RBA Governor Glenn Stevens spoke at the ASIC Annual Forum. His speech covered the normal gamut of macroeconomic analysis, and this section on financial resilience. Two points of interest, first, a fall in house prices in areas of high growth would be “helpful” and foreign banks, who are currently quite active, may become skittish and exit in a downturn.
Turning to financial resilience, Australian banks’ asset quality has generally been improving over the past couple of years. Like their counterparts abroad, in the post‑crisis period the banks have lifted capital resources, strengthened liquidity and reduced use of short-term wholesale funding. So their ability to handle either a funding market shock or an economic downturn has improved compared with the situation in 2008. At this stage we do not see a material problem in Australian financial or non-financial entities accessing capital markets. If anything, net bond issuance by Australian banks has been strong over recent months, and to the extent that banks are able to take advantage of this availability to extend the term of their wholesale liabilities, that will further improve their resilience to any funding disturbances that may eventuate. Wholesale funding is a little more expensive than it was, though marginal funding costs are still no higher than the average cost of the funding being replaced.
On the topic of loan quality, the strengthening of lending standards for housing that has resulted from the actions of both APRA and ASIC was timely. So often over the years, tighter standards tended to come too late and reinforced a downturn after it had begun. These measures have occurred ahead, so far as one can tell, of the point in the cycle when measures of asset quality start to deteriorate. Some moderation in house prices in some of the locations where they had been rising most rapidly, while not the direct objective of the supervisory measures, is also, in my judgement, helpful.
In the business space, the banking system has fairly modest direct exposure to the falls in oil and other commodity prices, with lending to businesses involved in mining and energy accounting for only around 2 per cent of banks’ total lending.
More generally, competition to lend to business has increased over the past couple of years and business credit growth has picked up appreciably. Overall, this is to be expected and is a welcome development at a time when a missing element of the economic growth story is capital spending outside the mining sector, which appears to remain very weak. One notable trend is the aggressive expansion of some of the foreign banks active in the Australian market. Here there is a note of caution. If these are taking opportunities left on the table where local players (or earlier foreign players) were simply too conservative, all well and good. But one is duty‑bound to observe that there is a history of foreign players expanding aggressively in the upswing only to have to retreat quickly when more difficult times come. It is worth remembering that cycle.
The peak LVR’s on investment mortgage transactions is down according to a speech today given by Heidi Richards, General Manager, Industry Analysis APRA, which developed further the information published yesterday relating to mortgage underwriting standards. This is important because 62% of bank lending is mortgage related (a high). Whilst much of the information in the speech covered the same ground, which we discussed yesterday, there was a striking piece of data on the LVR’s of investment loans.
More recently, APRA’s initiative to rein in growth in the investor segment of the market has prompted a number of ADIs to use LVR caps as a lever to reduce loan approvals in this segment. Although many ADIs traditionally required more equity for investment loans, some ADIs reduced maximum LVRs for investors significantly over the course of 2015. Note the actual distribution of loans approved for investors is much lower than these maximum levels, and overall, LVRs for investors on average tend to be lower than for owner-occupiers.
Two observations. First different lenders clearly had – and have different policies relating to LVR limits, and second LVR limits have been reduced, by some in recent times. For example, a maximum from 92.5% down to 65%! Others have not changed their maximum ratios (though may not be lending to the maximum of course).
Towards the end of her speech she brings together the various steps taken to reduce lending, and referring to the hypothetical borrower model summaries:
…the hypothetical borrower exercise illustrated a material tightening of lending standards that we believe is appropriate and reflects more sensible risk assessment practices. Between 2014 and 2015, the maximum loan sizes that could have been extended to our four hypothetical borrowers declined by, on average, around 12 per cent for investors and 6 per cent for owner-occupiers. The actual change for individual ADIs was greater, up to 25 per cent in some cases. This should not be interpreted as an indication that actual loan sizes are shrinking, however, only that the maximum allowable loan for a given borrower income profile is now more conservative.
The next two charts illustrate the key drivers of this result. For owner-occupiers, the largest impact has come from the use of more realistic estimates of living expenses. For investors, interest-rate buffers that ADIs now apply more consistently to the borrower’s other debts are most significant. I should mention that there are also changes to standards at some ADIs that are yet to be implemented, due to systems constraints or other hurdles, so these results will continue to evolve and we will most likely conduct additional exercises in the future.
