Martin North – Page 1033 – Digital Finance Analytics (DFA) Blog

Capital floors: The Design of a Framework Based on Standardised Approaches

The BIS also released a consultative paper which outlines the Basel Committee’s proposals to design a capital floor based on standardised, non-internal modelled approaches. The proposed floor would replace the existing transitional capital floor based on the Basel I framework. The floor will be based on revised standardised approaches for credit, market and operational risk, which are currently under consultation.

The floor is meant to mitigate model risk and measurement error stemming from internally-modelled approaches. It would enhance the comparability of capital outcomes across banks, and also ensure that the level of capital across the banking system does not fall below a certain level.

As noted in the Committee’s November 2014 report to the G20 Leaders, the Committee is taking steps to reduce variation in capital ratios between banks. The proposed capital floor is part of a range of policy and supervisory measures that aim to enhance the reliability and comparability of risk-weighted capital ratios. The Committee will consider the calibration of the floor alongside its work on finalising the revised standardised approaches.

Revisions to the Standardised Approach for Credit Risk

BIS has just released a proposal to strengthen the existing regulatory capital standards for discussion. This is one of a number of initiatives which are all driving capital requirements higher.

The proposed Revisions to the Standardised Approach for credit risk seek to strengthen the existing regulatory capital standard in several ways. These include:

reduced reliance on external credit ratings;

enhanced granularity and risk sensitivity;

updated risk weight calibrations, which for purposes of this consultation are indicative risk weights and will be further informed by the results of a quantitative impact study;

more comparability with the internal ratings-based (IRB) approach with respect to the definition and treatment of similar exposures; and

better clarity on the application of the standards.

The Committee is considering replacing references to external ratings, as used in the current standardised approach, with a limited number of risk drivers. These alternative risk drivers vary based on the particular type of exposure and have been selected on the basis that they are simple, intuitive, readily available and capable of explaining risk across jurisdictions.

Given the challenges associated with identifying risk drivers that can be applied globally but which also reflect the local nature of some exposures – such as retail credit and mortgages – the Committee recognises that the proposals are still at an early stage of development. Thus, the Committee seeks respondents’ comments and analysis with a view to enhancing the proposals set out in this consultative document.

The key aspects of the proposals are:

Bank exposures: would no longer be risk-weighted by reference to the bank’s external credit rating or that of its sovereign of incorporation, but would instead be based on two risk drivers: the bank’s capital adequacy and its asset quality.

Corporate exposures: would no longer be risk-weighted by reference to the borrowing firm’s external credit rating, but would instead be based on the firm’s revenue and leverage.

Further, risk sensitivity and comparability with the IRB approach would be increased by introducing a specific treatment for specialised lending.

Retail category: would be enhanced by tightening the criteria to qualify for a preferential risk weight, and by introducing an alternative treatment for exposures that do not meet the criteria.

Residential real estate: would no longer receive a 35% risk weight. Instead, risk weights would be based on two commonly used loan underwriting ratios: the amount of the loan relative to the value of the real estate securing the loan (ie the loan-to-value ratio) and the borrower’s indebtedness (ie a debt-service coverage ratio).

Commercial real estate: two options are currently under consideration: (a) treating the exposures as unsecured with national discretion for a preferential risk weight under certain conditions; or (b) determining the risk weight based on the loan-to-value ratio.

Credit risk mitigation: the framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts and updating the corporate guarantor eligibility criteria.

ASIC Provides Relief for 31-day Notice Term Deposits

ASIC today released a class order to facilitate term deposits that are only breakable on 31 days’ notice.

The Class Order [CO 14/1262] gives relief for 18 months to enable 31-day notice term deposits of up to five years to be given concessional regulatory treatment as basic deposit products under the Corporations Act (the Act). This is intended to give Government the opportunity to consider law reform.

As part of the Basel III reforms, the Australian Prudential Regulation Authority (APRA) will implement the liquidity coverage ratio (LCR) requirement from 1 January 2015, as set out in Prudential Standard APS 210 Liquidity (APS 210).

Term deposits that require 31 days’ notice for early withdrawal will receive favourable liquidity treatment under APS 210.

The new class order will provide industry with certainty that these sorts of term deposits will be treated as basic deposit products, subject to meeting the relief conditions.

The class order formalises ASIC’s previous conditional no-action position on 31-day notice term deposits. The relief conditions are about ensuring consumers can make confident and informed decisions when investing in the new type of term deposit.

They also help consumers understand the new requirement to give 31 days’ notice to ‘break’ their term deposit and ensure this is considered when the term deposit rolls-over.

ASIC will continue to work with industry to help ADIs meet the relief conditions, including carryover of arrangements from the previous no-action position to the class order, while ensuring consumer protection.

