Category: Economics and Banking

FSB Regional Consultative Group for Asia discusses FSB priorities and financial reforms in the region

Bank Negara Malaysia hosted the tenth meeting of the Financial Stability Board (FSB) Regional Consultative Group (RCG) for Asia in Kuala Lumpur.

At their meeting, members of the FSB RCG for Asia began by reviewing the FSB’s work plan and 2016 policy priorities, namely: promoting full, consistent and timely implementation of the international financial reforms; finalising the design of the remaining post-crisis reforms; and addressing new risks and vulnerabilities. They next considered vulnerabilities in the global financial system, their potential impact on Asia and possible policy responses, and regional financial stability issues.

In terms of new risks and vulnerabilities, members discussed the latest developments in financial technology and implications for financial stability. Related to this, they exchanged views on the latest trends and challenges in cybersecurity, supervisory approaches to enhance information technology risk management at financial institutions and market infrastructures, and the need for cooperation in cyber intelligence sharing, both domestically and cross-border. This discussion drew upon a 19 May workshop that took place in Hong Kong organised by the RCG – and involving both the public and private sector – that focused on financial technology and cybersecurity.

Members next turned their attention to corporate governance and steps being taken by regulators to address weaknesses identified during the financial crisis. Members shared experiences on how a robust governance framework can help the allocation of authority and responsibilities in a firm, in particular to its board and senior management; monitor performance; and ensure employees conduct business in a legal and ethical manner. Members also discussed mechanisms for strengthening individual accountability, including the role and responsibilities of the board, management and control functions.

In December 2015, the Basel Committee on Banking Supervision issued a second consultative document on Revisions to the Standardised Approach for credit risk as part of its broader review of the capital framework to balance simplicity and risk sensitivity, and to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions. Members discussed the revised proposal, including the use of external credit ratings to determine risk weights and the risk weighting methodology for different classes of assets. They also considered how the new proposal will impact banking systems in Asia.

The meeting concluded with a session during which members shared experiences with the implementation of resolution regimes, including requirements for recovery and resolution planning for domestically systemically important financial institutions. As part of the discussion, members explored ways to facilitate cross-border cooperation in the event of resolution actions.

The FSB Regional Consultative Group for Asia is co-chaired by Mr Norman T. L. Chan, Chief Executive, Hong Kong Monetary Authority and Mr Ashraf Mahmood Wathra, Governor, State Bank of Pakistan. Membership includes financial authorities from Australia, Cambodia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka, Thailand and Vietnam.

The FSB has six Regional Consultative Groups, established under the FSB Charter, to bring together financial authorities from FSB member and non-member countries to exchange views on vulnerabilities affecting financial systems and on initiatives to promote financial stability.

The FSB has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. Through its six Regional Consultative Groups, the FSB conducts outreach with and receives input from an additional approximately 65 jurisdictions.

The FSB is chaired by Mark Carney, Governor of the Bank of England. Its Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements.

 

The ‘imperfect’ consumers shut out of basic financial services

From The UK Conversation.

Imagine not being able to go on holiday because you cannot get travel insurance or it costs more than the trip itself because of your health. Or what about being denied free car insurance with your new car or turned down for a mortgage because you’re too old. Then there are a whole host of banking services that aren’t easy to access – from sorting out your current account to managing your pension and savings – if you’re unsure about the internet or cannot afford to go online.

These are common experiences for millions of people across the UK who are denied access to everyday financial services because of disability, disease, age, lack of digital skills or because of where they live, and are the findings of a paper I co-authored, published by the Financial Conduct Authority, the major UK regulator.

In the course of the research, we came across numerous cases. For example, one man in his 30s and working for the armed forces was refused an extension to his mortgage. The reason was that it would take the term past the age of 60, the compulsory retirement age for the Armed Forces, even though he intended to work longer and his state pension would not start until the age of 67.

In another case, Alison was living with terminal cancer and was given two to five years to live though was in relatively good health. When arranging a holiday, she was turned down flat by many travel insurers while others said they would call her back but never did. In the end she went with the only firm that would cover her, paying £1,300 for insurance for a ten-day cruise in Europe.

