Category: Banking Culture

RBNZ Consults On Cash – And Blows A Hole In The Australian War On Cash!

There is an interesting paper the Reserve Bank NZ has put out, seeking comments by 31 August. The Future of Cash Use. It was issued in June 2019.

The paper describes the transition to digital alternatives, and explains some of the reasons. But what caught my eye was this section. “All members of society will lose the freedom and autonomy that cash provides, be more exposed to cyber threats, and lose the ability to use cash as a back-up form of payment”. And “other activity in the shadow economy is unlikely to be affected by the disappearance of cash as people find other ways to circumvent the law”.

So two points, New Zealand followers you might want to read the paper, and make a submission – not been much publicity so far.

Those following the DFA campaign relating to the War on Cash in Australia, here is more evidence that the proposal to ban cash transactions above $10,000 will not achieve their stated aims – but of course there is a wider monetary policy objective, as we have discussed.

6 Considerations arising from having less cash in society

Given the trends in cash demand and the cost pressures on the commercial supply of cash in New Zealand, it is possible that cash will become less widely available or used in the medium to long term. The effects of less cash in society would be felt more keenly by certain groups of people who rely on cash and for whom no practicable substitute exists. The severity of these impacts would be worsened if the transition to a society with less cash acceptance occured before mitigating measures could be put in place. Further, the size of the affected groups might not be large enough to motivate cash providers to ensure future cash availability, but the size might also not be negligible.

This section summarises the information in table 1 and Appendix A and the issues that should be considered if cash use and availability decline.

Issue 1: People who are financially or digitally excluded could be severely negatively affected.

Cash provides access to the financial system for those who face barriers to financial inclusion. Further, in a society with less cash, barriers to digital inclusion could become barriers to financial inclusion.

  1. Barriers to financial inclusion include limited access to the banking system due to either a lack of trust in online security, skill or motivation to use online financial platforms, or banking restrictions. People who are not banked or have limitations to accessing the banking system tend to be people without identification and proof of address, people with convictions, people with poor credit histories, people with disabilities, illegal immigrants and children.Elderly people typically rely more than others on cash as a form of payment.
    This could be due to low trust in online payments, low ability or low motivation to learn new payment techniques. People with physical disabilities, such as sight or intellectual impairments, might also find cash a useful form of money. Children are also subject to financial exclusion as banks do not issue debit cards to children under the age of 13. Further, New Zealand banks have full discretion in the customers they service. This means that some people who do not meet certain bank policies cannot obtain or keep accounts with those banks. Appendix A describes additional groups that rely on cash rather than digital money.
  2. Barriers to digital inclusion include insufficient internet coverage, affordability constraints for technology hardware or data plans, lack of skills, lack of confidence and low motivation to use digital platforms. For example, even if people have access to the internet they might not be motivated to upload personal details to an online bank account due to privacy concerns.

Issue 2: Tourists, people in some Pacific islands and people who use cash for cultural customs might be negatively affected if they cannot use substitutes.

Tourists

Currently most tourists use cash as a reliable and easy-to-use form of payment. Reserve Bank research has revealed that cash is typically issued to Auckland and overseas and sent back to the Reserve Bank from the South Island. This movement is likely due to the movement of tourists. Many retailers in New Zealand do not accept credit cards (or contactless payments) due to their higher interchange fees, preferring instead to accept debit and EFTPOS cards (which require a New Zealand bank account) that incur much lower costs for the retailers.We are not aware of the extent to which inbound tourists’ own financial services’ fees or portability, or their prior understanding of transacting in New Zealand, influence this behaviour.

As per Appendix A, tourist access to payments in New Zealand could be met by overseas-issued debit cards if cash were not available. Further, competition might cause some retailers to accept tourist credit cards despite higher interchange fees if cash was not available. Bounie et al (2015) show that higher competitive pressures (the threat of losing sales) increase the probability that a retailer will accept credit card payments despite the higher costs.

Even if electronic payment alternatives were reliable, tourists might be disadvantaged due to language and cultural barriers that create actual and perceived barriers to payments in New Zealand. Further, tourists might be particularly vulnerable to risks of robbery or loss of payment cards if they could not rely on cash as a back-up payment.

Pacific Islands

Niue, the Cook Islands and Tokelau rely on New Zealand banknotes and coins for their physical currency. The size of these island economies has been thought to be a contributing factor to their use of New Zealand currency. In addition, these islands are formally defined as states in free association within the Realm of New Zealand. New Zealand banknotes are also used in the Pitcairn Islands.

The Reserve Bank does not have a formal arrangement to supply these economies with banknotes and coins. The supply of banknotes and coins to these islands is facilitated by commercial providers, tourists, and transfers from families. There are no ATMs on Niue and Tokelau. The Cook Islands has two ATM providers and also issues its own banknotes and coins. These islands also have access to digital money as in New Zealand.