Background

The definition of basic deposit product in section 761A of the Act does not specify the period of notice an ADI may require a depositor to give in order to make an early withdrawal from a term deposit of up to two years.

It is therefore unclear what notice period for withdrawal could be imposed that is consistent with the characterisation of a term deposit of up to two years as basic deposit product. ASIC’s view is that a notice period as long as 31 days for early withdrawal is unlikely to meet the definition of basic deposit product.

Section 761A of the Act provides that term deposits of between two and five years must allow an early withdrawal without prior notice in order to meet the basic deposit product definition (except for the special provision for mutual ADIs contained in reg 7.1.03A of the Corporations Regulations 2001).

Long-Term Unemployment Will Impact Wage Growth

In economic circles, the relationship between wage growth and unemployment is an important factor. Many will focus on the relationship between short-term unemployment and wage growth, but a paper released by the Bank of England highlights that long-term unemployment is also an important factor in the equation. Given the fact that wage growth is slowing in Australia, and long-term unemployment is rising, these findings are important.

The relationship between wage growth and unemployment is a key trade-off concerning monetary policy makers, as labour costs form a critical part of the inflationary transmission mechanism. One important question is how the composition of the unemployment pool, and specifically the share of long-term unemployment, affects that tradeoff. Detachment from the labour force is likely to increase with unemployment duration, so that the long-term unemployed search less actively for jobs and therefore exert less downward pressure on wages. If so, short-term unemployment may pull down on wage inflation more than long-term unemployment does. In this situation, policymakers might anticipate a period of high wage growth if short-term unemployment starts to fall to low levels even if the long-term unemployment rate remains elevated.

But there may be complications arising from the integral dynamics of unemployment. In this paper it emerges that the estimated disinflationary effects of long-term unemployment hinge on whether or not wage growth becomes less sensitive to unemployment as the latter rises – a form of non-linearity. One reason why the negative relationship between wages and unemployment might become flatter at high levels of unemployment is that workers may tend to resist cuts in their nominal wages. When unemployment is low, wage growth tends to be high as firms compete for a scarce pool of resources. But due to worker resistance to wage cuts the reverse might not hold to the same extent, with a relatively large increase in unemployment needed to reduce wage growth during a recession.

Why does this non-linearity matter for the measured effect of long-term unemployment on wage growth? It is because long-term unemployment inevitably lags behind movements in short-term unemployment as it takes time for the new unemployed to move into the long-term category. So high levels of long-term unemployed are only associated with lengthy periods of high unemployment. A flattening off of the relationship between wages and unemployment at high levels of unemployment would then imply that long-term unemployment does little to reduce wage inflation further. The apparently different effects of short and long-term unemployment on wage inflation could therefore be merely as a result of timing rather than labour market detachment among the long-term unemployed.

By modifying statistical models of labour market dynamics to incorporate this insight, this paper finds that there appears to be much less difference between the short and long-term unemployed in terms of their marginal influence on wage behaviour than is suggested by the recent literature. When the non-linearity described above is not taken into account, estimation results corroborate the finding already established in the literature that it is predominantly the short-term unemployed that matter for wage inflation. Long-term unemployment in this specification tends to have no statistically significant effect on wage inflation. When the non-linearity is taken into account, long-term unemployment has a much larger effect on wage inflation. For some of the specifications considered, the data fail to reject the hypothesis that short and long-term unemployment rates have equal effects on inflation. In some instances, the models even suggest that long-term unemployment creates more of a drag on wage growth than short-term unemployment does, all else equal. Statistical uncertainty makes it difficult to draw a very precise conclusion, but the results in this paper caution against excluding long-term unemployment from estimates of aggregate labour market slack as is suggested by much of the recent literature. Both the short-term unemployment rate and the long-term unemployment rate are likely to contain useful information for judging the degree of wage pressure in the economy.

How The Mining Boom Lifted Living Standards

In the RBA Bulletin for December 2014, there is a detailed analysis and modelling to show how the mining boom impacted the Australian economy. This is important because as we know the boom is fading, and the RBA has been looking for the housing sector to take up the slack.

The world price of Australia’s mining exports more than tripled over the 10 years to 2012, while investment spending by the mining sector increased from 2 per cent of GDP to 8 per cent. This ‘mining boom’ represents one of the largest shocks to the Australian economy in generations. This article presents estimates of its effects, using a macroeconometric model of the Australian economy. It summarises a longer research paper, which contains further details and discussion of the results (see Downes, Hanslow and Tulip (2014)). The model estimates suggest that the mining boom increased Australian living standards substantially. By 2013, the boom is estimated to have raised real per capita household disposable income by 13 per cent, raised real wages by 6 per cent and lowered the unemployment rate by about 1¼ percentage points. However, not all parts of the economy have benefited. The mining boom has also led to a large appreciation of the Australian dollar that has weighed on other industries exposed to trade, such as manufacturing and agriculture. However, because manufacturing benefits from higher demand for inputs to mining, the deindustrialisation that sometimes accompanies resource booms – the so-called ‘Dutch disease’ – has not been strong. Model estimates suggest that manufacturing output in 2013 was about 5 per cent below what it would have been without the mining boom.