Computer says no

Our research suggested that problems like these are only likely to grow as more services shift online and use automated processes that are not set up to deal with non-standard, “imperfect” consumers. This doesn’t even include people who live in rural areas with few bank branches and inadequate broadband and mobile reception, or the 17% of over-55s who have no access to the internet at all.

Many of us will have experienced the frustration of online systems that don’t quite fit our real-world circumstances. For “imperfect” consumers, the problem is far worse. Caught in a maze of impersonal processes, with decisions made by computers instead of people, there are those who are denied credit because their data is “thin” after working abroad for a number of years or on becoming newly widowed or divorced, with no financial products in their name.

In addition, as the population ages, more will bump up against blanket age limits and the proportion of people with health conditions is likely to rise.

Financial Conduct Authority

The numbers above for different groups are stark and measuring the scale of these access to financial services issues is difficult. Many people turned down for a product do not complain, so do not appear in complaints statistics, and firms do not keep data on how many would-be customers they turn away. Other consumers self-exclude, not bothering to apply because they expect to be turned down, often based on bad experiences in the past.

Since the government abolished Consumer Futures (originally the National Consumer Council) in 2014, the UK no longer has a statutory consumer body with a remit to research these kinds of issues and without proof of the scale of a problem, regulators, government and firms are often reluctant to act. The sad irony is that these consumers are shut out of the system and therefore cannot communicate their needs or wants to firms designing and delivering basic products like pensions and mortgages.

Access issues are especially important. The cradle-to-grave welfare state is a thing of the past, if it ever really existed. There was, at least, a belief that social housing, the NHS and state benefits would catch the homeless, the sick, the frail and the elderly, as part of a caring society.

These days, we are all expected to look out for our own financial well-being, sorting out our own safety nets, secure places to live and viable retirement. But being denied access to financial services means being shut out of modern life and put in a very vulnerable situation.

Author: Jonquil Lowe, Lecturer in Personal Finance, The Open University

Bank Profits Under Pressure – Fitch

AAP says Australia’s major banks face soft profit growth amid growing macroeconomic risks linked to low interest rates and government tax policy, according to Fitch. However. the agency has reaffirmed the ratings of all four major Australian banks at AA- with a Stable Outlook.

The credit rating agency believes low interest rates and government tax policies have likely contributed to risks that include rising household debt and diminishing housing affordability related to strong house price growth.

“Pockets of Australia’s property market may encounter potential oversupply of new residential housing and hurt house prices in those areas,” Fitch says.

“However, a stable labour market and historically low interest rates should limit the impact on the banks’ asset-quality.”

Fitch expects housing price rises to moderate to about 2% in 2016 due to tightened mortgage underwriting standards for investors and non-resident borrowers.

It highlighted continued challenges for Commonwealth Bank, Westpac, National Australia Bank and ANZ from the downturn in the resources sector, which has already led to an increase in bad loans in WA and Queensland.

“Fitch expects soft profit growth in 2016, mainly reflecting asset competition, low interest rates, moderate credit growth and rising impairment charges,” Fitch said in a statement on Friday.

ANZ has already cut its interim dividend after its first-half profit slumped by nearly a quarter, Westpac this month lifted first-half cash earnings a below-expectations 3.3 per cent, and Commonwealth Bank lifted first-half cash earnings 3.9 per cent back in February.

NAB posted the best results of the big four, lifting cash earnings 6.5 per cent following the disposal of its unprofitable UK business.

However, Fitch said a stable labour market and historically low interest rates should limit the negative impact on banks’ asset quality should residential property prices decline in some areas due to potential oversupply.

The agency also forecast a continuation of tightened underwriting criteria imposed last year.

“Some portfolios, such as resources, are likely to continue experiencing asset-quality pressure due to weak commodity prices, which Fitch does not expect to improve in the short-term,” Fitch said.

“However, the banks’ exposures to mining and dairy remain manageable relative to total exposures.”

Fitch said a hard landing for the Chinese economy could hit the big Australian banks, but that such a scenario is not its base case.

UK Regulators Finalise SRB Regulations; Shows Low Australian Bank Capital Ratios

The UK’s Financial Policy Committee (FPC) has released the final version of its Systemic Risk Buffer (SRB) framework for banks relating to Domestically  Significantly Important Banks) (D-SIB). It also shows Australian Banks relatively weaker capital position.

