Martin North – Page 1008 – Digital Finance Analytics (DFA) Blog

Online Business Activity Rises – Revenue Was $216 Bn Last Year

The recent ABS data relating on online business shows that whilst the total number of active businesses fell, online revenue grew by about 8%, compared with 4% the previous year. The number of firms fell from 770,000 to 757,000 (reflecting tough trading conditions, see our SME surveys). However overall internet generated income rose from $246 billion to $267 billion, which is about 15% of GDP.

Collection of data included in this release was undertaken based on a random sample of approximately 6,640 businesses via online forms or mail-out questionnaire. The sample was stratified by industry and an employment-based size indicator. All businesses identified as having 300 or more employees were included in the sample. The 2013-14 survey was dispatched in late October 2014.

The survey shows a significant rise in a social media presence up 18%, but this compares with a massive 44% increase in the prior year. We also see a rise in orders placed via the internet (up 4%), and fulfilled via the internet (up 10%). Almost all firms have broadband access.

Finally, average annual income for a small firm was more than $4,000, compared with a medium firm of $17,000. Larger firms generated more income, and the four largest employers generated on average $3.6 million.

Commerce through the internet is both mainstream, and likely to grow further, supported by the deeper penetration of smart phones and tablets, which enhance customer convenience, and innovation in terms of products and services. See our recent post. Many firms now see online as just another channel to market, but there are industry variations.

We see, for example that Information, Media and Telecommunications are some of the most active, whilst in finance and insurance, only 60% have a web presence, and 30% have a social media presence.

Low Interest Rates Not Connected With Business Investment Decisions

The RBA today published a paper on business investment decisions and their relationship to interest rate settings. They are clearly trying to understand why, when interest rates are in absolute terms low, business investment is still flat. Indeed in real terms, non-mining business investment in Australia has been little changed for several years.

“Firms typically evaluate investment opportunities by calculating expected rates of return and the payback period (the time taken to recoup the capital outlay). Liaison and survey evidence indicate that Australian firms tend to require expected returns on capital expenditure to exceed high ‘hurdle rates’ of return that are often well above the cost of capital and do not change very often. In addition, many firms require the investment outlay to be recouped within a few years, requiring even greater implied rates of return. As a consequence, the capital expenditure decisions of many Australian firms are not directly sensitive to changes in interest rates. Furthermore, although both the hurdle rate of return and the payback period offer an objective decision rule on which to base expenditure decisions, the overall decision process is often highly subjective, so that ‘animal spirits’ can play a significant role.”

“Analysis of the investment decision process helps to explain the subdued growth of non-mining business investment. First, there is some evidence of a tightening in investment criteria since the global financial crisis. For example, some firms have reduced their maximum payback period, suggesting implied discount rates for investment decisions may have increased even as long-term interest rates declined.

Second, identifying investment opportunities with returns exceeding the typical hurdle rate of around 15 per cent may be difficult for many firms given their expectations for the growth of their sales.

It is clear from discussions with liaison contacts that the overall decision process is highly subjective, which in turn allows ‘animal spirits’ to play a role. As noted, firms frequently reject investment decisions that satisfy self-imposed quantitative criteria on other grounds, such as concerns about the economic outlook, the availability of capital within the company, or shareholders’ preferences. Some managers have noted that they have taken a more cautious approach to capital expenditure since the financial crisis, either because there is more uncertainty about the future or they are more averse to taking risks. As a consequence, firms with a range of opportunities may only be willing to pursue the most profitable projects in the current economic environment.

Although changes in interest rates may not have a direct effect on investment decisions for many firms, interest rates will still have a powerful indirect influence on firms’ investment decisions. For example, a reduction in interest rates may improve firms’ cash flows through reductions in interest payments, freeing up cash for other purposes. More broadly, interest rates affect economic activity via a number of channels, including the saving and spending behaviour of households, the supply of credit, asset prices and the exchange rate, all of which affect the level of aggregate demand.

“Detailed discussions with managers and survey evidence indicate that the lack of direct interest rate sensitivity partly arises because Australian firms typically use effective discount rates that are high and sticky to evaluate capital expenditure opportunities. This reflects the use of hurdle rates that are considerably higher than the weighted average cost of capital and are adjusted infrequently, or a requirement that any outlay must be expected to be recouped within a few years”.

We think it may have something to do with the hurdle rate to assess projects, but it has more to do with levels of confidence. Many firms are still in hunker down and survive mode, not one which is conducive to encourage investment for future growth. Lack of demand of course becomes self-fulfilling.

When, Why, and What’s Next for Low Inflation?

A significant speech from the Bank of England by External MPC member Kristin Forbes “When, why, and what’s next for low inflation?: No magic slippers needed“.

