Economics and Banking – Page 405 – Digital Finance Analytics (DFA) Blog

ABC 7:30 Does Mortgage Debt Burden

On Monday 7:30 did a segment on the mortgage debt burden on Australian households. Using a leaked report prepared by APRA from before the GFC they indicated that the regulator was concerned about the level of mortgage debt in 2006, and included modelling to suggest that up to 7% of households could default by 2009, with ensuing pressure on the banks. At that stage mortgage debt was in the region of $700 bn.

Of course, the get-out-of-jail card was the GFC, with ensuing cuts in interest rates, the cash splash, and income growth meant the concerns were overtaken by events, and both households and banks survived (though some small ones were mopped up along the way). By the way, our own mortgage stress modelling should the same level of risks back then.

Jump forward to 2016, the total exposure of the banks to mortgages has doubled, interest rates are very low, and lending standards proved to be lax, such that the regulators have been tightening them recently. The big question is of course, whether the risks in the system, despite capital buffers being raised and lending criteria are being tightened, still exist.

We see mortgage stress at similar levels to those of 2006 (despite the ultra-low interest rates), 36% of loans are for investment properties, incomes are stagnant. Delinquency is set to rise.

If interest rates were to rise, some households would get into trouble. Our own modelling suggests about 9% of borrowers are now sitting with loans outside current underwriting limits.

And remember, the root cause is the RBA policy of using households to try and fill the hole left by the declining mining boom – housing finance growth was planned and wanted. Household debt has never been higher.

The global policy reform agenda: completing the job

Global keynote spreech by William Coen, Secretary General of the Basel Committee, at the Australian Financial Review’s Banking and Wealth Summit, Sydney, 5 April 2016.

Introduction

Good morning, and thank you for the opportunity to participate in this summit. It is a pleasure to be in Sydney. I would like to thank the Financial Review for inviting me to be part of this event, which is indeed timely, since the Basel Committee aims to finalise a number of important regulatory reforms this year.

This morning I will say a few words about our recent proposals and outstanding reforms. I will describe the approach we are taking towards finalising the global regulatory framework. Our goal, as always, is to promote a safe and sound banking system, which is critical to ensuring sustainable economic growth. Australia’s economic growth record over the past two decades is the envy of many. As is the stability of its banking system. But, as regulators, our focus is invariably on the downside risks rather than the upside. And as we have learned from the all-too-frequent episodes of banking distress that have occurred throughout the world – increasing bank resilience in good times is the most efficient and effective way of dealing with periods of stress, which inevitably occur.

Building bank resilience is of course linked to the issue of capital. I will therefore offer a few thoughts on the subject of the level of bank capital. While critically important, regulatory capital is not, however, the sole focus of regulators. Strong supervision is essential and, above all, bank’s internal risk measurement and management are paramount. I will conclude with a look at some other areas where we need to bridge gaps to ensure resilience and profitability over the long term.

The Basel framework as a bridge

A bridge is an apt metaphor for the Basel framework, especially here in Sydney, with the celebrated Harbour Bridge only a few hundred metres away. Bridges must be safe and sound. A safe and sound banking system is exactly what the Basel framework aims to support. Bridges facilitate movement, commerce and trade. The financial system plays a crucial role in directing investment and funds between individuals and businesses. Bridges are complex to design and build. They must be sympathetic to their surroundings and their design and construction rely on the expertise of many parties. Global cooperation between regulators, duly recognising individual circumstances, is the Basel Committee’s tried and tested way of working. And, once complete, international prudential frameworks for banksdeliver benefits for all, as do strong bridges.

As strong bridges bring prosperity, weak bridges can undermine it. A weak bridge jeopardises the safety of those crossing it, and may create wider problems for society at large. A loss of confidence in a structure or its builders shakes confidence in every similar structure. These knock-on effects can be severe and persistent. So it is essential that a bridge, like the Basel framework, is built to last.

We must also not forget the importance of regular maintenance. The Harbour Bridge opened with four traffic lanes but now has eight, together with a complementary tunnel. Some parts are repainted every five years, while others last as long as 30 years. We face the same imperatives with the Basel framework. Maintenance does not imply re-opening every previous decision; we understand the importance of stability and certainty. But it does mean staying vigilant to market developments and keeping in mind the increasingly widespread use of the Basel framework.

Finalising global regulatory reform

The major outstanding topics that we will finalise this year relate to credit risk and operational risk. The Basel Committee recently published proposals on revising these two areas of the regulatory framework. Earlier this year, we finalised the regulatory capital framework for market risk.

One of our main goals this year is to address excessive variability in risk-weighted assets modelled by banks. Some – not us – have already dubbed these reforms “Basel IV”. I do not think the title in itself is important but I note that each moniker bestowed on the global regulatory framework was characterised by a substantial change from the earlier version. Basel II was a significant departure from the Basel I framework; while Basel III was a vastly different set of rules again. The current set of proposed reforms are meant to revise elements of the existing framework rather than introduce new ones. As such, I would not refer to these revisions as constituting “Basel IV”.