Graph 3 also shows an estimate of the increase in the volume of goods and services produced arising from the boom. Higher mining investment directly contributes to higher aggregate demand. Furthermore, higher national purchasing power boosts consumption and other spending components. Higher mining investment also increases the national capital stock and hence aggregate supply. There are many further compounding and offsetting effects. The estimated net effect is to increase real GDP by 6 per cent.

The mining boom raises household income through several different channels within the model (Graph 8). As of 2013, employment was 3 per cent higher than in the counterfactual, largely due to the boost to aggregate demand. Real consumer wages were about 6 per cent higher, reflecting the effect of the higher exchange rate on import prices. Property income increased, reflecting greater returns to equities and real estate. A larger tax base led to lower average tax rates, all of which helped raise real household disposable income by about 13 per cent. As can be seen in Graph 8, household consumption is estimated to initially rise more slowly than real household disposable income. That is, the saving rate increases. This reflects inertia in consumption behaviour, coupled with a default assumption that households initially view the boom as temporary. In the medium to long run, as it becomes apparent that the change in income is persistent, savings return toward normal and consumption rises further. In the long run, consumption will adjust by about the same proportion as the rise in household disposable income.

Changes in the composition of consumption are an important determinant of how the mining boom affected different industries (Graph 9). Demand for motor vehicles and other consumer durables are estimated to have increased strongly, reflecting lower import prices and strong income growth. Relative price changes for most other categories of consumption were smaller, with consequently less effect on their relative demand.

The mining boom can be viewed as a confluence of events that have boosted mineral commodity prices, mining investment and resources production. This combination of shocks has boosted the purchasing power and volume of Australian output. It has also led to large changes in relative prices, most noticeably an appreciation of the exchange rate. The combination of changes in income, production and relative prices has meant large changes in the composition of economic activity. While mining, construction and importing industries have boomed, agriculture, manufacturing and other trade-exposed services have declined relative to their expected paths in the absence of the boom. Households that own mining shares (including through superannuation) or real estate have done well, while renters and those who work in import-competing industries have done less well.

Payment Card Access Regimes

The Reserve Bank has varied the Access Regimes for the MasterCard and Visa credit card systems and revoked the Access Regime for the Visa Debit system. The variations and revocation are effective from 1 January 2015.

In March 2014, the Payments System Board made an in-principle decision to modify the Access Regimes. This reflected its conclusion that, while the original Access Regimes were appropriate when introduced, changes in industry structure and in the ownership of the card systems had meant that the regimes were now unduly restricting access. Accordingly, the amended framework will provide the card systems with the flexibility to expand membership beyond existing participants. The card systems will be required to have in place transparent eligibility and assessment criteria and to report information about membership and applications to the Bank.

The Visa Debit regime was originally introduced to deal with technical issues arising from the interaction of Visa’s rules and the credit card Access Regime; these issues no longer apply and accordingly the Visa Debit regime will be revoked.

At the time of its in-principle decision in March, the Board noted that implementation was contingent on a number of other factors. Most importantly, amendment of the Banking Regulations 1966 was required for the variations to be effective. Amendments to the Banking Regulations that mean that credit card issuing and acquiring will no longer be considered banking business come into force on 1 January 2015.

Fast Retail Payment Systems

In the December 2014 edition of the RBA Bulletin, there is an important article on the emerging fast retail payment systems. Here are some of the most salient points:

In December 2014, a group of Australian financial institutions announced that funding had been secured for the next phase of the New Payments Platform (NPP), which will provide the capability for Australian consumers and businesses to make and receive payments in near to real time. The NPP is one example of a fast retail payment system, a number of which have been implemented in other countries in recent years.

Advances in technology – in particular improved telecommunications, faster processing speeds and wide penetration of internet connectivity – mean that real-time payments can be extended to the high-volume, low-value payments used by consumers and businesses (‘retail payments’). Systems implemented in a number of countries allow businesses and consumers to make and receive payments in near to real time, with close-to-immediate funds availability to the recipient. Fast retail payment systems can benefit end users of payments systems, and also payment providers themselves – for example, by replacing the use of relatively costly cheque payments with real-time transfers using a payment application on a mobile device.