Kristin Forbes explained why she is confident that inflation is currently “on track to rebound toward target” by early 2016. And unlike the solution to deflation proposed in the Wizard of Oz, the UK’s rebound will not require “assistance from wizards or magic slippers”.

Kristin opens by noting the “remarkable shift” in most developed countries; from inflation “too high” in the 1970s, to “just right” in the 1990s to mid-2000s, to falling to levels that raise concerns about being “too low” over the last few months.
Kristin then considers several concerns that have been raised about current low inflation and finds some “overhyped” and others worthy of close attention. The first of these is the claims that consumers and businesses could delay purchases and investment if they expect items to be cheaper in the future. Kristin finds this argument “unconvincing for the UK today”. Instead the evidence suggests that “consumers tend to spend more – not less – on items whose prices fall”.

Likewise the claim that low inflation will make it harder for individuals, businesses and governments to repay debt “have some merit” but are not applicable today; “interest rates are near historically low levels, credit is readily available for most credit-worthy borrowers, debt-servicing ratios are relatively low, and low inflation is expected to be short lived.”

A more significant concern is that the current low level of inflation will have persistent second-round effects by lowering inflation expectations which could in turn supress wage growth. This is something for the MPC to watch closely but “there is not yet any evidence that low inflation has significantly held back wage growth. Instead, wage growth has picked up over the period that inflation has fallen.” In fact, “the rapid normalization of the labour market should continue to support wage increases – even in an environment with low headline inflation”.

Kristin dedicates most of her analysis to the final concern; that “low rates of global inflation, or just low inflation in individual countries with strong links to the UK, could create additional spillover effects that drag on UK prices”. An unusually large number of countries are currently experiencing deflation or low inflation, and there is a risk that the UK could be exposed to weak prices abroad through its significant export and import markets or even “latent competitive effects”.

The recent downward movement in core inflation, however, seems to be driven more by sterling’s 18% appreciation than by any spillover effects from low inflation in other countries. Kristin confirms this by introducing an expanded set of measures of domestically-generated inflation, which show remarkable stability in domestic inflation over the last year, after removing the effects of exchange rate movements – and even upward movement in wages and unit labour costs. A detailed analysis of the effects of inflation in other countries finds that “inflation in some of the UK’s more important trading partners (such as Germany) may have some small additional effects on UK inflation rates. But inflation in many economies with strong ties to the UK – whether through location, colonial linkages, language, or other variables – does not exert any significant effect on UK inflation. Even key trading partners’ inflation rates do not seem to generate any consistent and significant spill-overs to UK core inflation rates.” Therefore, low inflation elsewhere seems unlikely to cause low-inflation to persist for longer than currently expected.

All of which leads Kristin to conclude that “inflation is currently on track to rebound toward target without any need for assistance from wizards or magic slippers.”

Apps Drive a Revolution in Digital Banking

Given the massive rise in mobile and tablet use, the role of finance related apps is changing. Whilst most of the major banks in Australia offer some basic functionality, its mostly a version of internet banking, or payments. Yet there are examples of apps which are much more aligned to specific customer groups, and frankly much more sophisticated in terms of function and form. Banks need to take their apps strategy up to the next wave of innovation if they are to build sustaining relationship with digital banking users. We think the future is based on form and function, and needs to be tailored to specific customer segments and their specific needs.

To illustrate this, today we look at a few of the apps out there available in the USA, and some of which which may be coming here. The examples are more to stimulate thought and illustrate the underlying thinking. We are not necessarily advocating these apps, but we think they illustrate digital disruption in play.

The first is Qapital which says “is the everyday banking service that helps your money go further”. The Swedish startup launched its saving service in March to consumers save for big-ticket items and trips. American users can set up separate FDIC-insured Qapital-branded savings accounts into which they can automatically drop money from their existing bank accounts.

Save automatically using rules

Essentially, the app allows a user to set up rules to turn almost any activity into a savings trigger. These rules could include one that fines you when you indulge (e.g. each time you buy a cream cake), round up transactions and sent the odd cents to a savings account, or create a budget, and if you come in under, the balance is sent to savings. They also add IFTTT (If This Then That) functionality. With this you can set up savings triggers to automatically put money toward savings goals every time you buy from a nominated store, Starbucks or walk another kilometer, or almost anything you want. They even can link it to a Twitter #tag, or a particular weather forecast. Essentially you set the rule, set and forget, and the savings accrue. “There are almost 200 IFTTT channels to choose from, with thousands of triggers and actions. Make your Qapital savings deposits trigger something fun, or turn a tedious chore into a chance to pay yourself for your trouble. Make your own recipe or check out some of our favorites”.