These changes reflect the policies of each lender, but it is always possible that practice may be divergent from policy. Lenders generally allow some scope for the standard credit criteria to be overridden by experienced lending staff. APRA would clearly be concerned if these tighter policies were being undermined in practice to any material degree.
As a result, we are taking a hard look at loans approved outside serviceability policy. Many loans are approved or declined based on automated criteria. In some cases, however, an application might be referred for a manual decision because it marginally fails a serviceability test. The loan might ultimately be approved by a lending officer with appropriate delegation if there is other evidence that the borrower can service the loan—this might be, for example, because there is other income that was not captured in the decisioning tool, the borrower is on maternity leave with temporarily lower income, or for bridging finance. However, there is also the potential for weaker loans being approved, and in our view ADIs need to have good oversight and monitoring of these approvals. APRA data shows a recent uptick in loans approved outside serviceability; anecdotal evidence indicates much of this relates to loans in the pipeline that were preapproved under older, looser criteria now being settled. So we expect to see this volume taper off.
Another way to look at the situation is that there are tranches of loans which were written under more generous underwriting terms, for at least the last 2-3 years. These loans may well have a higher probability of default down the track (after all why else would APRA want to tighten the criteria), so it will be interesting to see if indeed defaults rise higher than average in these loan pools. Across the board defaults are up, if only a little. For the major bank issuers, the 30 day delinquency rate increased to 1.15 per cent at December also up from 0.94 per cent at September according to Moody’s.
APRA’s Insight Issue One 2016 included a section on mortgage underwriting standards. The recent falls in average loan sizes noted in the recent monthly banking data reflects tighter underwriting standards. APRA data also highlights the diversity of underwriting standards in the market.
One key element of ADIs’ lending practices is the method by which they assess a customer’s ability to service a loan against a range of potential future circumstances. This assessment of loan serviceability is not merely a legal obligation for lenders; it is also an important, prudent risk management practice.
Loan serviceability methodologies
In making serviceability assessments of borrowers, most ADIs currently use a methodology in which they calculate the borrower’s Net Income Surplus (NIS). Computing NIS is a multi-faceted calculation, with a number of different inputs, and for which the relative importance of each input is not always clear. Assessing the relative prudence of NIS assessments across ADIs can therefore be problematic, as it can be difficult to determine the extent to which one conservative assumption outweighs another less- conservative assumption, and apparent minor differences in methodology can sometimes have a significant impact on the overall outcome.
To assess and compare lending standards across ADIs, one technique used by APRA has been a Hypothetical Borrower Exercise (HBE). In early 2015, APRA asked a number of the larger ADIs to provide their serviceability assessments for four hypothetical mortgage borrowers — two owner-occupiers and two investors — using their policies in place as at 31 December 2014. This allowed APRA to compare the lending decisions of ADIs based on identical borrower characteristics. Importantly, it also allowed APRA to disassemble assessments into their component parts. In May 2015, APRA outlined some results and conclusions from the first HBE.1
To test how lending policies had changed in response to APRA’s scrutiny, APRA ran a second HBE in late 2015, based on the policies ADIs had in place as at 30 September 2015. By asking the same population of ADIs to assess the same four hypothetical borrowers, not only could APRA compare across ADIs, it could also compare the same ADI at two different points in time.
The four charts below relate to the four calculation components for one of the hypothetical borrowers — in this case, a ‘typical’ investor. The blue bars show the results for December 2014, while the red dots show the September 2015 results for the same lender. Each chart is sorted with the most conservative lender for that particular component (as at September 2015) on the left, and the least conservative on the right.
Chart A – Income recognised (less tax and haircuts)
Percentage of gross pre-tax income
Bars represent individual lender data
Chart B – Minimum living expense assumptions
Percentage of borrower pre-tax salary income
Bars represent individual lender data
Chart C – New mortgage
Interest rate used in serviceability assessment
Bars represent individual lender data
Chart D – Existing mortgage
Interest rate used in serviceability assessment
Bars represent individual lender data
The current interest rate on the existing mortgage debt is 5.2%
Chart A shows income recognised, as a percentage of gross pre-tax income. While the assessment of PAYG salary income has usually remained the same between the two periods, a number of lenders have applied larger haircuts (i.e. discounts) to less stable sources of income such as overtime, bonuses, commissions, investment dividends and rental income.