Fast retail payments can be thought of as payments that are available for use by the recipient a short time after the payment has been initiated by the sender – within minutes, or indeed seconds. This contrasts with many established retail payment systems that rely on batch processing where funds are made available on the next business day, or even several days later – particularly in the case of cheques. There are three steps within the payment process relevant for achieving fast payments – clearing, posting and settlement. First, following the initiation of a payment by the customer (payer), the exchange of payment instructions and the calculation of payment obligations between financial institutions (referred to collectively as ‘clearing’) need to be performed in real time. Many retail payment systems have tended to clear payments infrequently in batches, making timely receipt of funds by the payee impossible. Second, the recipient’s financial institution must act on the payment instructions it receives in the clearing process to make funds available to the recipient (‘posting’) in near to real time. Finally, the payer’s financial institution needs to ‘settle’ the funds owing to the receiver’s financial institution for the payment. This typically occurs by transferring funds between accounts held by financial institutions at the central bank (Exchange Settlement Accounts in Australia’s case). Clearing and posting need to occur quickly for a system to be, in effect, a ‘fast’ system. However, settlement between financial institutions need not be completed before funds are made available to the recipient customer. There is therefore freedom for settlement to occur in a number of ways and indeed the fast retail payment systems implemented to date have taken varying approaches. While there have been significant developments in recent years, the concept of fast retail payments is not new. For example, Japan’s Zengin Data Telecommunication System (Zengin System) was established in 1973. The development of fast payment systems has generally occurred in one of two ways: through the extension of existing infrastructures (such as high-value systems or real-time ATM infrastructure) to accommodate high-volume, fast retail payments, or through new purpose-built infrastructure. In most cases, new specialised infrastructure has been adopted for retail payments, but there are examples of hybrid systems processing both high-value and retail payments. For example, Japan’s Zengin System clears both high-value and low-value funds transfers in near to real time, but settlement arrangements vary with transaction size. Switzerland’s Swiss Interbank Clearing (SIC) provides for near to real time clearing and settlement of high-value payments and some retail funds transfers. A range of other countries have introduced fast retail payment systems either as hybrid systems or as dedicated low-value systems since 2000. Australia’s NPP system will rely on newly developed clearing infrastructure, with settlement occurring in real time through a new component of the Reserve Bank’s high-value settlement system, the Reserve Bank Information and Transfer System (RITS).

The use of mobile phones as an access channel for fast payment services is a focus for a number of fast payment systems, including in the United Kingdom, Sweden and Singapore. This dovetails particularly well with some services for easier addressing of payments. For instance, the Paym service recently introduced in the United Kingdom enables mobile phone numbers to be used as payment addresses for person-to-person payments (Payments Council 2014). Users register their mobile phone number and link it to their bank account number. They can then send and receive real-time payments to other registered users using their mobile phone numbers through their bank’s internet portal.

The broad approach to providing infrastructure that would support fast retail payments in Australia was established by the industry Real-Time Payments Committee (RTPC) and published in February 2013 (APCA 2013). The RTPC proposed the establishment of a mutual collaborative clearing utility to provide the payments infrastructure to which authorised deposit-taking institutions would be connected for real-time clearing of payments. This utility, known as the Basic Infrastructure (BI), will not be commercial in nature and will provide a platform through which a variety of payment services can be offered. While financial institutions will be able to offer basic payment services to their customers using only the BI, the model proposed by the RTPC anticipates that a variety of ‘overlay services’ will be able to use the BI to offer commercially oriented services, for instance through a commercial scheme. Participation by financial institutions in any particular commercial overlay would be voluntary. This model was chosen with the view that it would provide the greatest scope for innovation and competition between financial institutions and payment providers in the services that can be offered to end users. The RTPC also proposed that an agreed overlay service, referred to as the ‘Initial Convenience Service’ (ICS), would be built at the same time as the BI, to help establish a compelling proposition for use of the NPP from the outset. While the ICS will be the first overlay to give payments system users access to fast retail payments, it is intended to be the first of a number of overlay services that could be developed over time. The BI and the ICS comprise two of the three main components of the NPP. In addition, the Reserve Bank is developing a Fast Settlement Service (FSS) that will provide line-by-line real-time settlement of transactions processed through the NPP. This model will enable real-time clearing and settlement for retail payments, with the recipient’s financial institution able to provide fast access to funds without incurring interbank settlement risk. The interaction of these three components – BI, ICS and FSS – is illustrated below (Figure 1). Consistent with the approach taken in recently developed fast retail payment systems, the NPP will operate 24 hours a day, 7 days a week and will incorporate ISO 20022 messaging standards to facilitate the inclusion of richer remittance information with transactions. The NPP model also includes an addressing solution, enabling users to receive payments without having to supply BSB and account numbers to the payer. This combination – of real-time capability, 24/7 operations, richer messaging functionality and easier addressing – addresses the key gaps in the payments system identified by the Strategic Review. The capacity for new overlay services to utilise the system should also be a vehicle for innovation and competition.