Going forward, Qapital have plans to partner with Intuit (which makes the finance software behind Quickbooks), which will expand Qapital’s dynamic IFTTT recipe features to users with accounts at over 20,000 smaller banks across the U.S. and by the end of the year, Qapital will release its own branded Visa debit card through the bank that backs all Qapital accounts, the Iowa-based Lincoln Savings Bank.

This is an example of “Gamification” – the application of game mechanics to non-gaming tasks. These mechanics may include leaderboards, points, badges, rankings, specific goals, and rewards (either real or imagined). The overarching concept behind gamification is that it provides someone incentive to do something they otherwise might not do. It turns work into a game, something boring into something fun. Some customers just love it – others will hate it!

Another app example is LevelMoney. The app can connect to a users bank and any other credit cards – they have more than 18,000 financial institutions – and users also input data such as income, bills, and how much you want to save each month. The app calculates a cash balance you can safely spend each day.

Its big on spending tracking an budgetting. It can also automate payments. Its like a personal finance assistant.

Another example is Digit. This app connects to your transaction account, and when there is sufficient money in the account transfers a small amount to a savings account, every few days. Its not like a regular monthly savings plans, it responds to whats happening in the account. When needed a user can request the savings back, and it will be returned in 24 hours. It guarantees never to over-draw your transaction account. Digits communicates with you mostly via text message.

Finally, there is Acorns, which is a financial service that allows users to invest money from a mobile phone. Acorns Grow Inc. was founded in the United States of America in 2014. Now Acrons plans to commence beta testing in Australia in the third quarter of 2015 with the final Acorns product going live in February 2016.

Acorns helps users proactively invest. The app can round up each of your credit, debit or bank transactions to the nearest dollar, and invest the change into a choice of five diversified portfolios. Simply connect a credit card, debit card or a bank account, and tell Acrorns about yourself. You then select a portfolio based on your own investment goals and the amount of risk you’re comfortable taking. There are no account minimums, no commissions, and fractional investing so even small balances are fully invested. All this via your mobile phone which makes it easy to fund and track your investment account. Acorns is currently available for iOS 7 and 8 and android device running 4.1 and higher. Acorns will also be available via a Web application which will also be launched at the same time as the mobile device.

It worth noting that you can not opt out of any of the ETFs in Acorns’ portfolios, nor of the stocks or bonds of which the ETFs are comprised. You also do not have the option of choosing to invest in any other stocks, bonds, Bitcoin, or other securities through Acorns. There are however multiple ways to fund your Acorns account:

Lump Sums: You may add or withdraw money by entering any desired amount on the Deposit/Withdraw screen. There are no fees for depositing or withdrawing money.
Automatic Investments (Recurring Deposits): You may set up recurring deposits on a daily, weekly, or monthly basis. Select the amount of money you wish to invest regularly, and then choose the desired time period.
Round-ups: You may link your spending bank accounts (credit or debit card) and then round up the virtual change from every transaction. These round-ups can then be manually or automatically moved into your Acorns account.

This can take 5-7 business days to process before the funds become available in your nominated bank account. It can take 1-3 business days for funds transferred to your Acorns account to become available to invest. These funds will be shown as “pending” during this time period. There is currently a daily deposit limit of $10,000. You can withdraw any amount from your balance at any time. Acorns Grow Australia Fund is a registered managed investment scheme (MIS) and regulated under the Australian Securities & Investment Commission (ASIC).

You can monitor your spending through the app and website, allowing you to spot investment opportunities. To access this, you‘ll need to provide your online banking login information. However, this information is not stored and is not viewable by Acorns—it’s simply used to import your spending activity. This will not enable money to be transferred from your bank account.

As cash becomes quaint, are ATMs on path to obsolescence?

From The Conversation. Before the advent of the internet, the greatest gain in customer convenience within retail banking came from the creation of automated teller machines (ATMs).

Is it time for the ATM’s requiem? Old ATM via www.shutterstock.com

ATMs led to significant advances in how customers access financial services because – coupled with the direct deposit – they freed workers from so many routine tasks. No more depositing a paycheck in person, inquiring about balances or paying utilities solely during banking hours. ATMs enabled impromptu dinners and last-minute shopping over the weekend.

But now that we have so many other alternatives to fulfill our banking needs – we can deposit a check with a snap from our smartphones – do we really need ATMs? Why do we require physical cashpoints given that mobile payments and e-commerce continue to grow, heralding the “death of cash”?

Claims that the ATM is a passing technology are almost as old as the idea of a cashless society, and for a variety of reasons it’s probably premature to predict its demise.