Cultural customs

New Zealand’s banknotes have been referred to as the country’s business card. The designs on the notes represent many of our cultural icons and contribute to our national cultural identity. Cash is also used in many cultural customs in New Zealand. Some cultures that use cash as gifts in traditional ceremonies might find that part of their cultural identity is lost if they can no longer access cash easily. For instance:

  1. A Chinese custom is to give cash to junior family members and friends during celebrations including New Year (Hoong Bouw — giving money in red envelopes), at funerals, and during tea ceremonies in traditional Chinese culture.
  2. Some cultures have a wedding money dance where cash is gifted to the bride and groom as they dance (the Philippines’ Saya ng Pera, and the Taualuga in Samoa, Tonga and Western Polynesia).
  3. Western cultures give coins to children who lose their baby teeth (Tooth Fairy).

Issue 3: All members of society will lose the freedom and autonomy that cash provides, be more exposed to cyber threats, and lose the ability to use cash as a back-up form of payment.

If cash use and availibility were to decline, an issue for all members of society could be the loss of freedom that cash provides in terms of autonomous spending and wealth stores, privacy, ability to live off the grid, and ability to avoid the banking system. This could result in a significant loss of social freedom in aggregate and increased cyber security risks (leading to an increase in national security risks). Lastly, society would lose the benefit of cash as a ‘back-up’ form of payment, although the usefulness of cash in this role is limited.

Reduced freedom

Cash is anonymous, so provides consumers with autonomy or discretion in how they choose to spend their money or store their wealth. The feature of full anonymity creates personal and societal freedom and has not been replicated in digital currencies. There are three elements in this freedom; the first relates to the desire for privacy in making transactions, the second relates to the desire to avoid banks or government regulation, and the third relates to exposure to cyber-crime.

First, cash payments and balances cannot easily be traced. Central agents and third parties (such as banks and governments) cannot easily intervene or stop cash payments outside the banking system. This is a unique feature of cash and is not fully replicated by any other form of money. This anonymity gives people full control of and discretion with their finances. Independent bank accounts could provide personal freedoms but they are not always available or sufficient. For example, individuals who are in abusive and controlling circumstances might benefit from cash as it is easier to obtain and hide when other personal freedoms are restricted.35 Additionally, people might feel that they benefit from the choice of using an anonymous form of payment if it were ever needed.

However, the difficulty in tracing cash makes it relatively more vulnerable to theft, accidental losses and fraudulent payments (inadvertently accepting counterfeit notes). For this reason, some argue that people would be better off with a partially anonymous form of payment, where only the minimum information is given regarding the identity of the payer and payee in each transaction, but each transaction is recorded. These payments include, for example, vouchers, and prepaid gift (debit or scheme) cards.36

Second, the offline and anonymous features of cash enable people to separate their transactions and stores of wealth from the banking system and some government interventions. There are legitimate motivations for this separation.

  1. There is currently no guarantee of the safety of bank deposits in New Zealand.37 Banks take household and business deposits and lend them to borrowers — there is a risk that borrowers might not be able to service their debts. Households and businesses could lose their deposits if banks were engaging in overly-risky lending or if a severe series of events occurred and many loans were not repaid.
  2. People might also want to remove their savings from the banking system if the Reserve Bank charged negative interest rates to stimulate the economy. Cash provides an avenue for people to avoid this form of government intervention or any other government intervention that might occur in the future, such as capital controls.
  3. Relatedly, people might want to store wealth outside the banking system if they have low fundamental trust in banks or the government. Examples are individuals who have immigrated to New Zealand from countries where trust in the financial system is low, or where government appropriations of assets were not uncommon. If there were less cash in society, individuals would lose their privacy and autonomy from government in the sense that all their transactions and savings would be fully traceable if permitted by law.

Third, storing and transacting in cash reduces exposure to cybercrime, such as financial losses and identity fraud. On a societal level, New Zealand might be more exposed to cybercrime such as state-funded cyber threats if it were totally reliant on the banking system and digital money for all transactions and savings. On a personal level, some people might prefer to keep their identities and finances offline due to cyber concerns.

The loss of freedom in society in the above three areas could result in demand for a form of digital currency issued by the central bank that replicates some of the autonomy of cash. There are other assets in which people could store their wealth that are offline and removed from the financial system, for example, commodity assets and property. However, these are more difficult to transform into spendable money and can come with a different set of risks including fluctuating values.