The framework highlights again that further risk capital will need to be held so that financial firms will be able to absorb losses while continuing to provide critical financial services. In the UK, depending on the size of the institutions, the buffer will be set between 0 and 3%. The SRB increases the capacity of UK systemic banks to absorb stress, thereby increasing their resilience relative to the system as a whole. The FPC judges that the appropriate Tier 1 capital requirement for the banking system is around 13.5% of Risk Weighted Assets.

Note, separately, an additional capital weight, per the Basel framework will apply for global systemically important banks (G‐SIBs).

Of special interest to Australian Banks is this table which shows that on a comparable basis, local banks here currently are required to hold less capital than peers in many other countries. Is the D-SIB here at 1% correctly calibrated? – especially, given 63% of all bank lending is residential property related?

UK-DSIB

The UK document just released, sets out the framework for the SRB that will be applied by the PRA to ring‐fenced banks, and large building societies that hold more than £25 billion in deposits and shares (excluding deferred shares), jointly, ‘SRB institutions’. The aim of the SRB is to raise the capacity of ring‐fenced banks and large building societies to withstand stress, thereby increasing their resilience. This reflects the additional damage that these firms could cause to the economy if they were close to failure. The FPC intends that the size of a firm’s buffer should reflect the relative costs to the economy if the firm were to fall into distress. The PRA will apply the framework from 1 January 2019 and later this year will consult on elements relating to the implementation of the SRB.

Overall, based on an analysis of the economic costs and benefits of going concern bank equity, the FPC judged the appropriate non‐time‐varying Tier 1 capital requirement for the banking system, in aggregate, should be 11% of RWAs, assuming those RWAs are properly measured. As up to 1.5 percentage points of this can be met with additional Tier 1 contingent capital instruments, the appropriate level of common equity Tier 1 capital is around 9.5% of RWAs. This judgement was made on the expectation that some of the deficiencies in the measurement of risk weights would be corrected over time. Until remedies are put into place to address this, the appropriate level of capital is correspondingly higher. On current measures of risk weighting, the FPC judges that the appropriate Tier 1 capital requirement for the banking system is around 13.5% of RWAs. This assessment refers to the structural equity requirements applied to the aggregate system that do not vary through time. In addition to baseline capital requirements, the FPC intends to make active use of the countercyclical capital buffer that will apply to banks’ UK exposures.

Under the SRB Regulations, the FPC is required to produce a framework for the SRB at rates between 0 and 3% of risk‐weighted assets (RWAs) and to review that framework at least every two years. The legislation implements the recommendation made in 2011 that ring‐fenced banks and large building societies should hold additional capital due to their relative importance to the UK economy. The FPC has considered its equality duty, and has set out its assessment of the costs and benefits of the framework.

Systemic importance is measured and scored using the total assets of ring‐fenced bank sub‐groups and building societies in scope of the SRB, with higher SRB rates applicable as total assets increase through defined buckets.

SRB-UKThose with total assets of less than £175bn are subject to a 0% SRB. The FPC expects the largest SRB institutions, based on current plans, to have a 2.5% SRB initially. Thresholds for the amounts of total assets corresponding to different SRB rates could be adjusted in the future (for example, in line with nominal GDP or inflation) as part of the FPC’s mandated two‐year reviews of the framework.

In July 2015, the FPC issued a Direction and a Recommendation to the PRA to implement the leverage ratio framework for UK G‐SIBs and other major UK banks and building societies on a consolidated basis. The FPC anticipates that the leverage ratio framework will be applied to UK G‐SIBs and other major UK banks and building societies at the level of the ring‐fenced bank sub‐group from 2019 (where applicable), as well as on a consolidated basis.

 

Review of Card Payments Regulation Outcomes

The Reserve Bank has today released the Conclusions Paper and three new standards which they say will contribute to a more efficient and competitive payments system. As expected the review has focussed on reducing excessive payment surcharges, changes to interchange fee bench-marking and the inclusion of the American Express companion card system. The RBA has not designated UnionPay, JCB, Diners Club, or any other systems. Accordingly the RBA’s new standard does not apply to transactions carried out using those systems.