The rapid embrace of the digital and resistance to the traditional by today’s youth may eventually bring about the ATM’s end, but for a long time to come, the ATM will likely remain central to our relationship with money.

Slow pace of change

First off, banknotes and ATMs are two of the most ubiquitous products in the world. Whereas banknotes have social meaning, cashpoints recede to the background of everyday life. Most urbanites typically stick to the same three to five cash machines for most transactions.

Banknotes and coins still represent 9% of the eurozone’s economy and 7% in the US, according to the Bank for International Settlements. Even in almost cashless Sweden, cash still makes up 3% of the economy.

Secondly, people like the freedom to choose between alternative payment options. So even as we use smartphones more often to make purchases at the grocery store, credit cards are still how we buy most things online, and we keep cash in our wallets for smaller items.

Thirdly, changes in retail payments have proven to be very slow rather than disruptive, and their path differs from country to country, suggesting it’ll be a while before the ATM is displaced.

To illustrate this long-winded process of innovation, consider that the first cash machine emerged in 1967, yet the device became mainstream only in the 1980s.

Today, most of the 2.6 billion bank ATMs currently in operation still run on Windows XP – an operating system Microsoft stopped supporting last year. The industry plans to upgrade and even make the switch to non-Microsoft systems, but that change may not take place until around 2020. That’s largely because the average life of an ATM hovers around six years.

Another example is the contactless ATM, which is beginning to slowly take hold with the rise of smartphones. It could make the transaction more secure and reliable by reducing possibilities for card skimming as well as offering the advantage of “client present.” Yet my own research came across references to ATM manufacturers considering devices that would interact wirelessly with customers as early as the 1990s. So it’s an open question why it took so long for this functionality to emerge.

Industry growth

In the meantime, the global market for ATMs continues to expand, but this growth is increasingly skewed and uneven. Global shipments of new ATMs reached a record 466,000 in 2014, up 5% from the previous year, according to London-based Retail Banking Research.

On a regional level, the picture is much more varied. Double-digit gains in the Asia-Pacific market contrast with double-digit declines in North America and Central and Eastern Europe.

Allied Market Research expects that growth to accelerate in the coming years. The US-based group forecasts the number of ATMs to surge 11% a year through 2020.

A fragile future?

Despite that optimistic forecast, the future of the ATM may be fragile as its once cutting-edge functionality becomes ubiquitous through other devices.

Back in 1975, technology companies IBM and NCR promised customers that ATMs would, in the not too distant future, be a one-stop shop for all their banking needs, from making deposits and dealing with account inquiries to making account transfers. Today all of that can be done online, while the functionality of most ATMs in developed countries has been cut down to the bone.

Despite this, the ATM still appears to have a home within banks’ self-service strategy, which is based on greater complementarity rather than cannibalization among delivery channels and means of payment.

The “omnichannel” is the buzzword that will dominate the industry over the next five to seven years. It envisions enabling customers to do their banking and interact with their financial institutions however they like — at the branch or ATM or via the internet or a mobile device.

And even as banks strive to make customer interactions more seamless, they’re also slow to push full automation too quickly because it reduces opportunities to engage in high-margin sales – think mortgages and other loans and services.

The process of balancing convenience through automation with maximizing sales opportunities involves reorganizing the ATM fleet to ensure high availability and an enhanced customer experience to retain, and even increase, customer loyalty while not losing customer trust.

Millennials and the future of banking

Perhaps the biggest issue shaping ATMs in the near future will concern the choices of millennials, those for whom the internet, mobile phones and plastic cards are a fact of life, checks are unknown and cash is quaint.

They challenge financial institutions and their business models to do more faster because they have easier and faster access to better technology than offered by the banks’ legacy systems through the multitude of apps on their smartphones, wearables, tablets and elsewhere.

Left to their own devices, millennials could spell the end of the ATM by 2035 or thereafter.

But that’s still a long way off, and cash – the raison d’etre for the ATM – is still king. Even for most advanced economies, cash represents about half of transactions below US$50.

So it will be a while before we see the end of the crisp paper bill and the coins that fill jars across the globe. In other words, “Long live the ATM!” – so long as there remains a need for after-hours and quickly dispensed cash.

Author – Bernardo Batiz-Lazo, Professor of Business History and Bank Management at Bangor University

Structural Features of Australian Residential Mortgage-backed Securities

The RBA has published a paper on Structural Features of Australian Residential Mortgage-backed Securities. It provides a useful overview of the securitisation market in Australia, which is one important element in product funding. We have summarised some of the key points.