New Liquity Rules Will Reduce Deposit Rates Further

RBA Assistant Governor (Financial Markets) Guy Debelle speaking at the 27th Australasian Finance and Banking Conference in Sydney on 16 December 2014 summarised the changes to bank liquidity which are translating to lower deposit rates for savers in 2015. We already highlighted the falling deposit rates for savers (despite no change in the RBA rate).

“Today I will talk about the imminent arrival of the revised liquidity regime for the Australian financial sector. I will recap some of its features, particularly how they relate to the Reserve Bank, and discuss some of the impact that it is having on market pricing.

An important aspect of the Basel III liquidity standard, the Liquidity Coverage Ratio (LCR), comes into effect in under one month’s time at the beginning of 2015. The LCR requires that banks hold sufficient ‘high quality liquid assets’ (HQLA) to withstand a 30-day period of stress. The amount of HQLA a bank needs to hold is determined by the composition and maturity structure of its balance sheet. The more liabilities that run off within that 30-day window, the more HQLA that needs to be held. At the same time, particular types of investors or depositors are assumed to be less stable than others (in terms of their likelihood of withdrawing funds), which also results in a greater need for liquid assets.

As has been known for some time, the Australian financial system does not have an especially large stock of HQLA. The only instruments that have been deemed to meet the Basel standard of liquidity are debt issued by the Commonwealth and state governments (CGS and semis) along with cash balances at the Reserve Bank. The banking system’s overall liquidity needs are greatly in excess of what could reasonably be held in those assets. To put some numbers on this, APRA has determined that for next year, the Australian banking system’s liquidity needs amount to $450 billion. The total stock of CGS and semis on issue currently amounts to around $600 billion. If the banks were to attempt to meet their liquidity needs solely by holding only CGS and semis, a number of problems would arise. Firstly, any attempt would likely be in vain, because there are a large number of other entities which are required to or want to hold CGS and semis too. Second, in the process of trying to do this, the liquidity of the market for these securities would be seriously compromised. This would be completely self-defeating as the overall aim is to have the banks hold more liquid assets.

To address these circumstances, an important component of the liquidity regime in Australia is the committed liquidity facility (CLF) where, on the payment of a 15 basis point fee, banks will be able to obtain a commitment from the Reserve Bank to provide liquidity against a broad range of assets under repurchase agreement.

APRA has recently determined that the total CLF requirements of the Australian banking system for 2015 amount to around $275 billion. This amount was determined by first assessing that the amount of CGS and semis that could reasonably be held by banks without unduly affecting market functioning was $175 billion. The Reserve Bank provided this assessment to APRA. The CLF amount is then simply the difference between this and the overall liquidity needs of the system.

The banks that require a CLF from the Reserve Bank sign a deed of agreement with us and pay their fee before the end of this year. Then from the beginning of next year, the arrangement comes into effect.

I have talked before about some of the impact on pricing in various markets of the new liquidity regime.[⁴] We have attempted to limit the impact on the price of CGS and semis, but necessarily, because the banks are holding more of these securities than previously (Graph 1), the price is higher (and the yield lower) than would otherwise be the case.

Graph 1

Overall, the impact of the LCR on market pricing is relatively small. The larger changes have been around deposit pricing and the terms and conditions of deposits, which I will come to shortly, but there have been some other effects which are worth commenting on.

Firstly, a less discussed aspect of the liquidity standard is the requirement for a demonstrated internal liquidity transfer pricing model for banks. This has required banks to fully reflect the liquidity cost in the price of the various services they offer customers. This has resulted in a change in the price and/or terms and conditions of a number of facilities. One noteworthy example is a line of credit where, in the past, banks often did not factor into the price they charged for this facility, the potential draw on liquidity this entailed, particularly in a stressed situation. On the other hand, longer fixed-term deposits are more attractive to banks and consequently have been repriced upwards (see below).

A second impact which has been evident more recently is a widening in the spread between bank bills and OIS (Graph 2). In the depths of the crisis, such a widening was often an indicator of stress in the financial situation. But that does not appear to be the case currently as other indicators of bank creditworthiness are little changed, including spreads on longer term borrowing and CDS premia.

Graph 2

Instead, our assessment is that in large part, this reflects the new liquidity regime combined with some other dynamics in the market. The graph shows that the widening has been most pronounced at the longer bank bill maturities, and indeed is quite small for a one month bank bill. This is because issuing a one month bill has little attraction to a bank: its liquidity cost is relatively high as its maturity is likely to occur within the 30-day liquidity window. Hence a bank would need to hold HQLA of similar size to the amount of funding the bank bill raised. Instead, there is a greater incentive to issue at longer maturities and so the spread on 6-month bills has widened by more as there has been greater supply of such paper.