The banks says the new standard is likely to result in some reductions in the generosity of rewards programs on premium and companion cards for consumers. Some adjustment in annual fees on these cards is also possible. Commercial and corporate card products often provide significant benefits free of charge to the company holding the card. It is possible that there will be changes to either the pricing or services provided by these products. These changes are part of the process of improving price signals to cardholders and creating a more efficient and lower-cost payments system.

Note that the new surcharging framework only applies to payment surcharges – that is, to fees that are specifically related to payments or apply to some payment methods but not others. Some merchants apply fees, such as ‘booking’ or ‘service’ fees, which are unrelated to payment costs and apply regardless of the method of payment (this is for instance common in the ticketing industry). The surcharging framework is not intended to apply to these fees but merchants will be required to meet all provisions of the Australian Consumer Law in terms of disclosure of any such fees.

The Review was initiated with the publication of an Issues Paper in March 2015. After extensive consultation with stakeholders, the Bank published some draft standards in December 2015. The Bank received submissions on the draft standards from more than 40 organisations and the staff have had over 50 meetings with stakeholders since their release. There was significant support for the proposed reforms from end users, including major consumer and merchant organisations.

The new surcharging standard will preserve the right of merchants to surcharge for more expensive payment methods. However, consistent with the Government’s recent amendments to the Competition and Consumer Act 2010, the new standard will ensure that consumers using payment cards from designated systems (eftpos, the debit and credit systems of MasterCard and Visa, and the American Express companion card system) cannot be surcharged in excess of a merchant’s cost of acceptance for that card system. Eligible costs are clearly defined in the standard and new transparency requirements will promote compliance with and enforcement under the new framework. With the cost of acceptance defined in percentage terms, merchants will not be able to impose high fixed-amount surcharges on low-value transactions, as has been typical for airlines. The ACCC will have enforcement powers under the new framework, which will take effect for large merchants on 1 September 2016 and for other merchants on 1 September 2017.

The new interchange standards will result in a reduction in payment costs to merchants, which will place downward pressure on the costs of goods and services for all consumers, regardless of the payment method they use. The weighted-average benchmark for credit cards has been maintained at 0.50 per cent, while the benchmark for debit cards has been reduced from 12 cents to 8 cents. The weighted-average benchmarks will be supplemented by ceilings on individual interchange rates which will reduce payment costs for smaller merchants. Commercial cards will continue to be included in the benchmarks, but the Board has decided for the present against making transactions on foreign-issued cards subject to the same regulation as domestic cards. Schemes will be required to comply with the benchmarks on a quarterly frequency, based on weighted-average interchange fees over the most recent four-quarter period. These tighter compliance requirements will ensure that the regulatory benchmarks are an effective cap on average interchange rates. The new interchange standards will largely take effect from 1 July 2017.

To address issues of competitive neutrality, interchange-like payments to issuers in the American Express companion card system will now become subject to equivalent regulation to that applying to the MasterCard and Visa credit card systems. More broadly, to prevent circumvention of the debit and credit interchange standards, there will be limits on any scheme payments to issuers that are not captured within the interchange benchmarks.

These changes to the regulatory framework are consistent with the direction of reforms suggested in the Final Report of the Financial System Inquiry and endorsed in the Government’s October 2015 response to the Report.

UK Regulator Seeks To Lift Banking Competition

The UK’s Competition and Markets Authority (CMA) has outlined a wide-ranging package of proposals to tackle the issues hindering competition in personal current accounts (PCA) and in banking services for small and medium-sized enterprises (SMEs). It includes new protections for overdraft users. They expect the package of remedies, taken together with ongoing technological developments, to result in significant changes to the operation and structure of retail banking markets in the UK.

At present, it is hard for bank customers to work out if they are getting good value. Bank charges are complicated and opaque and many customers think it is difficult and risky to change banks.

As a result, nearly 60% of personal customers have stayed with the same bank for over 10 years and over 90% of SMEs get their business loans from the bank where they have their current account.

This means that competitive pressures are weak, so banks do not need to work hard enough on price or quality of service.