A residential mortgage-backed security (RMBS) is a collection of interrelated bonds that are secured by a dedicated pool of residential mortgages (the ‘mortgage collateral pool’). The payments of principal and interest on these bonds are funded from the payments of principal and interest made on the underlying mortgage collateral by the mortgagors. Historically, RMBS have provided an alternative to bank deposits as a source of funding for residential mortgages. This has been particularly important for smaller authorised deposit-taking institutions (ADIs) and non-ADIs that have limited access to deposit funding or term funding markets.

By allowing smaller institutions to raise funding in the capital markets, RMBS promote competition between lenders in the residential mortgage market. After increasing steadily in the early 2000s, issuance of Australian RMBS to third-party investors fell in the wake of the global financial crisis when these securities were adversely affected by a loss of confidence in the asset class globally despite the low level of mortgage defaults in Australia. The market has recovered somewhat over the past couple of years.

RMBS have been an eligible form of collateral in repurchase agreements (repos) with the RBA since 2007. During the height of the global financial crisis, RMBS formed a significant part of the RBA’s repo collateral and hence played an important role in the RBA’s response to the crisis. Currently, RMBS form the largest class of securities held under the RBA’s repos, although unlike the earlier episode, this has been in response to innovations in the payments system. From 1 January 2015, the RBA has provided a Committed Liquidity Facility (CLF) to eligible ADIs as part of Australia’s implementation of the Basel III liquidity standards. In total, the CLF provides ADIs with a contractual commitment to $275 billion of funding under repos with the RBA, subject to certain conditions. Given that RMBS are eligible collateral that could be provided to the RBA were the CLF to be utilised, they represent a substantial contingent exposure for the RBA and, hence, understanding RMBS is particularly important in terms of managing the RBA’s balance sheet.

While discussions of RMBS often focus on the mortgage collateral pool, as all payments to investors are made from the cash flows generated from this pool, the structural features of RMBS play an equally important part in determining the risks facing the holders of these securities. The ‘structure’ of an RMBS refers to the number and size of the interrelated bonds of the RMBS, the rules that determine how payments are made on these bonds and various facilities that support these payments.

This article provides a summary of the structural features typically found in Australian RMBS and how these have evolved over the past decade.

One element of note is tranching.

In summary, tranching enhances one part of the RMBS liability structure at the expense of another, by reducing credit and prepayment risk on the senior notes, while increasing these risks for the junior notes. Since 2005, there has been an increase in the degree of tranching in Australian RMBS. The average number of notes in an RMBS has increased from three in 2005 to four in 2015, with most of the increase occurring after 2008. The increase has been concentrated in the junior notes (which are typically rated below AAA), with the average number of such notes increasing by 1.5 per RMBS. The increase has been more pronounced in RMBS issued by non-ADIs.

The higher number of tranches for RMBS issued by non-ADIs reflects the need for non-ADI sponsors to fund their mortgage lending fully through RMBS issuance. This has led RMBS issued by non-ADIs to be structured with a larger number of tranches with different characteristics that appeal to a broad range of investor risk appetites.

The structures of Australian RMBS have evolved over time. Australian RMBS have generally become more structured over the past 10 years, especially since the global financial crisis: the tranching of both credit and prepayment risk has increased; the use of principal allocation mechanisms that vary over the life of the RMBS has become more widespread; bullet notes have been added; and various external and internal support facilities have continued to be used.

The increased structuring, which has developed to address changing market conditions, does not necessarily create more risk for investors, especially if they are provided with transparent and complete information about RMBS structures. Indeed, there has been a significant increase in the size of the credit enhancement provided to the most senior notes through the subordination of junior notes, with the increase in excess of the requirements of the credit rating agencies. The reliance on external credit support from LMI has also declined.

Understanding RMBS structures is essential to the effective risk management and valuation of RMBS because the RMBS structure determines how the risks generated from the securitised mortgages are borne by each particular RMBS note. Given the importance of RMBS as collateral in the RBA’s repurchase agreements, the RBA has a keen interest in understanding RMBS structures.

The RBA’s reporting requirements for repo-eligible asset-backed securities, which come in effect from 30 June 2015, will provide standardised and detailed information, not only on the mortgages backing RMBS, but also on the RMBS structures, including their cash flow waterfalls.

Wage Growth Decline

The RBA published a paper on The Decline in Wage Growth. In real terms wages are static or falling for many, and we note from our own surveys that as a result, households are under increasing stress, because costs of living continue to rise. In fact the recent cuts in the mortgage rate as the cash rate has fallen, as effectively got people off the hook. This would reverse quickly if rates started to rise, because the average mortgage is bigger now, and held for longer. But whats behind the decline? We summarise the discussions.

The rate of wage growth has important implications for the macroeconomy. Wages are the largest source of household income and the largest component of business costs, and so have significant implications for consumer price inflation. Wage growth has declined markedly in recent years to the lowest pace since at least the late 1990s, according to the wage price index.