Therefore, people might demand a central bank digital currency that provides lower traceability than current electronic payments and accounts and presents an alternative to the banking system. This could be in the form of accounts with the central bank or tokens issued by the central bank, which carry a very low risk of default and sit outside the commercial banking system. A central bank digital currency could also be designed to provide a low cost form of payment to put downward pressure on uncompetitive prices in the payment system. Alternatively, consumers might ask for deposit protection and greater regulation of the banking system.38

People might also value the freedom and autonomy of cash for illegitimate reasons. As noted in section 2, cash is used in the shadow economy to facilitate illegal transactions or as a means to hide income and reduce tax and other obligations. The International Monetary Fund estimated New Zealand’s shadow economy at 11.7 percent of GDP in 1991 -2015. 39 It is difficult to assert what might occur in the shadow economy if we had less cash. At the margin, some shadow economy activities could be reduced as people consider the additional difficulty of engaging in them without anonymous payments. For example, some people might be dissuaded from buying illegal goods and services if they could not avoid leaving electronic records of their purchases. However, it is also possible that criminal activity would innovate to other mechanisms or forms of payment discussed below.

There is debate on whether the anonymity of cash enables crime or whether illegal transactions would continue without cash. Rogoff (2016) and McAndrews (2017) agree that, without cash, criminals could use commodity money (i.e. gold), foreign currency, and inflated invoices. But they disagree on the extent to which these substitutes would be used. Rogoff (2016) argues that there is no complete substitute for cash, so criminal activity would be hindered if there were less cash in society. McAndrews (2017) argues that inflated invoices would become the most likely medium of exchange for criminals. He suggests that a society without cash would likely move towards deeper institutional corruption of businesses as criminals launder money obtained from illegal transactions. He also warns that innocent businesses could find themselves forced into money laundering as criminals look for businesses to issue inflated invoices.

Issue 4 considers how some tax evasion might be reduced by less cash.

Loss of emergency back up

Cash can be a back-up payment mechanism when electronic payment systems are not in operation or otherwise unavailable. The Reserve Bank survey on cash use indicated that 37 percent of people held cash just in case it was needed (i.e. not for immediate transactions). Cash is particularly useful in case of ‘personal emergencies’, or localised or short disruptions in electronic payments systems, and after large-scale events conditional on the availability of retail stores able to accept it. Figure 2 shows a spike in CIC as a percent of GDP in 1999 that could be attributed to the ‘Y2K’ uncertainty.

Cash has several limitations in its usefulness as a back-up payment in case of large-scale events or natural disasters. Because the supply of cash and most retail operations are reliant on electricity and communications, IOUs between small groups or people who are known to each other might be more effective in periods of long electricity outages such as those that occur in natural disasters. There might also not be sufficient cash infrastructure capacity to meet a national transition to cash in an emergency.

In addition, the National Risk Unit does not recommend including cash in a civil defence kit or give guidance on the best means of payment in a national disaster response period. This could be because people already have their essentials in their civil defence kits, retail stores might not be operating, and emergency responders will provide additional supplies. In the weeks following the Christchurch February 2011 earthquake, public demand for cash did not increase substantially. Commercial banks anticipated an increase in demand for cash and increased their stores of cash and set up temporary ATMs based on generators. However, the bulk of these cash stores returned to the Reserve Bank relatively quickly. Figure 2 shows CIC did not peak as a share of the population during 2011.

Issue 4: On balance, there would be limited effects on budgeting, financial stability and government revenue.

Transitioning to a society with less cash does not significantly or negatively affect household budgeting, financial stability and government revenue.

Budgeting

Cash is widely cited as a budgeting tool. Psychological studies show that paying in cash incites a higher psychological pain of parting with funds. This is because the tangible nature of cash results in high transparency of payments and so generates a greater awareness of spending.40 This greater ‘pain of paying’ encourages less spending and is useful for managing discretionary spending, but it could reduce willingness to pay bills or debt. Shah et al. (2016) suggest that consumers should automate their essential payments and savings using online banking then spend disposable (leftover) income using cash. Cash might also be useful for limiting spending when people need to keep money separate for other purposes.

People who prefer to use cash for budgeting might benefit from new electronic budgeting tools such as budgeting applications on mobile phones. For example, several banks in Dubai provide real time balance updates or notifications every time money is spent, replicating the relatively high ‘pain of paying’ that cash provides.

Cash is not the only nor the most important budgeting tool available for people with low or no disposable incomes, high debts, overspending habits, or poor mental health. For these groups, commonly cited budgeting tools include awareness and education, direct credits, multiple bank accounts, and removing overdrafts and credit. Cash is used for people who are in full financial management in a Total Money Management programme as they are allocated their weekly spending in cash.41

However, the anonymity of cash makes it difficult for budgeting advisors to identify areas of overspending. Cash also enables people to default on automatic payments (for bills or debts) as they can withdraw their full bank account balances into cash. Further, withdrawing money into cash puts people at a higher risk of robberies than if they did not withdraw their money. For example, people who withdraw their income payments from ATMs at night to avoid automatic payments (processed in the morning) face a risk of robbery, particularly if these habits are well known in the community.