Chart B shows minimum living expense assumptions as a percentage of pre-tax salary income. Some lenders have made quite large changes to this component of their NIS assessment. This impact has typically arisen from two main sources:
considering borrower-declared expenses where these are greater than calculated benchmarks; and/or
scaling living expense assumptions in line with income.
Chart C shows the interest rate used in the serviceability assessment for this new mortgage. Various lenders have increased that rate in response to APRA’s December 2014 letter, in which APRA stated that prudent serviceability policies should incorporate a ‘serviceability buffer of at least 2 per cent above the loan product rate, with a minimum floor assessment rate of 7 per cent.’
Chart D shows the interest rate used in the serviceability assessment for an existing mortgage commitment. Here, the changes are even more dramatic than for Chart C, as at the time of the first HBE a number of ADIs were not using any serviceability buffer on existing debt.
These four components combine to calculate NIS. Whilst there was little overall change in NIS for the lenders that were already relatively conservative in December 2014, lenders that were the least conservative in December 2014 generally reported a significant drop in calculated NIS using their September 2015 policies. These changes had the effect of tightening the spread of calculated NIS from the most to the least conservative ADI. Overall, the maximum loan sizes reported by ADIs for the four hypothetical borrowers declined by, on average, around 12 per cent for investors and 6 per cent for owner-occupiers. (Note that this does not imply actual loan sizes are falling across the board; indeed the average size of loans continues to rise.)
Conclusion
APRA’s HBEs have proven a simple but effective tool for examining the impact of changes to residential mortgage lending policies during 2015.
Overall, debt serviceability assessments now appear to be both more prudent and more consistent across ADIs, relative to December 2014. APRA will continue to engage ADIs on this issue in 2016 to assess whether the observed improvements in sound underwriting practices are maintained. APRA will also be examining the extent to which loans are able to be approved outside an ADI’s own (tightened) policy parameters.
In the RBA Bulletin, released today, there is a section which shows major bank margins have improved. Essentially, the story is one of falling deposit rates, plus change in mix, and rises in home lending rates independent of the cash rate in recent months. Consumers are bearing the burden whilst big business lending rates and margins are being compressed thanks to competition from overseas banks. The big banks are benefiting the most from the margin improvement, which shows again their market power.
Consistent with the large fall in interest rates on term deposits, the level of term deposits in the system declined in 2015, mostly due to some maturing deposits not being rolled over. In contrast, transaction and at-call savings deposits grew strongly in the year .
Throughout 2015, banks also adopted pricing strategies aimed at reducing deposits from institutional depositors (such as superannuation funds), which are more costly to banks under the LCR framework. The change in the mix of deposit funding lowered the cost of those funds by 3 basis points owing to particularly strong growth in transaction deposits, which carry lower interest payments. In part, this reflects the rapid growth of mortgage offset account balances through 2015, where funds are typically deposited in zero-interest rate accounts but are used to reduce the calculated interest on the associated mortgage. One implication of the increased use of such accounts is the high ‘implied’ cost of funds for banks – equivalent to interest forgone on mortgages. Interest rates on mortgages are much higher than those on deposit products, so banks implicitly pay their customers the mortgage rate on funds held in offset accounts. However, money held in offset only accounts for about 6½ per cent of at-call deposits.
They make the point that housing rates generally declined in line with the cash rate in the first half of 2015, with the average outstanding interest rate on mortgages falling by around 50 basis points over that period. In the second half of the year, however, banks adjusted their lending rates such that the average outstanding housing interest rate for investor loans was only modestly lower over 2015, while rates for owner-occupiers declined by roughly 30 basis points over the year. Interest rates on investor loans were increased midyear, following concerns raised by APRA about the pace of growth in lending to investors. Increases in investor lending rates ranged from around 20–40 basis points, and were applied to both new and existing investor loans.