Wage measures with a longer history suggest that this has been the longest period of low wage growth since the early 1990s recession. Across these measures, the rate of annual wage growth has declined to around the pace of inflation, about 2–3 per cent. The slowing in wage growth has occurred alongside faster growth in labour productivity. This has also helped to moderate growth in labour costs for firms, beyond the impact of lower wage growth. Accordingly, growth in the labour cost of producing a unit of output (unit labour costs, or ULCs) has also declined markedly since 2012. Indeed, the level of ULCs has been little changed for more than three years – the longest such period since the early 1990s.

Even accounting for temporarily lower inflation expectations, real wage growth from the perspective of consumers has declined markedly, to around zero.

The recent low wage growth has not been unique to Australia. Internationally, wage growth has been lower than forecast for several developed economies in recent years, including some where labour markets have tightened considerably. Various factors have been proposed to explain this weakness, including secular trends that have been in place for some time and have also resulted in a general decline in the labour share of income. However, the decline in wage growth in Australia stands out, with the extent of the forecast surprise for Australia particularly large in the context of OECD countries in recent years

Several factors appear to explain much of the decline in Australian wage growth. There has been an increase in spare capacity in the labour market, and expectations of future consumer price inflation have declined to be a bit below average. Inflation in output prices in recent years has been particularly subdued, in large part owing to the lower terms of trade. More generally, the decline in the terms of trade and fall in mining investment in recent years mean that the economy requires a lower ‘real’ exchange rate, which has been in part delivered by low wage growth. A statistical model indicates that these factors do not fully explain the extent of decline in wage growth, suggesting that other factors, such as an increase in the flexibility of wages to market conditions, may also have contributed.

A range of related factors appear to explain much of the decline in wage growth in Australia in recent years. Below-average growth in economic activity has translated into subdued growth in labour demand, which has resulted in an increase in spare capacity in the labour market. At the same time, expectations for consumer price inflation have moderated to be below average. The decline in the terms of trade and falls in mining investment appear to have played a particularly important role, weighing on economic activity and placing pressure on firms to contain costs. This has partly unwound the relatively strong inflation in Australian unit labour costs over the period of the mining boom, which was part of the economy’s adjustment to the domestic income boost from the higher terms of trade. Altogether, the result has been an adjustment in Australia’s relative labour costs, improving cost competitiveness against other advanced economies. In effect, this has assisted in bringing about some adjustment of the real exchange rate. Statistical estimates suggest that these factors explain much, but not all, of the episode, meaning there may also have been some other forces at play including an improvement in the flexibility of wages.

While a large wage adjustment has taken place, wage growth is widely expected to remain low. Evidence from the Bank’s liaison with businesses, alongside surveys of firms and union officials, suggest that the general pace of wage growth is not expected to pick up over the year ahead. One further factor that may continue to weigh on wage growth is a ‘pent-up’ adjustment. Reports through the Bank’s business liaison in recent years have indicated that many firms and employees have been reluctant to bargain for wage growth below expected inflation of 2–3 per cent. Accordingly, wage outcomes of 2–3 per cent have been relatively common over the past couple of years among liaison contacts. Outcomes lower than this, which would imply a fall in real consumer wages, are generally seen to have a negative effect on worker morale and productivity, as well as on the retention of quality staff. So while the decline in wage growth has been large, it might have been larger still if not for this element of rigidity in real wage growth. Accordingly, a degree of ‘pent-up’ downward pressure on wage growth might remain for a time, even if labour market conditions more generally were to improve.

Bank Fees $12 Billion in 2014

The RBA just published the results of its annual bank fee survey, based on data from 16 institutions covering 90% of the Australian banking sector. Last year, overall fees rose 2.8% to $12 billion compared with 2.6% the previous year. The rise is a combination of rises in unit prices, and volumes. Households fees rose 1.5% to $4,141 million, and business grew 3.5% to $7,791 million. The data does not include wealth management, broker, loan mortgage insurance, or other fees across financial services and the non-bank sector.

Looking in more detail at households, higher fee income reflected growth in credit card and personal lending fees, whereas fee income from housing lending and deposit accounts declined.

Fee income from credit cards, which represents the largest component of fee income from households, increased by 5.9 per cent. You can read our previous analysis of the credit card business here.

Total deposit fee income decreased slightly in 2014, following a modest increase in 2013. The decrease in fees from household deposits was broad based across most types of fees on deposit accounts. In particular, account-servicing and transaction fee income, as well as some fee income on other non-transaction accounts (e.g. break fees on term deposit accounts) declined notably. This decrease was the result of fewer customers incurring these fees rather than a decrease in the level of fees, as well as customers shifting to lower fee products. However, this was partially offset by an increase in income from more frequent occurrences of exception fees (such as overdrawn fees and dishonour fees) and foreign exchange conversion fees being charged on deposit accounts involving such transactions.