Over the past two months, the original term to maturity of bank bills and certificate of deposits on issue has changed noticeably, with the stock of 6-month bills increasing by $7.3 billion (11 per cent) and 12-month bills by $1.4 billion (43 per cent). In contrast, the stock of outstanding bills with an original tenor shorter than five months has declined by a total of $9.7 billion (8½ per cent).

At the same time, the cost of Australian dollars in the forward FX market has been quite elevated. This high price in the forwards market has been due to a number of factors including the tendency of hedge funds to fund their Australian dollar shorts in this market, as well as an increase in the use of this market by foreign bank branches to fund Australian dollar lending.

Historically, Australian banks have tended to raise a significant share of their short-term funding in foreign markets, mostly in US dollars, and then swap them back into Australian dollars to fund their Australian dollar-denominated asset base. They would swap these foreign currency funds when the cost was sufficiently attractive, leaving it in foreign currency in the interim. Under the new liquidity regime, the cost of short-term foreign currency funding is higher, so this is less attractive. Combined with a higher swap cost, the all-in cost of short-term offshore funding is higher and hence domestic issuance is relatively more attractive. As a result we have seen more of it, which has contributed to the widening in the spread to OIS.

Finally, I will return to the impact of the LCR on deposit pricing. Graph 3 shows the evolution of the funding mix of Australian banks over the past decade. The rise in the share of deposit funding from 2008 is readily apparent, as is the decline in the share of short-term and long-term wholesale funding. The growth in deposits is now of a similar pace to that in bank lending, having been considerably faster over recent years. As a result, the deposit share of funding has levelled off.

Graph 3

The increase in deposit funding was in part a result of the increased returns on offer, as banks actively sought this outcome by offering higher interest rates. (It also reflected a shift on the part of investors for the perceived safety of a bank deposit.) The interest rate on both at-call and term deposits rose markedly compared with money market rates of equivalent maturity (Graph 4). As you can see from the graph, this process of paying higher deposit rates has largely run its course.

Graph 4

Within this overall repricing, there have been some changes in the mix of deposit rates and products as a result of the introduction of the LCR. As I mentioned earlier, banks have an incentive to reduce the amount of liabilities that roll off in less than 30 days. Deposits which are deemed to be subject to high run-off rates and those which are callable within 30 days will be more expensive for banks. Banks are therefore working towards converting many of these less stable deposits into a more stable deposit base. For example, retail and SME deposits are deemed to be ‘stickier’ than institutional deposits. Part of this transition is being induced by price signals: interest rates offered on new or existing deposit products which are deemed to be more stable are rising relative to interest rates on products deemed to be less stable.

These types of changes appear to have accelerated recently as we draw closer to the implementation of the LCR and probably still have some way to run. To date, we have seen only a few banks offer notice of withdrawal accounts to customers. These accounts require the depositor to provide the bank with 31 days or more notice of a withdrawal (obviously 31 days is one day longer than the 30-day liquidity stress period). Interest rates offered on these accounts are among the higher rates offered in the deposit market. It may be that we see a broader move to these types of accounts or changes in terms and conditions on existing accounts through the course of next year.

We have also seen a fall in the growth of term deposits relative to transaction and at-call deposits over the past few years. In fact term deposits as a share of banks’ funding has been falling while transaction and at-call deposits have been growing strongly. Part of this is because a flattening of the yield curve has made investors less inclined to invest in longer term deposits. But in part it is because under the LCR, some transactional and operational deposits are subject to lower run-off rates than deposits that are largely attracted by higher interest rates. Indeed, there has been some indication that banks have been transitioning depositors into deposit products treated more favourably under the LCR.

But banks are not limited to just changing their deposit offerings. We could see them look for more opportunities to package retail deposits with other products as the deposits of customers that also have other relationships with the bank are deemed to be more stable under the LCR.

So to conclude, the full implementation of the new liquidity regime in Australia is imminent. From the beginning of next year, banks in Australia will be fully subject to the Liquidity Coverage Ratio. This has already had an impact on the pricing and nature of a number of financial products, as well as the structure of bank liabilities. While the bulk of the impact may be behind us, there are still a number of changes in the pipeline, particularly around deposits.”

Half Of Households Not Confident They Get Best Financal Deals – ASIC

According to a recent ASIC survey, about half of Australians are NOT confident they are getting the best deal when making important financial decisions. They found that:

57% of population with credit card (7,112,000) are NOT confident that they are getting the best deal on their credit cards
45% of population with a mortgage (3,609,000) are NOT confident that they are getting the best deal on their mortgage
48% of population who have superannuation (7,107,000) are NOT confident that they have it sorted.

Australians don’t often seek independent expert advice when making important financial decisions.