At the end of last year, the Committee consulted on proposals to revise the standardised approach for credit risk. This is the approach used by the vast majority of banks around the world. The Committee’s objective was to promote, as much as possible, the standardised approach as a suitable alternative to the modelled approaches. The standardised approach is of course also relevant for banks using internal models, as it may form the basis for an “output floor”, should the Committee decide to adopt such a floor. An output floor would cap the amount of capital benefit a bank using an internally-modelled approach would receive vis-à-vis the standardised approach. The Committee is still considering the specific design and calibration of an output floor.

The Committee recently consulted on revisions to operational risk and the internal ratings-based approaches for credit risk. For operational risk, our proposal did not include a modelled approach. While internal models are an essential part of risk management for many banks, the question is what role they should play in prudential rules. This is particularly relevant for operational risk. The Committee’s recent proposals to calculate capital for credit risk do not eliminate the use of models but place additional constraints around their use for regulatory purposes. I would emphasise the word “additional” – the kinds of constraint that have been proposed already exist in some form in the capital framework. Before we finalise the standards by the end of this year, we will analyse comments and conduct comprehensive quantitative impact studies (QIS).

The resources required to conduct these QIS exercises at banks and supervisory authorities are extensive. The appropriate level of minimum regulatory capital is a central question and we have a dedicated task force that is looking specifically at the calibration of the capital framework. We are tackling this question from the perspective of each individual policy on the table this year but are also taking an aggregate, overall view.

What is the right amount of capital?

Many people think that the Basel framework is all about capital. In many ways, they are right. For the past 25 years, the foundation of the international approach to the prudential regulation of banks has been a risk-based capital ratio. With respect to regulatory capital adequacy, there are two factors to consider: first, what counts as capital; and, second, how much of it do you need.

With Basel III’s definition of capital reforms, the Basel Committee took a great stride towards answering the first question. There is now, I think, a consensus that Common Equity Tier 1 is the most important component of capital, though with an acknowledgement that some other financial instruments may have a role to play in certain circumstances. Charts 1 and 2 show that banks have made very good progress in adjusting and increasing their core capital base. Banks’ leverage ratios and risk-weighted ratios have increased since the global financial crisis, with most of this increase stemming from banks augmenting their capital resources.

The level of capital is a more difficult question. There are many views on what the “right amount” should be. Banks, investors, rating agencies, depositors and regulators all have a different perspective on what is optimal. Even within groups there are different perspectives. Inside banks, loan officers, traders, risk managers and senior management may respond to capital requirements in different ways. And different regulators have different views on the question of how much capital is the right amount.

At the Committee, we work hard to bridge these different perspectives and to come to a consensus on a prudential framework of minimum standards that support a level-playing field for internationally active banks while also ensuring their resilience across financial cycles.

The Basel Committee’s view of capital

From the Basel Committee’s viewpoint, we define minimum requirements and do not try to answer the question of what is the optimal level of capital. Instead, we try to answer a slightly different question: “Is bank capital enough to ensure safe, resilient banks that perform better in the longer term?”

The banking sector has raised capital levels significantly. But there are still some gaps in the framework, which we will bridge by year-end. Some stakeholders seek short-term fixes, with some investors (and perhaps others) taking an unhealthy, if understandably myopic, view of bank performance and resilience. Our focus is on a far longer term. The process of devising international regulations is not well suited to delivering the quick fixes that are sometimes sought. Basel standards are minimum standards that support a sound banking system at all stages of the financial cycle. There will be circumstances, related to an individual bank, jurisdiction or financial cycle, that warrant having more capital than the minimum. For example, Australia has signalled its desire for its banks to be “unquestionably strong”, with Common Equity Tier 1 ratios in the top quartile of the benchmark set by peers. Other jurisdictions have also adopted regulations that are more stringent than the Basel standards. While we do not intend to significantly increase overall capital requirements, this does not mean avoiding any increase for any bank. And, as I said, it does not preclude individual jurisdictions from imposing higher standards.

I noted earlier that a risk-based capital ratio has underpinned our framework for a quarter of a century. This is, at heart, a simple concept: the amount of capital needed for a given activity should reflect the risk of that activity. The higher the risk, the higher the capital. This principle of risk-sensitivity is still very important to the Committee but it is not the only consideration.

The 1988 Basel I framework had limited risk-sensitivity. This sensitivity increased over time. Basel II allowed considerable use of internal models to determine capital requirements. In principle, internal models permit more accurate risk measurement. But, if they are used to set minimum requirements, banks have incentives to underestimate risk. Several studies have found substantial variation in risk-weighted assets across banks. For example, Charts 3 and 4 show the range of risk weights estimated by banks in hypothetical portfolio exercises we conducted on the banking and trading books. Complexity in internal models, banks’ choices in modelling risk parameters and national discretions in the framework have all contributed to this variation. However, I think it’s fair to say that the wide discretion provided to banks in the current framework is likely a major driver of this high degree of variability.