Financial stability

A society with less cash does not pose a risk to financial stability. Cash represents a claim on the government and carries low default risk. In theory, the ability of depositors to convert their savings into cash represents a form of market discipline on banks that encourages them to operate prudently. However, there is little empirical evidence to support this. Engert et al. (2018) evaluate the bank runs during the 2007 – 2008 Global Financial Crisis and determine that cash withdrawals are a small and unimportant source of market discipline on banks. Shin (2009) finds that the Northern Rock bank run was triggered predominantly by wholesale runs, and the in-branch runs to cash were insignificant.

Market discipline is only one form of discipline safeguarding our financial system. Another form is regulatory discipline. The Reserve Bank is mandated to use prudential regulation and supervision to contribute to a stable financial system. The third form is self-discipline, whereby financial market institutions self-regulate to ensure their ongoing prudent operation.

The second aspect of stability is payment stability. Migrating from two payment systems to one payment system would consolidate operational risk in the single payment system. Greater emphasis would be required on ensuring the operational reliability of the single payment system if people could not easily revert to cash if there were a system outage. Most electronic payments (except cryptocurrencies) rely on the same back-end payment systems which, exhibit several single points of failure.42

Increased tax revenue and reduced seignorage

Government revenue could be affected in two ways if cash use and availability declined. First, removing the availability of notes and coins might increase tax revenue as businesses would no longer use cash to reduce their tax bills. The Inland Revenue Department has reported that the most common ‘hidden economy’ activity is the underreporting of taxable income, which includes income from cash jobs and transactions.43

Exactly how much tax revenue is lost due to this type of activity is unknown. A tax working group paper suggests that unincorporated self-employed individuals under-report approximately 20 percent of their gross income. This estimate is based on a study commissioned by Inland Revenue44 and could represent $850 million per annum in lost tax revenue from unincorporated (non-trust or non-corporation) taxpayers. There is considerable uncertainty as to the extent to which this number includes self-employed people who are evading tax by underreporting cash revenue versus other types of underreporting. It is also not certain that those reducing their tax burdens by underreporting cash revenue would increase their tax payments if cash were used less.45

Second, seignorage revenue might decline if the value of CIC declined significantly. Seignorage revenue is the profit the Reserve Bank makes from producing and selling cash and investing the profits, as well as any profit the Reserve Bank makes from financial market trading. 46 The Reserve Bank estimates that it made around $148 million in seignorage revenue last financial year by issuing cash and investing the profits.

Other activity in the shadow economy is unlikely to be affected by the disappearance of cash as people find other ways to circumvent the law, as described in Appendix A. People who can no longer launder cash will likely switch to other methods.

Banking Royal Commission Implementation Plan Revealed

The Treasurer has now (finally) released the proposed timetable for implementation of the recommendations from the Royal Commission made back in February.

It is entitled “Restoring Trust In Australia’s Financial System”, but of course the big question is, will these measures once implemented really get to the heart of the issue – we doubt it.

This is because the final Commission report ducked the critical conflict of interest issue between selling financial services products and delivering them.

There is first the issue of unequal power between a consumer and a financial services organisation.

We know from the Commission that financial services players consistently sought to maximise their returns, even when the best interests of consumers are businesses are voided.

And we know that the general level of financial knowledge and expertise in the community is very low – indeed many do not understand, for example the concept of compound interest, the impact of fees on returns, and even what annual percentage benchmarks really mean.

So, my view is that the RC implementation will not be necessary and sufficient to restore trust in the financial system, even if the large players chose to address their cultural deficits in relation to doing right by their customers. And industry bodies are still fighting rear guard actions to avoid significant change.

Which then takes us back to the weak and compromised regulatory system we have, where APRA and ASIC appear to land more on the side the financial system rather than consumers. So, out of all this, who is minding the back of households and businesses?

In other words Frydenberg’s introduction to this small (14 page) document has a hollow ring to it – or as bankers use to write on bad cheques “words and figures differ!”:

On 4 February 2019, I released Restoring trust in Australia’s financial system, the Morrison Government’s comprehensive response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. In it, the Government committed to take action on all 76 of the Royal Commission’s recommendations and, in a number of important areas, go further. It represents the largest and most comprehensive corporate and financial services law reform package since the 1990s.
Of the Royal Commission’s 76 recommendations, 54 were directed to the Government, 12 to the regulators and 10 to the industry. Of the 54 recommendations directed to the Government, over 40 require legislation.

In addition to the Commission’s 76 recommendations, the Government in its response announced a further 18 commitments to address issues raised in the Final Report.

The Government has implemented 15 of the commitments it outlined in response to the Royal Commission’s Final Report. This comprises eight out of the 54 recommendations that were directed to the Government and seven of the 18 additional commitments the Government made as part of its response. Significant progress has also been made on a further five recommendations with draft legislation either introduced to the Parliament, released for comment or detailed consultation papers issued.

