met through other sources of APRA revenue (referred to as net cost offsets) and Government appropriations, including a special levy for the National Claims and Policies Database (NCPD). Taking into account $1.0 million in projected over-collected 2014-15 levies to be returned to industry, APRA’s underlying net levies funding requirement for 2015-16 is $117.5 million, an increase of $0.6 million (0.5 per cent) relative to budget for 2014-15.

A component of the levies is collected to partially offset the expenses of ASIC in relation to consumer protection, financial literacy, regulatory and enforcement activities relating to the products and services of APRA regulated institutions as well as the operation of the Superannuation Complaints Tribunal (SCT). In addition, the levies are used to offset the cost of a number of Government initiatives including the over the counter (OTC) derivatives market supervision reforms and ASIC’s MoneySmart programmes. $28.2 million will be recovered for ASIC through the levies in 2015-16.

Funding from the levies collected from the superannuation industry includes a component to cover the expenses of the ATO in administering the Superannuation Lost Member Register (LMR) and Unclaimed Superannuation Money (USM) frameworks. The estimated total cost to the ATO of undertaking these functions in 2014-15 is $18.3 million, of which $7.1 million was recovered through the levies. In 2015-16, it is estimated that the total cost to the ATO in undertaking these functions will be $17.9 million with the full amount to be recovered through the levies in line with the requirements of the Government’s CRGs.

The Department of Human Services administers the early release of superannuation benefits on compassionate grounds. The compassionate grounds enable the Regulator (the Chief Executive of Medicare) to consider the early release of a person’s preserved superannuation in specified circumstances. In 2013-14, the Early Release of Superannuation Benefits programme received 19,286 applications. This was a 7 per cent increase compared with the previous year. In 2014-15, the Early Release of Superannuation Benefits programme is forecast to receive approximately 20,500 applications. This will represent an approximate increase in volume of 6.3 per cent compared with the previous year.
The programme is expected to cost the Government $4.7 million in 2015-16 and, in line with the CRGs, this amount will be recovered in full through the levies.

Announced as part of the former Government’s Stronger Super reforms, SuperStream is a collection of measures that are designed to deliver greater efficiency in back-office processing across the superannuation industry. Superannuation funds will benefit from standardised and simplified data and payment administration processes when dealing with employers and other funds and from easier matching and consolidation of superannuation accounts. The costs associated with the implementation of the SuperStream measures are to be collected as part of the levies on superannuation funds. The levies will recover the full cost of the implementation of the SuperStream reforms and are to be imposed as a temporary levy on APRA-regulated superannuation entities from 2012-13 to 2017-18 inclusive. The levy payable is subject to the Minister’s determination. The costs associated with the implementation of the SuperStream reforms are estimated to be $61.8 million in 2015-16, $35.5 million in 2016-17, and $32.0 million in 2017-18.

The Treasury paper, prepared in conjunction with the Australian Prudential Regulation Authority (APRA), seeks submissions on the proposed financial institutions supervisory levies that will apply for the 2015-16 financial year. Closing date for submissions: Wednesday, 10 June 2015