Such variation makes it difficult to compare capital ratios. Basel’s Pillar 3 framework – in its original form – failed to provide sufficiently granular, and sufficiently comparable, information to enable market participants to assess a bank’s overall capital adequacy and to compare it with its peers. The Committee has since addressed some of these disclosure deficiencies. Furthermore, some asset classes are inherently difficult to model. Together, this suggests that the use of internal models to cover all risks does not strike the right balance between simplicity, comparability and risk-sensitivity in the regulatory framework. I think it is not only regulators who feel that the balance between these objectives has been skewed too far towards risk-sensitivity and complexity. I know that, in many cases, academics, analysts, investors and perhaps even bank managers and board members would agree that the benefits of simplicity and comparability have been undervalued.

The Committee is therefore proposing greater restrictions on the use of internal models. This includes removing the option of using internal models to determine risk parameters for certain exposure categories. These categories are typically characterised by a scarcity of default data and/or model complexity. Specifically, we have recently proposed to:

remove the advanced measurement approaches for operational risk, where the inherent complexity and the lack of comparability arising from a wide range of internal modelling practices have exacerbated variability in capital calculations and contributed to an erosion of confidence in capital ratios;

remove the internal modelling approaches for exposures to banks, other financial institutions and large corporates, where it is judged that the model inputs cannot be estimated sufficiently reliably for regulatory capital purposes;

adopt floors for exposures to ensure a minimum level of conservatism where internal models remain available. These floors would be applied at the exposure – rather than portfolio – level; and

limit the range of practices regarding the estimation of model parameters under the IRB approaches.

Strong capital, narrowly defined, is not enough

The design of the overall regulatory framework has evolved significantly following the financial crisis. The foundation of the risk-based capital ratio is still in place, albeit strengthened with tougher materials, in the shape of higher-quality capital. But we have made many changes around it. The framework has been improved to catch up with modern traffic flows, particularly complex or illiquid trading activities and off-balance sheet exposures. Layers of capital buffers provide extra resilience.

The biggest change has been the introduction of multiple regulatory metrics. The revised framework complements the risk-based capital ratio with (i) a leverage ratio, (ii) standards for short-term and long-term liquidity management, (iii) large exposure limits, (iv) margin requirements and (v) additional going- and gone-concern requirements for the world’s most systemically important banks. Overall, this approach is more robust to arbitrage and erosion over time, as each measure mitigates the weaknesses of the others (Table 1). A number of empirical studies have suggested that simpler metrics are at times more robust than complex ones. We have kept this in mind when developing the leverage ratio, among other measures.

An appropriate level of resilience, in our view, is that implied by the combination of metrics that now comprise the Basel III framework.

But have we done enough? From a supervisor’s perspective, completing the regulatory standards is a critical step, but not the whole story. The financial crisis revealed, among other things, that implementation of the agreed standards was remiss. There were also weaknesses in banks’ internal controls. Also, incentive structures were not always aligned with the banks’ long-term soundness.

We have spent several years developing a framework to make sure that banks’ capital and liquidity buffers are strong enough to keep the system safe and sound. But these buffers can only be as reliable as the underlying risk measurement and management. No matter what standards the Basel Committee and national supervisors set to safeguard the system, it is ultimately banks themselves that determine their risk-taking, risk controls, business incentives and, ultimately, success or failure. These factors determine the way people ultimately behave. And we all know that in our current global financial system, much like a failed beam or girder, the failure of an individual bank is likely to have wider repercussions.

What else is needed?

So what else is needed? There are three areas that I would like to note: improved corporate governance and culture, better IT systems and effective stress-testing.

Let’s start with corporate governance. As noted by the Dutch central bank, “today’s undesirable behaviour in financial institutions is at the root of tomorrow’s solvency and liquidity problems”.¹ The Basel Committee published Principles for enhancing corporate governance in 2006. They were revised in 2010, then again last year. The Committee has emphasised the need for more effective board oversight, with a focus on the skills and qualifications of individual board members as well as the collective board. The Principles also reinforce the imperative of rigorous risk management, appropriate resources and unfettered board access for the chief risk officer, as well as call for better discussions between a board’s audit and risk committees. Corporate culture has been an oft-publicised topic, with many senior management teams reinforcing appropriate norms for responsible and ethical behaviour. These norms are especially critical in terms of a bank’s risk awareness, risk-taking behaviour and risk management.