The Government’s implementation timetable is ambitious. Excluding the reviews that are to be conducted in 2022, under the Implementation Roadmap by mid-2020, close to 90 per cent of our commitments will have been implemented. By the end of 2020 remaining Royal Commission recommendations requiring legislation will have been introduced.

In this Implementation Roadmap, we set out how we will deliver on the remaining Royal Commission recommendations and additional actions committed to. This will provide clarity and certainty to consumers, industry and regulators on the roll out of the reforms.
Of course, the Government’s actions alone will not be sufficient to address the widespread misconduct identified by the Royal Commission. Individual firms must make the changes needed to their culture and remuneration practices to put consumers at the core of their business. I expect industry to also align with the urgency and priority the Government is giving to its implementation task.

The Government will ensure that key firms in the financial sector continue to address the issues identified by the Royal Commission.

At the request of Government, the House of Representatives Standing Committee on Economics will inquire into progress made by major financial institutions, including the four major banks, and leading financial services associations in implementing the recommendations of the Royal Commission. As previously announced, we will also establish an independent review in three years’ time to assess the extent to which changes in industry practices have led to improved consumer outcomes.

The Government is delivering lasting change in the financial sector to ensure public confidence is restored.

Finally, the Australian Banking Association came out with this:

Australia’s banks have welcomed the Government’s timetable for legislative change following the Hayne Royal Commission and will work with the Commonwealth to continue implementing the Commission’s recommendations.

While the forward agenda for the required legislative changes was announced this morning, banks are well down the track of implementing recommendations for which they are responsible to improve customer outcomes and earn back the trust of the Australian community.

Of the Commission’s 76 recommendations, 54 were directed to Government and more than 40 of those recommendations require legislative change. 12 are to be taken forward by the regulators, 10 are for industry to implement – eight of these are specific to the banking industry.

ABA CEO, Anna Bligh said: “Since the Final Report was handed down six months ago, banks have been working to make changes to ensure that the recommendations become part of their operating fabric.

“Make no mistake, banks understand what the community and Government expects of them and are raising their standards to rightly meet those expectations.

“The recommendations included six changes to the Banking Code. All six are underway.  The ABA has already drafted provisions implementing five of the changes, had them agreed to by banks and submitted them to the regulators for approval. These are now on track for full implementation by March 2020,” Ms Bligh said.

The sixth change relates to the definition of small business. Consistent with the Commission’s recommendation, the definition was recently changed in the new Banking Code to include businesses with fewer than 100 employees and this measure is now fully operational. The further recommendation to change the financial threshold from $3M to $5M will be subject to a review that will be overseen by ASIC who will examine the potential impacts on the provision of credit to small business. The review is underway and expected to be completed in early 2021.  

“In relation to culture within banks, many, including the major banks, have already completed reviews. These banks have also introduced mechanisms for the ongoing tracking of culture to determine whether actions are having the necessary impact. But banks understand that effective cultural change is not going to come about through implementing the Royal Commission recommendations alone. It will only be achieved by putting the customer at the heart of every decision our banks make.

“In addition, all banks continue to review how they remunerate staff, with a focus on good customer outcomes, not just meeting financial targets,” Ms Bligh said. 

Following the release of the Final Report, the ABA established a dedicated Royal Commission Taskforce to oversee the industry’s implementation of the recommendations. This Taskforce has met six times over the past six months and will continue to meet regularly to ensure the industry responds swiftly to the Government’s legislative processes and acts to fully implement the recommendations

Fake and Ineffective Regulation

From the excellent Wilson Sy, reproduced with permission.

Recently, on 13 August, the Federal Court rejected the case of Australian Securities and Investments Commission (ASIC) against Westpac for irresponsible mortgage lending and ordered the regulator to pay the bank’s costs.  Such failures at enforcing regulation have occurred numerous times in the past and have cost taxpayers many millions, for little benefit. 

The paper “The farce of fake regulation: royal commission exposed Australia” explains how enforcement failures have led to fake regulation in Australia. In relation to ASIC, the paper noted:

The new commissioner Sean Hughes declared that the mantra at ASIC going forward will be “Why not litigate?” He appears to have a short memory because he should know well from his past experience working at ASIC how costly, unsuccessful and unpopular litigation has been for the regulator. What is the point of more litigation recommended by HRC, if it only ends in failures?

The Hayne Royal Commission (HRC) discovered the lack of enforcement of regulation for past decades, but did not go far enough to discover why.  The reason is: due to the underlying neoliberalist assumption of market efficiency, Australian financial regulation was not designed to protect consumers.  Indeed, it is caveat emptor as noted by Wayne Byres, the chair of the Australian Prudential Regulation Authority (APRA).