The CMA considered whether the largest banks should be broken up but it came to the view that this would not address the fundamental competition problems. Having more and smaller banks, which customers still couldn’t easily choose between because of lack of transparency on fees and charges, would not significantly improve the market or give customers a better deal.

The CMA also considered whether to get rid of ‘free if in credit’ (FIIC) current accounts. Even though FIIC accounts are not really ‘free’, they do work well for many customers, and banning particular products would simply take away choice and risk the overall cost of accounts rising, not falling.

To transform the market the CMA believes banks instead need to be made to provide their customers with the right information so that they can easily find out which provider and type of account offers best value for them. The CMA also proposes to push the development of new online comparison tools and improve the current account switch service (CASS) to make switching banks more straightforward and give customers more awareness of, and confidence in, the process.

FIIC accounts are certainly not free for overdraft users, who represent nearly half of personal customers. The CMA’s proposals include new measures targeted at overdrafts, with a particular focus on users of unarranged overdrafts; in 2014, £1.2 billion of banks’ revenues came from unarranged overdraft charges.

The CMA proposes requiring banks to set a monthly maximum charge for unarranged overdrafts on personal current accounts. Customers may not even be aware of when they go into unarranged overdraft or realise the costs they are incurring, so the CMA also wants banks to alert people when they are going into unarranged overdraft, and give them time to avoid the charges.

Big technological changes are happening in banking, and the CMA wants to harness them to empower customers to compare and switch accounts. The CMA is proposing to require banks to move swiftly to introduce an Open API (application programming interface) banking standard. This standard will enable personal and SME customers to safely and securely share their unique transaction history with other banks and trusted third parties. This will enable bank customers to click on an app, for instance, and get comparisons tailored to their individual circumstances, directing them to the bank account which offers them the best deal.

The CMA also proposes that banks should be made to regularly prompt their customers to check that they are getting good value from their banking provider. When these prompts direct customers to digital comparison services which give tailored price-comparison and service quality advice, the foundation has been laid for a major change in the retail banking sector.

On these foundations, the CMA proposes to build a strong package of measures to deliver better banking services to SMEs. Making it easier for SMEs to shop around and open a new current account will reduce business owners’ reliance on their personal bank when choosing a bank for their business. By making the prices and availability of lending products more transparent, the majority of SMEs need not, as is the case now, turn directly to their existing bank for finance without considering other offers.

The package of changes could bring benefits to bank customers to the tune of £1 billion over 5 years.

Already, if personal customers switched to a cheaper product for them, annual savings could be on average £116; ranging from £89 on average for customers who do not use an overdraft, to £153 on average for overdraft users.

Alasdair Smith, Chair of the Retail Banking Investigation, said:

For too long, banks have been able to sit back and not work hard enough for their personal and small business customers. We believe the strong and innovative package of measures we are proposing will give customers the information and tools they really need to get a better deal out of the banks. They will also protect those who fall into overdraft from being stung with unexpected fees.

New entrants into a market are an important source of competition and innovation, and we are well aware of the current barriers to challenger banks in UK retail banking. What’s really holding them back is their ability to highlight to customers how new offerings compare with their current deal. Our package of banking reforms will help new competitors get a stronger foothold in a market which is of vital importance to the whole economy.

The CMA invites submissions in writing by 7 June. They will publish the final report in early August.

How Much Benefit Do Major Banks Get From Implicit Government Guarantees?

In a freedom of information request, released by the RBA we get some insights into the discussion around whether the major banks benefit from the implicit assumption that in a time of strife they will be bailed out by Government.

The credit ratings of Australian banks do benefit to some extent from rating agencies’ perceptions that the Government would support them if they got into trouble. The major banks and Macquarie receive a two notch credit rating uplift from S&P as a result of the rating agency’s expectation that these banks will receive support from the government in a crisis. Other Australian banks do not receive any rating uplift, as S&P does not expect government support.

The released documentation discusses the different modelling approaches and also some of the international analysis which has been done on the subject. The real benefit does appear to change over time (depending on the risks in the system) but the net conclusion is the majors do get benefit. It is hard to put a value in it, but a figure between $1.9 and $3.8 billion (between 14 and 28 basis points) was suggested in 2013.