Next, IT systems. Many in the banking industry recognise the benefits of improving IT infrastructure. Banks’ risk data aggregation capabilities have been a source of concern for the Committee for some time now. The global financial crisis showed IT systems failed to support the broad management of financial risks. Many banks could not properly measure risk exposures and identify concentrations quickly and accurately, especially across business lines and legal entities. Risk reporting practices were also weak.

In 2013, the Basel Committee set out its Principles for effective risk data aggregation and risk reporting. We are monitoring their implementation. Though progress is being made, there is still a considerable way to go.

Finally, stress testing. Although not part of the Pillar 1 framework, stress testing plays an increasingly important role in a number of jurisdictions. In some countries, stress testing is an integral part of the assessment process. In others, it is used for contingency planning and communication. For some banks, supervisory stress testing has proven to be the binding regulatory constraint. Stress testing is also used by banks as a risk management tool and by macroprudential authorities for policy analysis. Over all these areas, stress testing has demanded more resources in both banks and supervisors. The Committee is monitoring these developments closely. I should also recognise here that APRA has used stress testing as part of their supervisory framework for many years now – long before it became fashionable.

Conclusion

In conclusion, I hope I have given you a flavour of the Committee’s perspectives and priorities as we embark on the final parts of our post-crisis policy reforms. High-quality capital and robust capital ratios have always been, and will remain, the keystone in the Basel framework. But high-quality capital must be complemented with effective governance and appropriate culture; strong risk management processes and internal controls; and a broad view of risk that encompasses all of a bank’s activities.

Here in Sydney, you have one of the world’s most iconic bridges, which has served the city well for more than 80 years. During the eight years of its construction, between 2,500 and 4,000 workers were employed in various aspects of its building. Since it opened, it has been continuously maintained to keep it safe for the public and to protect it from corrosion. This is the eighth, and we hope the final, year of the construction of Basel III. While it might not appear on as many picture postcards, I hope that Basel III will also serve as a model of safety and soundness for many years to come. Thank you.

RBA Holds Cash Rate Once Again

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

Recent information suggests that the global economy is continuing to grow, though at a slightly lower pace than earlier expected. While several advanced economies have recorded improved growth over the past year, conditions have become more difficult for a number of emerging market economies. China’s growth rate has continued to moderate.

Commodity prices have generally increased a little recently, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Sentiment in financial markets has improved recently after a period of heightened volatility. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.

In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. Consistent with developments in the labour market, overall GDP growth picked up over 2015, despite the contraction in mining investment. The pace of lending to businesses has also picked up.

Inflation is quite low. Recent information has confirmed that growth in labour costs remains quite subdued. Given this, and with inflation also restrained elsewhere in the world, inflation in Australia is likely to remain low over the next year or two.

Given these conditions, it is appropriate for monetary policy to be accommodative. Low interest rates are supporting demand, while supervisory measures are working to emphasise prudent lending standards and so to contain risks in the housing market. Credit growth to households continues at a moderate pace, albeit with a changed composition between investors and owner-occupiers. The pace of growth in dwelling prices has moderated in Melbourne and Sydney and has remained mostly subdued in other cities.

The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.

At today’s meeting, the Board judged that there were reasonable prospects for continued growth in the economy, with inflation close to target. The Board therefore decided that the current setting of monetary policy remained appropriate.

Over the period ahead, new information should allow the Board to assess the outlook for inflation and whether the improvement in labour market conditions evident last year is continuing. Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.

Unqualified advice a growing problem, warns FBAA

From Australian Broker.

The Finance Brokers Association of Australia (FBAA) is warning brokers about offering unqualified advice which isn’t covered by their Professional Indemnity (PI) insurance.

The FBAA has cited a recent case in which a broker was found to have breached his duty of care by the Credit Ombudsman Service and forced to pay more than $115,000. The Ombudsman claimed the broker had given incorrect and unqualified advice.

In addition, the client – who was forced to sell an investment property at a substantial loss – took the legal action against the broker.

The chief executive of the FBAA, Peter White, says in this instance the broker went outside the bounds of his role by providing property advice and acting as a real estate agent when he did not have a licence to do so.

“This should serve as a warning to brokers. If you give unqualified advice, your Professional Indemnity insurance won’t cover you,” he said.

White is now urging brokers to educate themselves and update their knowledge of PI insurance.

“I would plead for any broker who may have let their education slide to update their knowledge on the rights and wrongs when it comes to advice and insurance.”

According to White, unqualified advice is potentially a growing problem as the line between financial planners and real estate property sales and other arms of the broking industry become blurred in an endeavour to diversify revenue streams.

“If you are only a qualified finance broker, act as a broker and do your best to meet your client’s needs. If you also want to assist a client in other areas like property purchasing, get the necessary qualifications and training otherwise you may be at risk of a life changing personal pay out,” White said.

How Does Bank Capital Affect the Supply of Mortgages?