In the ASIC vs Westpac case, the judge probably did not understand why a lender such as Westpac would knowingly make bad housing loans risking losses to the bank itself.  So the litigation hinged around the interpretation of responsible lending as to whether there is legal flexibility on the part of the lender to assess mortgage serviceability by using the benchmark Household Expenditure Measure (HEM) rather actual expenditures of individual borrowers.  

Clearly, complex rules by regulators on how a business should be run can usually be refuted by actual evidence and experience.  That is, ASIC does not have enough business knowledge or access to hard data to prove conclusively that the HEM criterion is the main cause of irresponsible lending.  Therefore, unproven causality was inadequate to compel a conviction.

There are so many other aspects of mortgage serviceability to which one could attribute irresponsible lending that it is difficult to see how picking one single aspect will lead to successful prosecution by the regulator.  Probably, by taking on Westpac, ASIC was merely showing that it was following the HRC recommendation for more enforcement.  Without understanding the real problem, HRC has been ineffective in reforming the financial system, as nothing much will change.   

The real reason for why the banks lend irresponsibly is not incompetence, but conflict of interest, because the bad loans they create can be packaged and on-sold to unwary investors as mortgage-backed securities.  Those mortgage-backed securities can be used for speculation with credit default swaps (CDS) and they can be sliced and diced to create other derivative securities such as collateralized debt obligations (CDO).

Hence irresponsible lenders can avoid adverse consequences to themselves by securitizing their loans.  One proven way of removing the perverse incentive to lend irresponsibly is to remove banks’ ability to securitize their mortgages by separating commercial lending from securitization under the prohibition which was the US Glass-Steagall Act.  When banks are broken up so that they are no longer “too big to fail”, they can be allowed to suffer the natural consequences of bad loans without being rescued with “bail-out” or “bail-in” and without protection from bank-runs by banning cash.

Major banks to participate in credit reporting system

In 2017 then Treasurer Scott Morrison announced a bill that would require the big four banks to participate fully in the mandatory comprehensive credit reporting regime.  Via The Adviser.

The legislation passed the House of Representatives but had not passed the Senate prior to the dissolution of parliament due to the election. 

The revised bill has introduced a new category of information within credit reporting, enabling hardship information to be reporting alongside repayment history information. 

Attorney-General Christian Porter also introduced new hardship arrangements to allow consumers to reveal hardship arrangements to other credit providers. 

“Proposed changes to the Privacy Act will make sensible changes to allow for transparent and responsible lending practices where people are subject to hardship arrangements,” Mr Porter said.

“The amendments will benefit consumers by making sure credit products are suitable, and ensuring consumers are encouraged to seek hardship arrangements if they are struggling to meet repayments under their credit contract.” 

The draft legislation has just been released for public consultation which will introduce these changes. 

“These changes balance the needs of both credit providers and consumers. They are intended to give credit providers relevant information about consumers who are in financial hardship, or have recently experienced hardship, in order to facilitate better and informed lending decisions,” said Mr Porter. 

The consultation period is open until September with interested parties welcome to comment on the draft legislation.

ASIC’s Responsible Lending First Round Hearings Concluded

The big four bank has told ASIC to consider the utility of the broker channel before proposing bespoke responsible lending obligations, adding that it has not identified a notable difference in the quality of loans originated by the channel.  Via The Adviser.

In February, the Australian Securities and Investments Commission (ASIC) launched a review to update its responsible lending guidance (RG 209), which has been in place since 2010.

ASIC opened consultation by inviting submissions from stakeholders within the financial services sector and has since commenced a second round of consultation in the form of public hearings, in which stakeholders that provided submissions have been called to provide further guidance.  

Appearing before ASIC during its first round of public hearings, Westpac’s general manager of home ownership, Will Ranken, was asked to provide an assessment of the quality of mortgages originated through the broker channel.

Mr Ranken noted that the bank’s verification requirements for loans originated via the proprietary channel are the same for those originated by brokers but acknowledged that broker-originated loans require an “extra layer of oversight and governance”.

“When a customer chooses to go to a broker, we’re one step removed, so there’s another layer of oversight and governance on the broker channel,” he said.

However, the Westpac representative stated that the bank has not observed substantive differences in the quality and characteristics of home loans originated by the third-party channel.

“If you look at performance, particularly the metric around 90-day delinquencies, they’re largely the same with our proprietary channel – there’s no meaningful difference between those channels,” Mr Ranken said.

“In terms of the tenure of loans, I think on average it’s measured in months rather than quarters. In terms of the difference [in the average tenure of the loans], it’s one or two [months].

“In terms of the size of a loan, if you look at averages, and averages can be a bit misleading, the average size of a loan through the broker channel is a little bit larger. That’s probably more for smaller loan sizes, customers are happier to deal with a branch, but for larger complex lending requirements, there’s a greater propensity for customers to go to a broker.”

Mr Ranken was then asked if Westpac would support a move by ASIC to prescribe different responsible lending obligations depending on how a loan is originated.