In November, the major banks raised mortgage rates across both investor and owner-occupier loans by 15–20 basis points, citing the cost of raising additional equity to meet incoming regulatory requirements. Of particular relevance, the Financial System Inquiry’s Final Report recommended higher capital requirements for banks using ‘advanced’ risk modelling (the major banks and Macquarie Bank) in order to reduce a competitive disadvantage relative to other mortgage lenders (FSI 2014). The other Australian banks similarly increased mortgage lending rates, despite not facing the same regulatory costs as the major banks.
Business rates generally fell by more than the cash rate in 2015, with large business rates falling by around 70 basis points and small business rates by around 60 basis points. These lending rates remain at historic lows. Banks reported that declines in business rates beyond the changes in the cash rate were driven by intense competition for lending, including from the Australian operations of foreign lenders.
The major banks’ implied spread, being the difference between average lending rates and debt funding costs, increased by around 20 basis points over 2015. This change was driven in roughly equal parts by the decline in average funding costs relative to the cash rate, and an increase in the average lending rate. However, lending rates and debt funding costs tend to move in line with each other in the longer run. The contribution to the aggregate implied spread from higher lending rates was entirely due to increases in housing lending rates, with the implied spread on housing lending now higher than the previous peak in 2009. However, the measure of funding costs used to calculate implied spreads does not account for the increased share of relatively expensive equity funding. As such, the increase in the implied spread for housing lending is likely to overstate the true change in major banks’ margins for this activity. Implied spreads on business lending declined over 2015. Consistent with strong competition, implied spreads on large business lending have returned to pre-global financial crisis levels, when there was strong competition, business conditions were highly favourable and risk premia were compressed. Much of the competition is coming from foreign banks, with the average rate on business loans written by foreign banks significantly lower than the rate being charged by Australian banks.
The average implied spread on other Australian banks’ lending has been around 25 basis points lower than for the major banks since 2005. However, there is considerable variation in implied spreads of the other Australian banks, driven more by the high variation in lending interest rates across banks than variations in funding costs. In contrast to the major banks, the spread on other Australian banks’ lending for housing declined over 2015 with their lending rates falling by more than their funding costs. The other Australian banks’ spread on business lending also decreased in 2015. The spread on business lending remains higher for the other Australian banks, which reflects the fact that these banks generally lend more to smaller business than the major banks, and do not compete as heavily with the major and foreign banks on large business lending.
Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft. A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. However, global economic and financial developments continue to pose risks. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo. Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.
In their statement of monetary policy, the Policy Board of the Bank of Japan said that Japan’s economy has continued its moderate recovery trend, although exports and production have been sluggish due mainly to the effects of the slowdown in emerging economies.
Overseas economies have continued to grow at a moderate pace, but the pace of growth has somewhat decelerated mainly in emerging economies. In this situation, the pick-up in exports has recently paused. On the domestic demand side, business fixed investment has been on a moderate increasing trend as corporate profits have been at high levels. Against the background of steady improvement in the employment and income situation, private consumption has been resilient. Meanwhile, the pick-up in housing investment has recently paused and public investment has been on a moderate declining trend, albeit remaining at a high level. Reflecting these developments in demand both at home and abroad, industrial production has continued to be more or less flat. Financial conditions are highly accommodative. On the price front, the year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is about 0 percent. Although inflation expectations appear to be rising on the whole from a somewhat longer-term perspective, they have recently weakened.
With regard to the outlook, although sluggishness is expected to remain in exports and production for the time being, domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors, and exports are expected to increase moderately on the back of emerging economies moving out of their deceleration phase. Thus, Japan’s economy is likely to be on a moderate expanding trend. The year-on-year rate of change in the CPI is likely to be about 0 percent for the time being, due to the effects of the decline in energy prices, and, as the underlying trend in inflation steadily rises, accelerate toward 2 percent.
Risks to the outlook include uncertainties surrounding emerging and commodity-exporting economies, particularly China, developments in the U.S. economy and the influences of its monetary policy response to them on the global financial markets, prospects regarding the European debt problem and the momentum of economic activity and prices in Europe, and geopolitical risks. Against this backdrop, global financial markets have remained volatile. Therefore, due attention still needs to be paid to a risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected.
The Bank will continue with “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate,” aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner. It will examine risks to economic activity and prices, and take additional easing measures in terms of three dimensions — quantity, quality, and the interest rate — if it is judged necessary for achieving the price stability target.