One submission to the financial system inquiry applied rates from the same study to the non-deposit liabilities of the major banks to estimate the dollar value of the implicit subsidy to these institutions at between $5.9 and $7.9 billion per year.

Systemic risks may be higher as a  result.

An implicit government guarantee creates on incentive for creditors to fund banks at rates below those justified by their financial health, thus providing an implicit subsidy. lf of significant size, this subsidy has the potential to distort competition and increase systemic risk.

However you read it, the majors are supported by the implicit Government guarantee. It does not seem to pass through to borrowers or depositors in better rates.

 

 

Remuneration Review to Extend Beyond Brokers (But In Secret)

ASIC has evidently released the final scope of its review of remuneration in the mortgage broking industry – but only to industry insiders. According to media, the corporate regulator has confirmed it will review the remuneration arrangements of “all industry participants forming part of the value distribution chain”. This includes lending institutions, aggregation and broking entities, and associated mortgage businesses – such as comparison websites and market based lending websites – and referral and introducer businesses.

But why, we ask, was the scope not publicly disclosed? Why are ASIC seeking input only from industry participants? We agree the remuneration review is required – but the lack of transparency is a disgrace.

We asked ASIC about this and they replied:

At this point in time, ASIC has not published a media release commenting on the review or making the review available for download at this stage.

ASIC will usually put out a public statement, such as a media release or media advisory, on significant regulatory activities and outcomes, in order to:

  1. be transparent and accountable for what we do
  2. help inform our regulated population and the public of expected standards and of our priorities and areas of focus.

So they are happy with a private review evidently!

Worth also bearing in mind, the UK banned commission payments in the mortgage industry, which has moved to a fee for service model.

From Australian Broker.

ASIC has released the final scope of its review into the mortgage broking industry, in which it confirms the review will extend far beyond mortgage brokers.

The final scope, released to the industry yesterday, sets out the parameters of the review. These were informed by input received from industry and consumer representatives through industry roundtables and subsequent written feedback. In it, the corporate regulator has confirmed it will review the remuneration arrangements of “all industry participants forming part of the value distribution chain”.

This includes lending institutions, aggregation and broking entities, and associated mortgage businesses – such as comparison websites and market based lending websites – and referral and introducer businesses.

ASIC also confirmed the review will extend to non-monetary benefits that relate to the distribution of residential loan products.

However, the review will not extend to loan products outside of residential mortgages, such as reverse mortgages or construction loans, which do not comprise a predominate proportion of the home lending mortgage market.

NAB has already come out in support of ASIC’s final scope.

“We believe ASIC’s scope is appropriate and we look forward to continuing to work with the regulator throughout the review,” Anthony Waldron, NAB EGM broker partnerships, said.

“We’re dedicated to working with brokers to deliver a great customer experience and we believe this review will help continue to build trust and confidence in the mortgage broking industry.”

 

Microfinance could wind up being the new subprime

From The Conversation.

Microfinance has been celebrated as a way to get money into the hands of poor people, and most famously women, so they can jump start small businesses. These tiny loans with minimal requirements to borrow have become a global phenomenon.

The 2005 United Nations “year of microcredit” was followed in 2006 by a Nobel Peace Price to the Grameen Bank in Bangladesh. In the decade since, microcredit has grown from a visionary call for women’s empowerment to a mainstay of economic development initiatives. Increasingly it has even moved into mainstream commercial banking. There seems to be a general consensus that for entrepreneurship, you simply add credit and stir.

It’s estimated that there are about 90 million active borrowers in microfinance institutions (MFIs) worldwide, and the sector granted US$81.5 billion in loans in 2012.

Meanwhile, MFIs have grown into emerging areas such as mobile banking, insurance and savings, education loans, and digital financial services. As the suite of financial services and products has expanded, so has the wider development mission. The notion of providing credit to poor women has evolved into the bigger idea of building a robust financial system that can serve poor and low income communities.

Like the microcredit movement that it grew out of, the push for “financial inclusion” challenges the current state of affairs. Currently, using money is by far the most expensive for people with the least money to spare. There’s a need to fundamentally rethink financial services along more inclusive lines.