In response, Mr Ranken warned that ASIC should consider the effect of such changes on the value proposition of the broker channel.

“I would say on providing additional guidance on one particular channel over another, it would be important to take into account the very valuable contribution that brokers do make to the overall market,” he said.

“Specifically, I talk to the level of competition that they facilitate in the market, either through providing independence and access to a multitude of lenders, as well as the service they give to customers in terms of assisting them with complex needs. 

“To the extent that guidance may require additional steps either on the lender or the broker themselves, we just want to balance that with ensuring that it maintains a viable and dynamic broker channel.”

When pressed on the question, Mr Ranken added: “We’re comfortable with the policies and procedures that we’ve got in place around the broker channel, so it’s hard to comment on guidance… The devil’s in the detail. It really depends on what the detail of the guidance would be.”

Other stakeholders, however, including consumer group CHOICE, have called on ASIC to enshrine specific broker obligations in its RG 209 guidance.

CHOICE pointed to research from ASIC’s review of interest-only home loans in 2016, which reported that mortgage broking record-keeping from verification enquiries was “inconsistent” and, in some cases, “fragmented and incomplete”.

Despite recent reforms from the Combined Industry Forum, which restricted the payment of commission to the loan amount drawn down by a borrower, the consumer group alleged that the supposed lack of record-keeping was “particularly harmful for consumers” because “brokers are currently incentivised to sell loans that will provide them with the largest commission”.

ASIC’s first round of public hearings concluded, with the second round of hearings to commence in Melbourne on Monday, 19 August.

The regulator is expected to publish its new guidance before the end of the calendar year.

What The HEM Decision Means

The key question now is will the banks revert to their previous practices of doing little to validate household spending patterns as part of the mortgage assessment processes. Some are already saying “buy now” with renewed vigour.

The Royal Commission revealed last year that some lenders ignored household expense data favouring the automated HEM decisioning. But on the basis of the finding, they are now in the clear.

Banks of course need mortgage lending to grow to enable their profits to rise, and in recent times that has been a problem. New lending momentum has been pretty slow.

HEM standards were tightened in July, meaning that the minimum spending benchmarks were lifted especially for households on higher incomes. Some banks have been asking for painful detail and history in lieu of using HEM, and this has slowed lending decisions but around half of loans are still approved by HEM.

We also need to link this with the APRA loosening of the interest rate hurdle which gives lenders flexibility on their decisioning (within limits).

ASIC is currently taking evidence from the industry on potential changes to responsible lending, and has said we should expect some revisions by years end. Plus they have previously stated that even if they lost the Westpac case, they would still insist that while HEM is a useful too it is not necessary and sufficient to meet their requirements.

The trouble is the original ASIC guidelines were vague, and the “non-unsuitable” formulation left significant ambiguity. This needs to be changed.

The way through this is to use debt to income ratios, something which has been in place in the UK and NZ for some time, as we know the risks of loss are greater when the Debt To Income ratios are higher.

But then the question will become, how prescriptive should the regulators be, and of course in the current weakening economic environment there will be an attempt to push lending harder.

So, my expectation is there will be some loosening of underwriting standards (which is bad) while the Banks can assume class actions relating to responsible lending will be unlikely to proceed.

I expect households will be required to certify the accuracy of their expenses, but that banks once they have that protection will be will to lending within the HEM framework.

So the bottom line is, yes, I expect more credit will be offered, the question is will households lap it up – leading to rises in prices (as credit growth and home price growth are linked), or will the weak wages growth, high costs of living and home price momentum (or lack of it) reduce demand.

The finance and real estate sector will be spinning hard to try and entice people into the market. Just remember we have the biggest debt bomb ticking away.

But the banks are also on notice now.

Amidst the court proceedings with ASIC, Westpac updated its group credit policies “to enhance the way [it] captures customer living expenses, commitments, and verify documentation.”

A Westpac spokesperson said, “We recognise sometimes it can be difficult for customers to provide a complete picture of their expenses and the enhancement of our expense categories means our staff and brokers have the opportunity to prompt customers to remind them about particular expenses they may have forgotten.”

AMP Announced $2.3 billion Loss And $650 million Capital Raising

In the first half of 2019 AMP posted a $2.3 billion shareholder loss due to a non-cash impairment to write down goodwill in Australian wealth management and legacy issues.  Via InvestorDaily.

The wealth giant has announced a $650 million fully underwritten capital raising which will enable it to set out on its new three-year transformational business plan. 

The shareholder loss is a far cry from last year when the group posted a shareholder profit of $115 million but the wealth giant was still able to announce an underlying profit of the half year of $309 million.

However this profit was also a decline in the first half of 2018 where the underlying profit was $495 despite royal commission and client remediation costs and was short of initial forecasts of a $390 million underlying profit. 