With a view to implementing “QQE with a Negative Interest Rate” smoothly, the Bank decided on operational details. Namely, (1) each financial institution’s “Macro Add-on Balance,” to which a zero interest rate is applied, will be reviewed every three months in principle; (2) in light of the role of money reserve funds (MRFs) in fund settlement for securities transactions, the amount outstanding of MRFs entrusted to a trust bank will be added to its Macro Add-on Balance (up to the amount outstanding of MRFs entrusted to this trust bank during the previous year); and (3) with the aim of further supporting financial institutions’ efforts to increase lending, in case where a financial institution increases the amount outstanding of borrowing from the Bank through the Loan Support Program and the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the Great East Japan Earthquake, twice as much as the amount of increase will be added to this financial institution’s Macro Add-on Balance.
They also provided details on some of their planned operations:
(1) Quantity Dimension: The guideline for money market operations The Bank decided, by an 8-1 majority vote, to set the following guideline for money market operations for the intermeeting period: The Bank of Japan will conduct money market operations so that the monetary base will increase at an annual pace of about 80 trillion yen.
(2) Quality Dimension: The guidelines for asset purchases With regard to the asset purchases, the Bank decided, by an 8-1 majority vote, to set the following guidelines: a) The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen. With a view to encouraging a decline in interest rates across the entire yield curve, the Bank will conduct purchases in a flexible manner in accordance with financial market conditions. The average remaining maturity of the Bank’s JGB purchases will be about 7-12 years. b) The Bank will purchase exchange-traded funds (ETFs) so that their amount outstanding will increase at an annual pace of about 3 trillion yen until the end of March 2016 and, from April, at an annual pace of about 3.3 trillion yen.1 It will also purchase Japan real estate investment trusts (J-REITs) so that their amount outstanding will increase at an annual pace of about 90 billion yen. c) As for CP and corporate bonds, the Bank will maintain their amounts outstanding at about 2.2 trillion yen and about 3.2 trillion yen, respectively.
(3) Interest-Rate Dimension: The policy rate The Bank decided, by a 7-2 majority vote, to continue applying a negative interest rate of minus 0.1 percent to the Policy-Rate Balances in current accounts held by financial institutions at the Bank.
APRA has written to all ADI’s with regards to the spate of mortgage reclassification between investment and owner occupied loans which amounts now to around $35bn of adjustments in the past few months. Reclassification seem to emanate from internal review within the banks when APRA introduced 10% speed limit on investment loans, and also is customer initiated following the price differences between owner occupied and investment mortgages which have emerged. These movements are “strange” and may reflect some divergence from the true state of play. The mix of loans clearly has an impact on policy, and has the potential later to impact potential capital requirements.
So APRA’s warning is timely. There are however no overt penalties of inaccurate reporting and some banks have made adjustments without any formal statements, although others did disclose significant recalculations.
A number of ADIs have recently reported significant changes in housing loan purpose between investment and owner-occupied. This letter provides guidance to assist authorised deposit-taking institutions (ADIs) report these data to APRA consistently and accurately.
These data are used in public policy decisions, prudential supervision and statistical publications. Where the change in loan purpose is not reported correctly (i.e. from the period that the change occurred), APRA, the Reserve Bank of Australia (RBA) and the Australian Bureau of Statistics (ABS) are impeded in accurately ascertaining the underlying movements in housing loans.
Reporting of fixed term housing loans must reflect the current purpose of the loan because the split by housing loan purpose is important for monetary policy and financial stability considerations.
Use of data
APRA uses these data for supervision and publication. The data are also used by the RBA and the ABS.
The classification of investment and owner-occupied housing loans is used by the RBA to:
calculate the financial aggregates;
assess the transmission of monetary policy through the financial system;
assess potential risks to financial stability; and
meet international statistical standards and reporting obligations.
The ABS uses the domestic books data to compile Gross Domestic Product, of which ADIs are a major component
Banks’ reporting of Statement of Financial Position ARF 320.0 (ARF 320.0)
In order to report loan data on the ARF 320.0 accurately each period, according to whether a loan is owner occupied or investment housing, ADIs must report data for existing (non-revolving) housing loans by current loan purpose.