Total fee income from housing loans decreased in 2014, with all components of housing loan fee income decreasing, including exception fees. This was due to a combination of fewer instances of penalty fees being charged, and lower unit fees as a result of strong competition between banks in the home lending market. Similar to 2013, there was a decrease in fee income from housing lending despite strong growth in such lending. Several banks again reported waiving fees on this type of lending for some customers.

Fees to business rose, across both small and large businesses.

Growth was driven by increases in merchant service fee income and, to a lesser extent, fee income from loans. Business fee income from deposit accounts and bank bills declined over 2014.

The increase in merchant service fees was mainly attributable to an increase in utilisation of business credit cards and a slight increase in some merchant unit fees. Merchant fee growth was approximately evenly spread across both small and large businesses. The increase in loan fee income was mainly from an increase in account-servicing and exception fees from small businesses, which was a result of higher lending volumes (including through the introduction of some new lending products). Fee income from loans to large businesses increased slightly due to a higher volume of prepayment fees (though this was mostly offset by declines in other fee income from large businesses).

The increase in exception fee income from business loans was also mainly from small businesses, mostly in the form of honour fees (fees charged in association with banks honouring a payment despite insufficient funds in the holder’s account).

Fee income from business deposits continued to decline in 2014, with most of the decrease resulting from lower account-servicing and transaction fees, particularly for small businesses (small businesses account for the majority of business deposit fee income). The decrease was the result of a combination of lower volume growth and customers shifting to lower fee products.

We observe that the “fee wars” appears to be over now (triggered by NAB a few years ago), and we expect to see subtle rises in fees as bank margins come under increasing pressure. Also, small business bears the brunt of the charges across a number of categories, and we expect this to continue, because the sector is under less pressure from a bank competitive standpoint, and many SME’s have no where else to go.

External Forces May Impact Bank Funding – And Households

On the international horizon there are two potential events which may impact Australian bank funding. Today we consider the potential impacts on the banks, and households. First, it is likely the FED will start to lift interest rates later in the year as they adjust towards more normal rates. Second within a couple of weeks the Greek situation will crystalise, with either a negotiated debt settlement or an early exit. Both these (not totally unconnected) issues could play on bank funding because the large banks here are still quite reliant on accessing the international financial markets.

In recent times funding costs have fallen from their very high levels during the GFC. Australian bond spread mirrors the global picture.

The question is what happens if the financial markets react negatively to the news from the USA or Europe? At very least we can expect greater volatility, and the risk premium on funding costs would likely be raised. This would potentially translate to higher funding costs for the banks because they do rely on the global financial markets (we have been a net importer of funds to support the banks for years).

However, the latest data shows that the banks have a greater proportion of funding from deposits compared with pre-GFC, and there has been a corresponding fall in short term debt funding.

So we think the Australian Banks are quite well placed, despite the potential need to raise an additional $20-30bn to meet expected changes to their capital ratios (work in progress but it is certain to rise). They have already shown their willingness to drop deposit rates more than the market, and we think it is likely this would go further.

In addition, they could reduce the discounts on mortgage lending, as currently they are quite high.

They could also throttle back on their lending – especially for housing – to better match deposit growth to lending growth. Finally, they have access to the RBA “emergency” fund if needed – The Committed Liquidity Facility (CLF).

The Reserve Bank is providing a Committed Liquidity Facility (CLF) as part of Australia’s implementation of the Basel III liquidity standards from 1 January 2015. Consistent with the standards, certain authorised deposit-taking institutions (ADIs) are required by APRA to maintain a liquidity coverage ratio (LCR) at or above 100 per cent. These ADIs may seek approval from APRA to meet part of their Australian dollar liquidity requirements through a CLF with the Reserve Bank. In consideration of the Reserve Bank’s CLF commitment to an ADI, the ADI must pay a monthly CLF Fee in advance to the Reserve Bank.

Industry insiders estimate the capacity of the facility could be as high as $300 billion, a substantial amount. In effect the banks are backed by a Government guarantee.

So, we think that the wash through of these international issues will not create major financial stability problems locally, but there may well be higher costs to savers and borrowers, and potentially Australian tax payers, if the RBA is called on to assist with liquidity, or worst case the deposit insurance scheme is called upon if a bank were to get into difficulty. Currently deposits up to $250,000 in ADI’s supervised by APRA are covered.