The Bank for International Settlements just released a working paper – “How Does Bank Capital Affect the Supply of Mortgages? Evidence from a Randomized Experiment.” Given the intense focus on banks lifting capital ratios, this is an important question. They conclude that higher bank capital is associated with a higher likelihood of application acceptance and lower offered interest rates, whilst banks with lower capital reject applications by riskier borrowers and offer lower rates to safer ones. In other words, changing capital ratios directly and indirectly impact lending policy, but not necessarily in a linear or expect way.

The recent financial crisis refocused the attention on how the health of banks affects financial stability and macroeconomic growth. In particular, the academic and policy debates currently center on the effects of bank capital on lending and risk-taking. Indeed, both macroprudential and the microprudential regulatory reforms propose to raise bank capital ratios and strengthen bank capital buffers, with the aim of preventing “excessive” lending growth and increasing the system’s resilience to adverse shocks.

Yet, there is only a limited degree of consensus on the effect of higher bank capital on lending. On the one hand, higher bank capital increases both the risk-bearing capacity of banks and incentives to screen and monitor borrowers, in this way boosting lending. On the other hand, as debt creates the right incentives for bankers to collect payments from borrowers, lower debt and higher capital may reduce banks’ lending and liquidity creation.

In this paper we study the effect of bank capital on banks’ propensity to grant mortgages and on their pricing. We also explore how bank capital affects the selection of borrowers and the characteristics of offered mortgages, deriving implications for risk-taking. Finally, to detect possible non-linearities, we provide nonparametric estimates.

We focus on mortgages, whose relevance for both macroeconomics and financial stability has been unquestionable following the 2007-2008 financial crisis. In the first half of the 2000s, a strong increase in mortgage originations fueled a housing boom in several countries (US, UK, Spain, Ireland). That boom in turn led to a high accumulation of risks, which subsequently materialized causing the failure of several banks and a large drop in house prices. Understanding how bank capital affects mortgage originations and the way banks select the risk profiles of borrowers is thus critical to evaluate developments in the mortgage market and the potential accumulation of both idiosyncratic and systemic risks.

We use a new and unique dataset of mortgage applications and contract offers obtained through a randomized experiment. In particular, we post randomized mortgage applications to the major online mortgage broker in Italy (MutuiOn-line) in two dates (October 16, 2014, and January 12, 2015). Upon submitting any application, the online broker requires prospective borrowers to list both their demographic characteristics (income, age, job type) and the main features of the contract requested (amount, duration, rate type). By varying those characteristics, we create profiles of several “typical” borrowers who are submitting distinct applications for first home mortgages. Crucially, through the online broker all participating banks (which include the 10 largest banks in the country accounting for over 70% of the market for mortgage originations) receive the same mortgage applications, defined by the same borrower and loan characteristics. Hence, our estimates are not biased by the endogenous selection of borrowers into contracts or banks and, furthermore, there are no missing data due to discouraged potential borrowers not submitting applications. We then merge those data with the banks’ characteristics from the supervisory reports and, in our empirical analysis, we include several bank-level controls to reduce concerns about omitted variable bias; we exploit the time dimension of our data and we include bank fixed effects to control for unobserved determinants of bank capital in the cross-section; finally, in some specifications, we include bank*time fixed effects, to fully account for all bank specific, time-varying characteristics.

On the one hand, we find that banks with higher capital ratios are more likely to accept mortgage applications and to offer lower APRs. On the other hand, banks with lower capital ratios accept less risky borrowers. However, we cannot rule out that less well-capitalized banks take more risk on other assets (business loans, securities).

We also provide a quantitative estimate of the effect of bank capital ratio on the supply of mortgages, using a nonparametric approach. We find that the capital ratio has a non-linear effect on the probability of acceptance, stronger at low values of the ratio, almost zero for higher values. This non-linearity is more pronounced when the borrower or the contract are riskier.

Note: BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.

Mortgage Delinquency Mapped

Today we release the latest modelling of our mortgage probability of default, and a map showing the current and predicted default hot spots across Australia. The blue areas show the highest concentrations of mortgage defaults. The average is 1.2%, but our maps show those areas a little above the average (1.2%-1.7%) and the most risky (above 1.7%). The highest risks are more than twice the national average.

Mining heavy states and post codes are under the most pressure.

As part of our household surveys, we capture data on mortgage stress, and when we overlay industry employment data and loan portfolio default data, we can derive a relative risk of default score for each household segment, in each post code. This data covers mortgages only (not business credit or credit cards, which have their own modelling).

Given that income growth is static or falling, house prices and mortgage debt is high, and costs of living rising, (as highlighted in our Household Finance Confidence index) pressure on mortgage holders is likely to increase, especially if interest rates were to rise. In addition, the internal risk models the major banks use, will include a granular lens of risk of default.

So, some borrowers in the higher risk areas may find it more difficult to get a mortgage, without having to jump through some extra screening hoops, and may be required to stump up a larger deposit, or cop a higher rate.