The instructions to ARF 320.0 item 5.1.1.1 owner-occupied housing loans state that the figure reported must:
Include:
the value of housing loans to Australian households, for the construction or purchase of dwellings for owner occupation; and
revolving credit or redraw facilities originally approved for a purpose of predominantly owner-occupied housing.
The instructions to ARF 320.0 item 5.1.1.2 investment housing loans state that the figure reported must:
Include:
the value of investment housing loans to Australian households, for the construction or purchase of dwellings for non-owner occupation; and
revolving credit or redraw facilities originally approved for a purpose of predominantly non-owner-occupied housing.
Therefore:
when an ADI becomes aware there is a change in the purpose of an existing (non-revolving) housing loan between investment and owner-occupied, the ADI must report that loan under the new purpose on the ARF 320.0 from the month that the change in purpose occurred; but
for housing loans to households comprising revolving credit secured by residential mortgage, the instructions state that the loan must NOT be reported under the new purpose but continue to be reported under the purpose of the loan for which it was originally approved.
Loans must be reported according to the purpose of the loan. Where the purpose of a loan is not for the purchase or construction of a dwelling, the loan should NOT be recorded under item 5.1.1.1 or 5.1.1.2 of ARF 320.0: the loan should be reported under the relevant loan item elsewhere in ARF 320.0. In particular, non-housing loans that are secured by residential property mortgages should not be reported under item 5.1.1.1 or 5.1.1.2, but reported under the relevant loan item elsewhere in ARF 320.0. For example, a loan to a sole trader business secured by a residential property mortgage would be reported in item 5.3 Loans to non-financial corporations.
Credit unions’ and building societies’ reporting of Statement of Financial Position ARF 323.0 (ARF 323.0)
In order to report data on the ARF 323.0 accurately each period, according to whether a loan is owner occupied or investment housing, ADIs must report data for existing (non-revolving) housing loans by current loan purpose. Switching of purpose between investment and owner-occupied housing loans should be recorded under the new purpose on the ARF 323.0 from the month that the change in purpose occurred.
As per the ARF 323.0 instructions, fixed term housing loans should be reported per the current purpose and therefore should change category when the purpose changes. Revolving credit and redraw facility housing loans should continue to be reported under the purpose that the loan was originally approved for.
Housing Loan Reconciliation ARF 320.8 (ARF 320.8)
Loans which switched purpose between investment and owner-occupied housing loans should be reported under the new purpose in the outstanding stocks on ARF 320.8 Tables 1, 2 and 3.
In Table 1 of ARF 320.8, if the changed purpose of housing loans is recorded in an ADI’s system as an internal refinance, then the change in classification should be reported as ‘Excess repayments due to sale of property or refinancing’ under the original purpose, and also as ‘Drawdowns (new loans and redraws)’ for the new purpose. An example of an internal refinance is when a new contract is signed by the customer. If the reclassifying by housing loan purpose is not recorded in your system as an internal refinance, then the reclassification should be recorded as ‘Other adjustments’ under both the original and new purpose. Once the reclassifying by housing loan purpose has occurred, any other flows related to that loan should be recorded under the new purpose.
In Table 1, the flow for the reporting period should be recorded under the new purpose. Opening balances in Table 1 of the supplementary information template should be reported as nil. In Tables 2 and 3, the balances should be recorded under the new purpose.
As per the Housing Finance ARF 392 series and Personal Finance ARF 394 series instructions, reclassifying by housing loan purposes should not be reported as a new loan approval if there is no change in the property offered as security or the lender. As such, it should not be captured in Table 4.
Housing Finance ARF 392 (ARF 392) series
The general instructions for ARF 392 (page 5) state that institutions should exclude commitments to refinance existing loans where there is no change in the property offered as security and the institution was the original lender. Therefore, switching of purpose between existing investment and owner-occupied housing loans should not be reflected in the housing approvals reported on the ARF 392. Loan purpose switching does not qualify as a new commitment, nor is it an external refinance.
Personal Finance ARF 394 series
Switching of purpose between existing investment and owner-occupied housing loans should not be reflected in new commitments reported on the ARF 394 in ‘Loans for personal investment purposes – dwellings for rent/resale’ and ‘Loans for personal investment purposes – refinancing’. Loan purpose switching does not qualify as a new commitment, nor is it an external refinance.