What could be wrong with expanding financial services to include the billions of people currently left out of the traditional banking sector?

More inclusive and democratic forms of banking surely bring financial services to people and communities that had been excluded from key markets. But academic research and policy analysts both sound some notes of caution. Economists such as Charlotte Wagner have studied the growth of microfinance and found it to be part of the same credit glut experienced in the traditional banking sector in the mid-2000s. It could be susceptible to the same boom and bust cycles.

Has the rapid expansion of credit left the sector vulnerable to an unstable global credit market? Disturbing stories of borrower suicides in India linked to over-indebtedness would point in that direction. A volatile market and increasing pressures on debt collection might be some unintended outcomes of a global push for financial inclusion.

My research on the hidden costs of microfinance began with two years of on-the-ground anthropological fieldwork on the culture of credit in Latin America. Behind the numbers, what was the experience of living on credit for the families, neighbourhoods, and communities enrolled in these development projects?

What I ultimately found was that women navigated an economic world that was awash in credit. In fact, many people in the financial services industry in Paraguay, from microcredit borrowers all the way up to a credit scoring executive, told me that when it came to credit they were “bicycling.” The common saying implied that they spun the pedals by paying off one loan with the next.

Turning the wheels of the “credit bicycle” meant constantly seeking out new opportunities to borrow. In practice, these debts were from development organisations, consumer credit, local businesses, savings and loan cooperatives, finance companies, and informal loans from friends and family. And they were directed toward a mix of small business ventures, consumption, and income smoothing. Microcredit, with its mission of financial inclusion and very lenient requirements for things like credit history, income, or collateral requirements, ultimately supported exactly this sort of “bicycling” credit.

Unintended consequences

The research suggests the “democratisation of finance” for micro-entrepreneurship could go the same way as that of the mortgage market, particularly in the United States: subprime lending.

The social justice impulse to promote access to banking services, especially to women, is a good one. But it is not that dissimilar to the social justice impulse to promote home ownership for people who had previously been excluded from the mortgage market. In the bigger picture, this also means the financial sector is increasingly targeting very vulnerable communities, whether poor women or low-income homeowners, as a source of profit.

The repayment rate on microcredit loans has been very high, up to 98%. In Paraguay, this was often because women feared losing this crucial lifeline and falling off the “credit bicycle.” Most of the borrowers I encountered would no more be able to do without debt than many in the developed world would be able to cut up their credit cards.

Like the mortgage market, though, perhaps one crucial element of financial inclusion will be to ask some hard questions of the protections needed as loans grow. We ask women borrowers to rely on one another and on their families to make their loan payments. They must look inward to their social networks for a safety net. As subprime lending reshapes their economic lives and livelihoods, we might also question how long those communities might be expected to shoulder the risks alone.

Author: Caroline Schuster, Lecturer, School of Archaeology and Anthropology, Australian National University

Five Critical Risks in an Era of Negative Interest Rates

A speech by Professor John Iannis Mourmouras, Deputy Governor of the Bank of Greece, examines the impact of low and negative interest rates on economies. He starts by stating that this unconventional monetary policy is not temporary. Rates will be ultra low for a long time. As a result, bank profits will be eroded; financial market will be negatively impacted; investors will be forced to take higher risks so creating stability risks; governments will not be under pressure to reduce debt; and operational risks increase.  He concludes that the time has come for other policy tools, including fiscal and structural ones.

After nine years of low interest rates and large-scale market interventions, the consensus is that this unconventional monetary policy is not temporary, while in most advanced economies the prospect for normalisation seems rather remote. Indeed, most of continental Europe (the euro area, Denmark, Sweden and Switzerland) and, as of last January, also Japan have moved towards a much more accommodative monetary policy by introducing negative policy interest rates, and/or negative central bank deposit rates. Together with forward guidance and quantitative easing, such measures have created an unprecedented situation, in which nominal interest rates are negative in a number of European countries across a range of maturities in the benchmark yield curve, from overnight to even five- or ten year maturities! Indeed, 88 of the 346 securities in the Bloomberg Eurozone Sovereign Bond Index have negative yields, thus nearly $2 trillion of debt issued by European governments is currently trading at negative yields. Illustrative examples are those of Switzerland and Germany, in which 18 out of 19 bond issues and 14 out of 18 bond issues respectively are priced with negative yields. As a result, almost one quarter of the world’s GDP is produced in countries with negative interest rates.