84% of people with credit cards did not seek independent expert advice on the matter
54% of people with a mortgage did not seek independent expert advice on the matter
67% of people who set up a super did not seek independent expert advice on the matter

This demonstrates that many consumers don’t know where to go for independent information or how to make the best choice and find out what’s important in choosing a credit card, mortgage or superannuation. Nearly all Australians (92%) think it would be useful if all Australians had access to a free and independent source of help on financial matters such as managing their money or how to reach their financial goals. Looking at the product specific findings:

Credit cards : 57% (7,112,000) of Australians are unsure or don’t think they have the best deal on their credit cards. 84% of people (9,540,000) who have credit cards did not seek independent expert advice on the matter. Of those who have credit cards:
GENERAL: 84% of people with a credit card get no independent advice on credit cards yet 25% are confident they didn’t get a good deal; and 33% are either NOT confident, or don’t know if they got a good deal
YOUTH: Less 25 to 49 year olds (37%) are confident they are getting the best deal on their credit card than 16-24 year olds (42%). The highest numbers of confident people are in the 65+ age group but still 45% of them are unsure
AN ISSUE FOR 25 to 49 YEAR OLDS: Less 25-49 year olds than any other age group are confident that they think they’re getting the best deal out of their credit cards. Reasons for this are likely to be due to a very high proportion of the 25-49 year age group have a mortgage. Only 27% don’t have a mortgage compared to 72% of 50+ or 87% of 16-24. Hypothesis they may be more aware of the LOW rate of mortgages compared to credit cards, or that they should bundle CC into mortgage offer. Other age group’s confidence that they are getting the best deal on their credit cards is: 65+ are 55%; 50+ are 49%; 16-24 are 42%; 25-49 are 37%. (Average is 43%, so 25 to 49s are below average).
STATE: More people in SA (32%) are confident that they DON’T have a good deal on their credit card, than in any other state. Less Victorians/Tasmanians likely to think they don’t have a good deal (22%)
GENDER: Women feel less confident then men that they are getting the best deal on their credit card (47%) to (53%)
ADVICE: Among those who had sought independent expert advice when getting a credit card half (54%) were confident that they were getting the best deal possible on their credit cards, compared to 34% of those who didn’t seek independent advice.
Mortgage: With 46% of people with a mortgage (3,609,000) NOT confident that are getting the best deal on their mortgage, there is a large portion of the population that lacks this assurance. Over half those with mortgages did not seek independent advice (54%). Young first home buyers seek less advice on mortgages than any other age group and are the least confident that they got the best deal on their mortgage. 65% of 18-24 year olds with a mortgage say they’re unsure or don’t think they got the best deal on their mortgage. Conversely, 25-49 year old home buyers were the most likely to seek independent advice (56%) and are more confident than any other age group that they got the best deal on their mortgage. People living outside capital cities were less likely to have sought independent expert advice when choosing a mortgage (37% vs 52%)
YOUTH: Fewer 16-24 year olds (35%) are confident they got the best deal on their mortgage, compared to any other age group. 25 to 49 year olds (57%) are highest. Average is 55%
YOUTH: Far more 16-24 year olds (36%) are confident they have did NOT get the best deal on their mortgage compared to 20% for 25-49 year olds. Average is 21%
YOUTH: Yet fewer 16-24 year olds (27%) than any other age group sought independent advice about their mortgage. Average is 46%; 25-49 year olds (56%); 50+ are 31% and 65+ are 23%
25 to 49 YEAR OLDS: More 25-49 year olds (56%) got advice than any other age group, compared to the average (42%)
ADVICE: 54% of people who have a mortgage did not seek independent advice.
Superannuation: Approximately half of Australians (48% or 7,107,000) are NOT confident they have their super sorted out. Though this statistic improves with age, there are still 29% of the population (1,505,000) aged 50+ who have NOT sorted their super or don’t know if it is. 67% of people (9,413,000) who last joined a superannuation fund did not seek independent expert advice. But among those that did, 67% were confident their superannuation was sorted out, compared to only 49% of all Australians who feel this confidence. It can be inferred that those who got advice, received value and confidence out of it.
AGE: Under 50s were much less likely to be confident their super was sorted, compared to other age groups; 16-24 at 39% and 25-49 at 41% and 50+ at 72%
STATE: More people in Victoria//Tasmania are likely to feel confident they have their super sorted than in any other state. Average is 52%. Victoria/ACT is 57% compared to 48% across all other states
ADVICE: Under 50s were less likely to have sought independent expert advice when choosing a super fund, compared to other age groups; 16-24 at 14%, 25-49 at 28%. The average of ALL people whether or not they have superannuation is 26%. The average of those with super is 33%.