Banks’ reporting of Impaired Assets ARF 220.0
Loans which switched by purpose between impaired investment and owner-occupied housing loans and between past due investment and occupied housing loans should be recorded under the new purpose categories on the ARF 220.0 Parts 1B and 2B from the reporting period that the reclassification occurred.
The Basel Committee on Banking Supervision has issued for consultation Pillar 3 disclosure requirements – consolidated and enhanced framework. Pillar 3 of the Basel framework seeks to promote market discipline through regulatory disclosure requirements. The proposed enhancements include:
the addition of a “dashboard” of key metrics,
a draft disclosure requirement of hypothetical risk-weighted assets calculated based on the Basel framework’s standardised approaches, and
enhanced granularity for disclosure of prudent valuation adjustments.
The proposal also incorporate additions to the Pillar 3 framework to reflect ongoing reforms to the regulatory framework. These include, for example, disclosure requirements for:
the total loss-absorbing capacity (TLAC) regime for global systemically important banks,
The Committee’s proposal would also consolidate all existing Pillar 3 disclosure requirements of the Basel framework, including the leverage ratio and liquidity ratios disclosure templates. Together with the Revised Pillar 3 disclosure requirements issued in January 2015, the proposed disclosure requirements included in this consultation would comprise the single Pillar 3 framework.
The Committee welcomes comments from both Pillar 3 users and preparers on the proposals described in this consultative document here by Friday 10 June 2016.
However, latest results from our surveys indicate that ever more households want to bank digitally. So, given the compelling data from our surveys, what has happened to the number of branches in Australia in recent years? As branches are expensive, have outlets been closed in response to the digital migration?
Analysis from the APRA Point of Presence databases shows that the total number of branch outlets has grown slightly between 2013 and 2015. There were 5,478 outlets in 2013, 5,496 in 2014 and 5,480 in 2015. Overall almost no change.
Analysis of the count of branches by selected banks, which includes agency outlets, shows that most have reduced their footprints slightly, other than Bendigo/Adelaide Bank, who grew their footprint by 5.6% in 204-15.
On the other hand, Bank of Queensland has reduced the number of franchise branches and recorded a drop of 8.1% in 2014-15.
We conclude that so far banks are not responding to the digital revolution by closing branches, although some have reconfigured existing ones into smaller and more efficient units.
We segment households into three groups. Digital Luddites are the last bastions of traditional banking and centre on branch and ATM access, value face to face conversations, and the bank brand. They are migrating from PC’s to smart devices to access online bank services (if they use them).
In contrast, Digital Natives expect 24×7 access, mobile banking, near-field payments and online applications. They expect their bank to be in the social media environment, and would value video-conferencing with the bank advisor. Branch access, bank brand and face to face conversations are not important to this group.
Digital migrants are somewhere in between, however, more are demanding more from online services.
We think that existing players need to be thinking about how they will deploy appropriate services through digital channels, as their customers are rapidly migrating there.
We see this migration to digital is more advanced among higher income households. So players which are slow to catch the wave will be left with potentially less valuable customers longer term.
Here is a glimpse of our latest profitability index which shows how much less valuable Digital Luddites are compared with digitally aligned households. There is a real risk of stranded costs in the branch network.
Players need to adapt more quickly to the digital world. We are past an omni-channel (let them choose a channel) strategy. Digital migration needs to become central strategy because the winners will be those with the technical capability, customer sense and flexibility to reinvent banking in the digital age.
The bank branch has limited life expectancy. Banks should be planning accordingly.
The Australian banking industry is a classic economic ‘oligopoly’ with the so-called ‘Four Pillars’ or ‘Big Four’ (National Australia Bank (NAB), Commonwealth Bank of Australia (CBA), ANZ and Westpac) dominating not only the banking sector but the whole financial sector and arguably the economy.
The big four banks account for over 25% of the market capitalisation of the ASX 200, and are valued at over $360 billion. In total, the four banks reported assets in 2015 of some $3.5 trillion or about 10 times the size of BHP and RIO combined, and profits for their latest financial year of over $30 billion between them.