In QLD, locations including Camooweal, Clermont, Theodore, Loganlea and Gulngai score the highest.

In NSW, locations including Quirindi, Stanhope Gardens, Duri, Greta and Brewarrina scored high.

In VIC, Berwick, Endeavour Hills, Darnum, Moonee Ponds and Pascoe Vale scored the highest.

In WA, Butler, Port Kennedy, Merriwa, Secret Harbour and Nowergup scored high.

In SA, Montacute, Marree, Macclesfield, Stirling and Uraidla scored the highest.

Australia’s Most Hated Fees Revealed

ATM fees frustrate Australians more than other banking and credit card fees and travel booking fees according to new research from ING DIRECT. Almost all Australians will take some action to avoid paying ATM fees – half will walk 10 minutes out of their way to get to a free ATM and 42 per cent will buy something they don’t need to get cash out.Almost half of the people who hate travel fees feel they are being ripped off. Top 5 accepted fees include Wi-Fi, restaurant service charges and mobile data roaming

Almost three quarters of people (72 per cent) who hate ATM fees say that it is because they believe it’s a service that should be free.

Psychologist Amanda Gordon explained, every day millions of people are feeling the frustration of paying fees and charges they think are unfair.

“Fee frustration may not seem significant, but these feelings of resentment can impact our ability to maintain a positive outlook in other aspects of our lives. Financial issues are regularly raised as a cause of stress for Australians, particularly among young women. Interestingly, ING DIRECT’s research shows that millennials and women were more likely to feel frustrated or angry about paying fees.”

“Bad spending habits are hard to break. Just like other habits, we need to become aware of what we are doing, stop following that same well-worn pathway without thinking, and actually notice where our money is going, rather than just complaining that it is disappearing. The best way for Australians to get ahead is to consciously and regularly focus on their finances by practicing money mindfulness,” said Gordon.

Apathy costing Australians dearly when it comes to paying unnecessary fees

John Arnott from ING DIRECT said people should not have to pay fees to access their own money.

“When you think about the total cost Australians pay in fees and charges it can have quite an impact on the family budget, which is already strained for many people.”

“Australians waste $500 million on ATM charges each year so it’s no surprise that’s the fee that tops the list. Our research shows almost all Australians will take some action to avoid ATM fees, but still too many people are paying. If you make two or three withdrawals a week, you are talking more than $300 a year, which is $300 too much,” he said.

Top ten fees Aussies find hardest to bear

ATM fees
Bank monthly account fees
Booking fees for events and tickets
Credit card surcharge fees
Credit card annual fee
Travel fees (e.g. airline booking fees)
Fee for receiving a paper statement by mail
Charge to use public toilets
Road toll charges
Late payment fees

Top five fees Aussies accept

Wi-Fi fees
Restaurant service charges
Mobile data roaming charges
Parking meter fees
Currency conversion fees

Mortgage delinquencies to rise in 2016

From Australian Broker.

A slowdown in house price growth coupled with sluggish economic conditions will result in an increase in mortgage delinquencies in Australia during 2016, according to one global credit rating firm.

According to Moody’s Investor Services, the proportion of Australian residential mortgages more than 30 days in arrears was 1.20% in November 2015, compared with 1.19% in November 2014, and that is expected to rise again in the coming year.

“We expect the Australia-wide delinquency rate for mortgages showing more than 30 days in arrears to increase in 2016, but remain at a low level,” Moody’s assistant vice president and analyst Alana Chen said.

“We also expect that Australia’s GDP growth will likely be towards the upper end of our 1.5% to 2.5% forecast range for 2016, but this will be below the long-term average of 3.5%. We believe this economic backdrop will prompt a slight increase in the Australia-wide mortgage delinquency rate in 2016,” Chen said.

While Moody’s Investor Services is predicting a nation-wide increase in mortgage delinquencies in 2016, it won’t be spread evenly across Australia.

The ratings firm believes there will be further bad news for resource states; Western Australia, the Northern Territory, and to a lesser extent, Queensland, with the bulk of the increase in delinquencies to be found in those markets.

In Western Australia, the rate of mortgage holders more than 30 days in arrears rose by a significant 0.48% over the year to November 2015 to 1.71%, the highest mark in the country.

Though delinquencies will are predicted to rise in those states, performance in New South Wales will help to keep the nation-wide rate of delinquencies relatively low.

“With delinquencies in NSW remaining steady and those in other states set to continue to edge higher, we expect that the Australia-wide delinquency rate will increase slightly over 2016 but remain low,” Chen said.

Moody’s Investor Services claims a slowdown in house price growth in NSW will be balanced out by the “positive effect of healthy economic and labour market conditions.”

Are Deposit Interest Rates On The Up?