OECD Says Raise GST, Change Taxes, Use Macroprudential

The OECD survey of Australia, just released, makes a number of important observations and recommendations about how the quality of life experienced can be sustained as the mining boom ebbs. Here are the main findings:

Australia’s material living standards and well-being compare well internationally, reflecting a well-managed and successful economy. The economy is slowing as the prolonged mining boom recedes. Output growth of about 3% is expected for 2014 and 2.5% in 2015. Macroeconomic policies are appropriate for the current conjuncture while long term prosperity depends on ensuring that structural settings help all forms of economic activity and promote broad-based productivity growth.

Ensuring price and financial stability. Inflationary pressure is contained. Low interest rates are supporting activity and the rebalancing of growth. House prices have grown by about 10% over the past year, prompting construction activity but also attracting some speculative demand. Strong prudential regulation and a concentrated financial sector have supported financial stability, but the latter has also created concerns about competition and credit supply in some segments.

Pursuing fiscal consolidation and ensuring efficient tax and public spending. Gross public debt has risen from below 20% of GDP to over 30% since the global financial crisis. The budget faces significant volatility from movements in global prices for natural resources, and past spending commitments have created a medium-term structural fiscal challenge. Australia’s heavy reliance on inbound investment and exposure to resource market fluctuations provide strong arguments for fiscal discipline and low public indebtedness. The country has a comparatively light tax burden overall, but the heavy reliance on direct taxation is not ideal. Public-spending efficiency in some services is adversely affected by overlapping responsibilities and complex funding arrangements between federal and state governments.

Improving framework conditions for business. Improvements in productivity growth will require reforms across a wide range of structural policy areas including taxation, competition and deregulation. Government plans to ramp up infrastructure investment make sense, but only if funds are spent efficiently. Targeted business support needs to be judicious as it can be a short step from value-for-money subsidy to outlays on corporate welfare.

Encouraging employment, deepening skill, and addressing inequality. The importance of raising participation, combined with budgetary concerns, means effective welfare-to-work policies remain a priority. The government plans to incentivise unemployed youth, including lengthening the benefit waiting period. A proposed liberalisation of higher education tuition fees and reforms to student support aim to improve competition, access and choice. It will be important to monitor the impact of these reforms, particularly for students from disadvantaged backgrounds.

Tackling environmental challenges. The government is fundamentally changing Australia’s environmental policy, replacing a carbon tax with a suite of planned new measures, including a mechanism to provide incentives to businesses for reducing emissions. Ramping up road building provides opportunities to extend road pricing. Ensuring efficient supply chains for water is important.

Key recommendations

Ensuring price and financial stability
● Continue intensive monitoring of the housing market; maintain deep micro-prudential oversight and consider using macro-prudential tools to bolster credit safeguards and signal concern.
● Examine credit and competition issues in the financial sector; consider reducing banks’ implicit guarantees, tackling risk-weighting advantages in mortgage lending, improving credit databases.

Pursuing fiscal consolidation and ensuring efficient tax and public spending
● Prioritise medium-term fiscal consolidation to rebuild fiscal buffers in light of Australia’s exposure to external risk and consider establishing a stabilisation fund.
● Rebalance the tax mix; shift away from income and transaction taxes, make greater use of efficient tax bases such as the Goods and Services Tax and land tax.
● Reform federal-state financial relations; reduce grant conditionality further, instigate state-level tax reforms to enhance funding autonomy, and increase state-level responsibilities and accountabilities.
● Address federal-state shared responsibilities to improve efficiency; improve co-ordination and co-operation and in some cases, health care in particular, consider a reallocation of responsibilities.
● Strengthen capacity for assessing and comparing state-level public services; further develop performance indicators; and continue enhancing the availability and quality of data.

Improving framework conditions for business
● Ensure infrastructure delivers value for money through robust and transparent cost benefit analysis both to ensure economic use of the existing stock and appropriate selection of new infrastructure projects.
● Concentrate on broad support for business; prioritise corporate-tax rate cuts, reduce regulatory burdens and continue to be tough on corporate welfare and tax avoidance.
● Strengthen competition; continue adjusting network-industry regulation and improve the competitive environment more generally in light of the review currently underway.

Encouraging employment, deepening skills and addressing inequality
● Monitor the proposed welfare reforms to ensure they raise work-force participation cost effectively without adverse social outcomes. Better target superannuation (pension) tax concessions.
● Monitor the proposed higher education reforms to ensure that choice and quality is enhanced and access is not compromised.

Tackling environmental challenges
● Achieve greenhouse-gas emission targets; ensure the proposed Emission Reduction Fund is efficient through: i) robust measurement and verification methods; and ii) implementation of a safeguard mechanism that prevents offsetting emissions elsewhere in the economy.
● Make transport policy greener; enact the proposal to index excise duty on retail fuel, expand other use-based vehicle charges and extend public transport.
● Continue strong commitment to water reform including the Murray-Darling Plan.