In an oligopoly, the dominant players operate a very similar business model. This is true of the Big Four, which operate within a structure known as ‘universal banking’. Not only do each of these behemoths run a traditional retail and business bank, they also have wealth management (mainly retail superannuation fund management) and insurance subsidiaries. To complete the picture, each of the four runs a wholly owned bank in New Zealand, again dominating the banking system in that country. The banks operate throughout Australasia, often with competing branches (and valuable jobs) in each small town – Australia is ‘over banked’.
The risks of having one of the most concentrated banking systems in the world were outlined in 2012 by the International Monetary Fund (IMF), it warned that Australia’s banks had:
“broadly similar business models and reliance on offshore funding leave them exposed to common shocks and disruptions to funding markets. Against a still worrying global environment, these risks will need to be closely monitored, particularly if the domestic economy slows sharply.”
Among the four banks, there is constant jockeying for prominence and any one time one bank climbs to the top of the pile. At the moment, the clear winner is CBA, largest by capitalisation, latest annual profits and staff employed with the lowest Cost to Income Ratio (CIR). Another winner is Westpac, the smallest by assets and employees but with an enviable CIR and Net Interest Margin (NIM) leading to excellent profit results. Meanwhile, NAB trails the others by profitability and with a low NIM and high CIR, will be likely do so for some time. Nonetheless, NAB is by any standards a very profitable company, if a bit overshadowed by the other banks this year.
It should be noted that not all banks report their financial results at the same time in a completely consistent fashion. However each quarter the banks are required to report their risk numbers to the Australian Prudential Regulation Authority (APRA), the banking regulator. These so-called APS 330 reports give a picture (albeit slightly murky) of where banks are taking risks and the size of those risks.
These numbers show that the banks hold roughly similar amounts of assets, so-called Risk Weighted Assets (RWA) and associated capital. Although Westpac, being slightly smaller, has about 10% less of each. This data shows Big Four banks are still predominantly lending institutions with about 86% of their Risk Weighted Assets (RWAs) related to credit.
While ANZ has a higher proportion of corporate and business lending than the others, about 23% of its credit (RWAs) relates to retail, mainly residential mortgage, lending. With a few notable exceptions, such as CBAs exposure to interest rate risks and NAB’s operational risks, the risk numbers are similar across the banks.
From an analysis of prior APS 330 reports (not shown), it appears that, although the RWAs for residential mortgages have increased slightly for all banks (mainly because lending has increased), the banking sector has not factored in much additional capital to cover the potential for the busting of a housing bubble.
The large Australian banks will in the next year face headwinds from a number of directions. First, any busting or even deflation of Australia’s real or imagined housing bubble will undoubtedly give the banks serious headaches.
Likewise, the end of the mining boom is already beginning to take its toll on mining companies, even the largest. If the gloom spreads, loans to the sector might be under pressure. Last, but far from least, banking scandals will definitely come to the fore this year especially market manipulation and product misselling.
Disruption from technology
Following the retreats of both NAB and ANZ from their respective overseas forays, it looks like the four banks are going to resemble each other even more as they are all embarking on strategies that target the same Australasian retail, mortgage and business markets. But there is at least one significant point of difference between the banks that might give a clue to potential shifts in future.
In banking, as in other industries, technology is critical. After an outsourcing deal that went sour, in 2008 the CBA board was forced (some say was brave enough) to embark on a complete refresh of its ageing IT systems, often called a Core Systems Replacement (CSR).
After some significant project blowouts, CBA eventually got the CSR to work and their annual profit numbers are beginning to reflect that success. Meanwhile, NAB is in the middle of its almost decade long CSR project (called Nextgen) and is constantly changing its management, which does not bode well for its completion in the near future. On the other hand, the new Chief Information Officer (CIO) of Westpac has denied that the firm needs a CSR, and has embarked on a much needed face-lift to the bank’s ageing systems.
After a number of attempts to change its core systems, the new management of ANZ have just announced that they are hiring an ex-Google executive to become its head of ‘digital banking’ – but to do what is still not certain.
Given the oft repeated fact that some 70% of IT projects fail, it looks like one or more of the banks are in for some big headaches over the next decade.
For this snapshot, the information is collected from the latest annual reports (2014-2015), except for CBA which reported its semi-annual numbers in February 2016. The risk figures are taken from the 2016 December quarter APS 330 reports of the banks to APRA, which are available at the banks’ websites.
Author: Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University