It looks like Banks will need to compete harder for deposit balances in the light of new regulation, and adverse international funding costs. This is in stark contrast to the past couple of years when savers took a bath.

The data from the RBA (to end February) shows that key benchmark rates for some deposits lifted. This trend has continued, with some attractor rates at 3.5%, and some standard deposit rates on the rise.

In contrast, we also see lending rates to SME’s moving up, and some mortgage rates to borrowers are also higher – though selected refinance discounting is also available to some.

In recent times the costs of international funding, which is the other main source of bank funds, has lifted (and is also more volatile) thanks to the higher perceived international risks and possible future interest rates. For example the CDS spreads are higher now.

This matters, because Australian banks have a higher proportion of their loan books funded by these wholesale sources, as data from Moody’s shows. Whilst there has been a fall in the mix, compared with 2008, Australian banks are still reliant on these international capital flows. Thus any international volatility feeds though into local bank balance sheets.

The other point to note is that Australian banks have a higher proportion of short-term funding, compared with global peers. Moody’s has provided data on this recently.

APRA’s consultation, announced last week, on Net Stable Funding Ratio will make it relatively more attractive for banks in Australia to fund their books from deposits rather than from wholesale capital markets. As a result, we expect to see competition for deposits, and potentially higher interest rates on offer. This trend will gain more momentum as the implementation date for NSFR approaches in 2018.

The implication of this may be we see a further fall in exposures to overseas funding, and thus less pricing volatility; but it may also mean that interest rates to some borrowers – especially SME’s who are less able to respond, and some mortgage holder segments will rise.

The question will be whether the re-balancing of all these forces will be managed so as to maintain net bank profitability, or whether the squeeze will flow to their bottom line. Nevertheless, Savers may for a change, get some good news – provided that is they shop around. We note from our surveys that more than half of households with savings on deposit do not know their current rate of return, and inertia is a powerful force stopping many maximising their savings returns.

Then of course, there is the question of whether the RBA cuts the cash rate benchmark as we progress through the year.

UK Regulator Looks At Reverse Mortgages

The UK Prudential Regulation Authority (PRA) has released a discussion paper (DP) on equity release mortgage (ERM), or reverse mortgages. Given the complex nature of these products, their valuation, risk assessment and capital treatment are under review, and the regulator is seeking industry input. They are especially focussing on what “fair value” for these mortgages might be.

The PRA has observed that firms writing ERMs typically restrict the initial valuation to the amount lent (which is a transaction price observed in a market), for example by including a spread of appropriate size when discounting ERM cashflows, and updating the valuation (including the spread, where appropriate) to allow for new information affecting the valuation as it emerges.

In Australia, reverse mortgages have not really taken flight, with the latest APRA data showing about $2.7 bn of reverse mortgages outstanding (compared with $1.35 trillion all home loans), comprising around 29,000 loans outstanding, and an average balance of just $96,000. There has been little growth in recent years.

That said, the recent run up in house prices here, and the aging population may suggest a growing demand. Therefore it is worth looking at the issues the UK regulators are wrestling with. This is a complex product area requiring careful regulation.

ERMs are a type of lifetime mortgage. This DP is directly relevant to lifetime mortgage products with the following features: they are restricted to older customers, they do not have a fixed term, they generally have a no negative equity guarantee, and there is no obligation to make regular interest payments on the capital. For simplicity, this sub-set of equity release products is referred to as ‘ERMs’ for the purpose of this paper, but the PRA is aware that other definitions of ERMs are used in the industry.

ERMs allow capital to be released from residential properties without requiring the property to be sold. ERMs are loans secured by way of a mortgage on a residential property, repayable on ‘exit’ (death; or move to a care home; or voluntary repayment, either for an individual borrower or a couple) rather than at a fixed maturity date. In the United Kingdom (UK), loans are advanced as a lump sum, or through flexible drawdown facilities. In general it is possible to ‘port’ ERMs from one property to another if the borrowers wish to move house, subject to certain restrictions, which may include a requirement to make a partial repayment of the outstanding loan.

Loan interest is generally at a fixed rate, but can be variable or vary subject to a cap. In general, interest accrues to the loan balance without regular payments being made, so that the final repayment is larger than the amount lent, often significantly so. Sometimes interest payments can be made and these may be lower than the interest that would otherwise accrue. Such interest payments can be terminated by the borrower, in which case interest starts to accrue again. The accruing nature of the interest leads to the name ‘reverse mortgage’ being used in some territories.

In the UK, there is often a guarantee that on certain forms of repayment any excess of the accrued loan amount above the (sale) value of the property will be written off or waived by the lender, subject to certain conditions. This is known as a ‘no negative equity guarantee’ (NNEG). For an ERM product to meet the Product Standards within the Statement of Principles of the Equity Release Council, it must incorporate a NNEG. This means the NNEG has become a standard feature of the UK ERM market.