There are, however, a number of concerns associated with the use of negative interest rates, each of which is considered in turn.

I. Erosion of bank profitability: As negative deposit rates impose a cost on banks with excess reserves, there is a higher probability that the banks’ net interest margins (the gap between commercial banks’ lending and deposit rates) will shrink, since banks may be unwilling to pass negative deposit rates onto their customers to avoid an erosion of their customer base and subsequent reduced profitability. The extent of the decline in profitability will depend on the degree to which banks’ funding costs also fall. The central bank could reduce concerns about bank profitability by raising the threshold at which the negative central bank deposit rate applies, as the Bank of Japan recently introduced a three-tier system, a different way from the ECB’s negative interest rate policy. Doing so, however, it could reduce the transmission of negative deposit rates to market rates, namely the power of negative interest rate policy transmission through the credit and portfolio rebalancing channel. Moreover, compressed long-term interest rates also reduce profit margins on the standard banking maturity transformation of short-term borrowing and lending at a somewhat longer term. So far, lenders have been reluctant to pass on the costs of negative rates to customers and have taken almost all of the burden. But, as recent research by the BIS
shows, the impact on profitability becomes more drastic over time, as short-term benefits such as lower rates of loan defaults diminish.

II. Negative effects on financial markets: Money market funds make conservative investments in cash-equivalent assets, such as highly-rated short-term corporate or government debt, to provide liquidity to investors and help them preserve capital by paying a modest positive return. While these funds aim to avoid reductions in net asset values, this objective may not be attainable if rates in the market are negative for a considerable period of time, prompting large outflows and closures and reducing liquidity in a key segment of the financial system. For insurance and pension funds, a low-for-long interest rate environment poses challenges, which may even be exacerbated if rates enter into negative territory. They may find themselves unable to meet fixed long-term obligations. Life insurance companies will also be less able to meet guaranteed returns.

III. Excessive risk-taking: Increased financial stability risks, stemming from search for yield and higher leverage. Keeping interest rates at negative levels for a long time increases borrowing attractiveness in key sectors of the economy and the risk of bubbles. This can not only lead to an inefficient allocation of capital, but leave certain investors with more risk than they appreciate, as investors in search of higher yields necessarily turn to excessive risky assets.

IV. Disincentive for government debt reduction: With interest rates at negative levels, governments are under no pressure to reduce their debt. Negative rates actually encourage them to borrow more. And if government borrowing becomes a sort of free lunch, there is a clear disincentive for fiscal discipline. Ultra-low interest rates flatter the debt service ratio, painting a misleading picture of debt sustainability. For instance, persistent negative rates may potentially act as an “anaesthetic” to governments of eurozone countries, especially in the europeriphery, meaning that they will proceed only slowly with fiscal and structural reforms, given the fiscal space that they gain from lower debt servicing costs.

V. Operational risks: The issuance of interest-bearing securities at negative yields may face design challenges. Areas that are commonly mentioned as sources of concern are interest bearing securities, particularly floating-rate notes (renegotiating, collecting interest, use as collateral) in the context of negative interest rates. More generally, if negative rates were to prevail for long, they may entail the need to redesign debt securities, certain operations of financial institutions, the recalculation of payment of interest among financial agents, and other operational innovations, the costs of which may offset negative rate benefits. For instance, most option-pricing models either do not work or do not work well with negative interest rates, particularly entailing risks for the compatibility of trading systems and other market infrastructure.

In brief, persistent negative rates may change expectations and create distortions (for instance, in terms of saving habits and, in that sense, they may be a topic for behavioural economists to look at). It is still unknown what their long-term effects will be (e.g. on the erosion of bank profitability). In contrast, QE has been tested successfully in the US and the UK and I would also like to remind you that monetary policy– conventional or unconventional – entails considerable time lags. It takes time to see the results at full length. However, there is definitely something positive about negative interest rates: it is a strong reminder that the time has come for other policy tools, including fiscal and structural ones.