The capital raising, together with the sale of AMP Life to Resolution Life for $3.0 billion, will form the financial backing for the ambitious program announced by chief executive Francesco De Ferrari. 

“The strategy we’re launching today repositions AMP for the future, there’s a strong need for what we offer across all of our spectrum. And we have the business model to capitalise on the significant industry disruption that’s occurring,” he said. 

The strategy includes plans to reinvent its wealth management business to “help clients realise their ambitions” and will shift focus to direct-to-client channels and digital solutions. 

The strategy will also integrate AMP Bank solutions with wealth management, grow AMP capital through differentiated capabilities and transform AMP culture to be client-led with effective management of financial and non-financial risk. 

It is estimated that this program will cost between $1.0 billion and $1.3 billion said Mr De Ferrari with an element of that to be delivered by cost savings. 

“To deliver the strategy, we are investing between one at $1.3 billion during the next three years, and of this investment, approximately a third will be spent on growth…a third of this to take cost out of our business. We’re going to spend the last third of this investment toward de-risking the business and addressing legacy issues,” he said. 

According to AMP’s release $350 million to $450 million will be spent on growth, the same amount realising cost improvement, including a delivery of $300 million in cost savings by 2022 and a $350 million to $450 million investment in tackling legacy issues. 

Mr De Ferrari said it was important that the balance sheet remains unquestionably strong and the capital raising would allow AMP to implement its strategy and continue growth. 

“The capital raising and the AMP Life sale will provide the funds to implement immediately our new transformational strategy, which creates a simpler, higher growth and higher return AMP that’s focused on clients and ensures that our balance sheet will be unquestionably strong,” he said. 

AMP also confirmed it was on track to complete its remediation program during 2021 with an initial estimate of $778 million including both aligned and salaried advisers. 

The amount provisioned as part of total estimate has increased by $16 million to $672 million reflection lost earnings and program costs with $60 million spent to date. 

AMP’s chief financial officer designate John Patrick Moorhead has confirmed he is leaving the role with James Georgeson, current deputy CFO being appointed to the role of acting CFO and will commence handover with retiring CFO Gordon Lefevre. 

Mr De Ferrari also saw his remuneration adjusted to $2.45 million to reflect the share price of the group preceding his start date and the face value of his buyout incentive has decreased to $7 million from $10 million. 

The board has also replace the recovery incentive with the new award to have a face value of $4.4 million, down from $6 million.

APRA fines Westpac for failing to meet legal reporting requirements

The Australian Prudential Regulation Authority (APRA) has served infringement notices on Westpac Banking Corporation (Westpac) and two of its subsidiaries for failing to meet their legal obligations to report data to APRA.

Westpac, along with two of its registered financial corporations (RFCs), St George Finance Holdings Limited and Capital Finance Australia Limited, breached the requirements of the Financial Sector (Collection of Data) Act 2001 (FSCODA) by failing to report data by the required deadlines. Westpac was up to 20 days late in filing its reports for the month ending 31 March 2019 under the Economic and Financial Statistics program, which were due on 1 May. The two RFCs missed the same deadline by up to 37 days.

The RFCs were also up to 28 days late in submitting their reports for the month ending 30 April 2019. Additionally, all three Westpac entities were between 9 and 28 days late in filing their reports for the quarter ending 31 March 2019, which were due on 10 May 2019. 

Failure to submit monthly or quarterly returns within the timeframes specified by APRA’s reporting standards is a strict liability offence.

APRA sent show cause notices to the Westpac entities on 22 July seeking their responses to APRA’s intention to serve them with infringement notices over the FSCODA breaches. After assessing Westpac’s responses, APRA has decided to proceed with the issuing of infringement notices.

Under the terms of the infringement notices, APRA requires the Westpac entities to pay a cumulative penalty of $1,501,500. This is the maximum financial penalty APRA can issue for infringement notices under FSCODA.

APRA Deputy Chair John Lonsdale said APRA’s reporting standards were legally binding in the same way as its prudential standards.

“Access to accurate and timely data is critical for APRA to monitor effectively the safety and stability of the banking, insurance and superannuation sectors.”

“By issuing these infringement notices, APRA wants to send a strong message to industry that compliance with our reporting standards is mandatory, and cannot be considered secondary to other business priorities,” Mr Lonsdale said.

The Westpac entities have until 6 September to pay the fines imposed by the infringement notices

The Real Issues Behind The Cash Ban

I discuss the draft legislation which was released last Friday, after hours, by Treasury, and consider the implications, with Robbie Barwick from the CEC.

IOTP show:

CEC Show with Helen Edwards:

Treasury Document:

Email: blackeconomy@treasury.gov.au with the subject line:

Submission: Exposure Draft—Currency (Restrictions on the Use of Cash) Bill 2019

https://cecaust.com.au/stop-bail-in-petition