Two other points to highlight. First, household savings ratio are on their way down, from their highs post GFC. We would expect households to hunker down and save more if there was an external shock, thus bolstering bank deposits (and a likely flight to quality, as we saw in the GFC). We do not think a run on an Australian bank is likely.

Second, bank net margins are compressing thanks to the severe competition in mortgage lending. This dynamic may change if there was an external shock, as demand for mortgages eased, providing some relief.

In addition the US Australian dollar exchange rate would probably drop, providing some relief. However, second order impacts, namely slowing economic activity, falls in confidence, and rising unemployment which may follow from a global shock, in turn have the potential to impact the banks much more, because it would translate into risks in the housing sector basket, where they have been placing their eggs in recent times.

The facts on Australian coal production

From The Conversation. Talk of the demise of Australian coal production is largely political, not economic.

The problem for the countries that presently mine and burn coal is that there are currently few low cost alternatives. Most countries in the world today are focused on trying to ensure their citizens have access to electrical power. This is difficult without low cost base load electricity production and at present, coal provides an affordable solution.

As at the end of 2012 there were 75 countries producing coal. These countries ranged from Nepal with production of 17,640 short tons in 2012, through to China with production of 4.017 billion tonnes in the same year.

It’s worth noting that Australia was ranked 5th (after China, the United States, India and Indonesia) with coal production of 463 million tonnes in 2012. While these rankings move around a little over time there is no doubt Australia is still a major player in the market for coal.

Regional coal production

U.S. Energy Information Administration (EIA) U.S. Energy Information Administration (EIA)

If you focus on regional coal production since 1980 (see chart above), it is clear production in most regions is levelling out or falling except for Asia and Oceania. When you break this group down there are four major producers involved: China, India, Indonesia and Australia, with a large number of other countries producing considerably less. This is evident in the chart below. Coal production has increased in each of these countries since 1980 though the rate of increase since 2000 is greatest for China.

Coal production by China, India, Indonesia and Australia

U.S. Energy Information Administration (EIA)

While Australia’s coal production is important, it is not the largest coal producer. There are a number other countries in the world that produce very large amounts of coal. If Australia were to cease production of its coal there would be an initial increase in world prices. Nevertheless, it is expected that other producers would fill the gap, particularly given the more recent falls in demand for coal.

If the demise of coal was close, you would expect to see it in the share prices of coal producers, as investor expectations shifted on the future of the firms and their ability to produce cash in the future.

The figure below provides standardised total returns for two portfolios of coal companies listed on the Australian Securities Exchange. The figure also includes the S&P/ASX 200 share market index standardised portfolio value for the same period and the AUD price of Australian thermal coal. There were four miners (including BHP Billiton) included in the portfolio early in the 2000s though this quickly expanded to 10 by 2005 through to 21 from 2011.

The portfolio values and the share market index are standardised to a value of A$1.00 at the end of December 1999 and the total returns are compounded over the period to provide an indication of how the value of the coal mining firm portfolios and the share market have changed over the period.

There is a fair spread of different sized coal producers in the portfolio including BHP. Portfolios are graphed both with and without BHP Billiton, though inclusion of BHP Billiton has little impact. Private non-listed companies are not included in the portfolios.

Coal equally weighted portfolios of ASX listed coal producers

Datastream for share prices and share price index and Index Mundi for the Coal price. Index Mundi

Coal company values have been volatile, relative to the Australian share market (S&P/ASX200 index) over the last 15 years, particularly since 2006. Yet, there is also evidence of some stability over the last couple of years, particularly since 2012.

Coal mining company values have fallen since 2011 though they appear to have stabilised by 2013. The overlaid AUD coal price per tonne tells a different story with its highest price recorded late in 2008 followed by price falls for the remainder of the period. These results are not consistent with the collapse of the coal industry. Indeed, the recent stabilisation of coal mining company prices, after the collapse of 2011 suggest a quite different story.

The anti-coal movement is gaining momentum in Australia. AAP

Given these results it seems odd that superannuation funds and large investors might be considering divesting their investments in coal. There is no question that coal mining company share prices have fallen dramatically from the highs of 2011 but it is not altogether clear that that these companies will disappear in the near term given current share prices. And it would be a brave investor that chose to divest its investment in BHP Billiton or Rio Rinto Limited because part of their business involved the extraction of coal.

It would appear that carbon capture and storage has failed to provide the solution to the CO2 emissions generated from burning coal, yet alternative sources of energy are relatively expensive at present. Governments can change the relative cost of coal through carbon markets, carbon taxes or direct legislation. Yet the global reality for coal appears to be reflected in coal mining share prices. The economics suggest it is here to stay for some time yet.

Author – Richard Heaney, Professor at University of Western Australia