ERMs receivables are held – either directly or indirectly – by a range of different financial institutions, including life insurers, banks, building societies and other lenders. ERMs require long-term funding that is sufficiently flexible to adapt to the timing and amount of repayments, both of which may vary from expectations. In particular, annuity writers have liabilities with long-term and relatively predictable cashflows. So (taking into account their other capital and liquidity resources) some of these firms consider that cashflows from a suitable portfolio of ERMs offer a sufficiently good match for some of their annuity liabilities and provide a good risk/return trade-off, given the long duration and reasonably predictable cashflows of a sufficiently large portfolio of ERMs.

In the UK, ERMs are not actively traded in a secondary market, although the PRA is aware of some bilateral transactions between firms. Some ERM holdings have been externally securitised in the past, but the PRA is not aware of widespread use of securitisation as a means of funding ERMs in the UK.

It is common for lenders to require properties to be insured and maintained as part of the loan terms and conditions. There is a risk that maintenance may reduce over time as borrowers become older and potentially cash-poor, and the financial interest of the borrowers in the property reduces. This ‘dilapidation risk’ may lead to the performance (as an asset) of residential properties connected with an ERM being inferior to the performance of similar properties that do not have such a connection. Conversely, if the loan advanced is used to improve the property, then performance may be superior to similar but unimproved properties.

The responsibility for the sale of the property upon exit may, in some circumstances, rest with the lender who, for risk management purposes, may be willing to reduce the sale price in order to reflect a ‘quick sale discount’ on a vacant property, subject to obtaining the best price for the owner within reasonable timescales. If so, this will further increase the value of the NNEG. There may be a relationship between the desirability of offering a quick sale discount and market-wide movements in house prices.

Part of the loan interest rate can be considered as a charge for the cost of the NNEG. Higher interest rates lead to higher NNEG costs, other things being equal, and so (depending on how the ERM is priced) there is potentially a limit to how much the cost of the NNEG can be recouped through an increase in interest rates. Lenders therefore control their overall exposure to NNEGs primarily by restricting loan-to-value (LTV) ratios. LTVs are typically age-dependent, with LTVs lower at younger ages and increasing with age, reflecting changes in expected exit rates. Some lenders offer to advance larger amounts to borrowers in poor health, based on medical underwriting.

From the provider’s point of view, the future value of the ERM at any given exit date depends on whether or not the NNEG bites. If the NNEG does not bite, the loan plus accrued interest is repaid to the provider in full; if it does bite, the repayment is restricted to the value of the property. Thus the present value of the ERM is equal to the sum of: (i) the present value of the loan plus accrued interest at exit date, if and only if the NNEG does not bite; and (ii) the present value of receiving the property, if and only if the NNEG does bite. The computation of this involves, amongst other things, estimating the present value of receiving the property at exit, and – in order to estimate the probability of the NNEG biting – the volatility of the underlying property price.

Thus when the probability of the NNEG biting is low (typically at shorter durations) the value of the ERM approximates to the present value of receiving the loan plus accrued interest at exit. When it is high (typically at longer durations), the value of the ERM approximates to the present value of receiving the property at exit. Note that the present value of the ERM can never exceed the present value of receiving the property at exit, where a NNEG is in place.

The proportion of loans assumed to exit at any given date depends on the probabilities of death, entry into long-term care and early repayment. The mortality experience of the remaining borrowers can be expected to change as borrowers go into long-term care.

The challenges of valuing ERMs include estimating exit probabilities, estimating drawdown rates (for products permitting future drawdowns) and setting property-related assumptions. In addition, appropriate discount rates need to be set for the cashflows being valued. Some of these challenges are explored in the chapters that follow.

The former Individual Capital Adequacy Standards (ICAS) regime permitted insurers to derive a liquidity premium directly from ERMs. Where appropriate, this led to a reduction in the value of liabilities backed by ERMs. The current Solvency II regime has a similar concept in the form of the matching adjustment, but with more prescriptive rules than ICAS. In particular, ERMs do not have fixed cashflows and so do not meet the Solvency II eligibility criteria for inclusion in an MA portfolio. This has led some firms to restructure their ERM portfolios to meet these eligibility criteria

On 6 November 2015 the PRA published a Solvency II Directors’ update1 stating that during 2016 it would undertake an industry-wide review of ERM valuations and capital treatment. The Directors’ update referred to mark-to-model assets more generally but specifically mentioned ERMs, where there are particular challenges and a range of perspectives on the degree of risk embedded in ERMs and how they should be valued. This DP is the first part of this review.

ERM industry stakeholders (including without limitation life insurers, banks, building societies, other lenders, trade bodies, brokers, credit rating agencies, consultants, actuaries and auditors) are invited to participate in the DP by providing answers to the questions. The PRA also invites responses from academics, particularly those with experience of property valuation and the valuation of contingent claims in incomplete markets.