Economics and Banking – Page 410 – Digital Finance Analytics (DFA) Blog

Central banks and digital currencies

In a speech delivered at the London School of Economics, Ben Broadbent outlines the importance of innovations in digital currencies – and what the economic implications of central banks introducing their own might be.

Ben explains that digital currencies like Bitcoin are, in themselves, extremely unlikely to become widely used alternative units of account, displacing the dollar or pound. Rather, the interesting aspect of these digital currencies is the settlement technology that underpins them, the so-called “distributed ledger”. This system allows transfers to be verified and recorded without the need for a trusted third party: the role that central banks currently perform for commercial banks.

Ben argues that, while clearing payments through a distributed ledger rather than a central bank may not have any significant macroeconomic effects in and of itself, what would prove significant is how the technology could be used to widen access to the central bank’s balance sheet beyond the commercial banks it currently serves.

Ben states: “That might mean adding only a narrow set of counterparties – non-bank financial companies, say. It might mean something more dramatic: in the limiting case, everyone – including individuals – would be able to hold such balances.”
The potential that distributed ledgers offer to expand access to central bank balance sheets encapsulate the distinction between ‘private’ digital currencies – which essentially seek to substitute central banks as settlement agents – and ‘central bank digital currencies’, which could result in central banks expanding their role as trusted third parties.

The macroeconomic impact of central bank digital currencies would depend on their precise design and the degree to which they competed with the main form of money in the economy currently: commercial bank deposits. As Ben notes, the public is already able to hold claims on the central bank through cash – and if all a central bank digital currency did was to offer a substitute for paper currency, it’s not clear the macroeconomic effects would be that substantial.

Even then, however, Ben argues you would expect to see some drain from commercial banks. This drain would be greater the more closely a central bank digital currency resembled a genuine bank account. Notably, flows into central bank digital currencies, and out of commercial banks, would pick up at times whenever people were concerned about the strength of the financial system.

Any such shift towards a relatively widely accessible central bank digital currency would therefore have two important implications: “On the one hand, it would probably make [commercial banks] safer. Currently, deposits are backed mainly by illiquid loans, assets that can’t be sold on open markets; if we all tried simultaneously to close our accounts, banks wouldn’t have the liquid resources to meet the demand. The central bank, by contrast, holds only liquid assets on its balance sheet. The central bank can’t run out of cash and therefore can’t suffer a “run”.

Ben adds: “On the other hand, taking deposits away from banks could impair their ability to make the loans in the first place. Banks would be more reliant on wholesale markets, a source of funding that didn’t prove particularly stable during the crisis, and could reduce their lending to the real economy as a result.”

Ben reflects that, in many ways, this debate on the future of digital currencies is resurrecting some of the older arguments in economics. Some admirers of private digital currencies like Bitcoin see them as a means of bypassing central banks altogether – a campaign recognisable to advocates of “free banking” in the 19th century. If it were a close substitute for bank deposits, on the other hand, a central bank digital currency would mean a more prominent role for the central bank; it would also represent a shift towards a “narrower” banking system, another argument with a long history.

Ben notes that while some have suggested that central banks will have to issue digital currencies to meet the “competitive threat” posed by private sector rivals. However, for Ben, “the more important issue for central banks considering such a move will be what it might mean for the funding of banks and the supply of credit”.

ASIC and brokers: Communication breakdown?

Further information on the debate about Mortgage Brokers, this time from MPA. The article highlights the issues in play.

From Sam Richardson, Mortgage Professional Australia.

Navigating Regulation is part and parcel of running a business. Occasionally however, it determines the future direction, not only of a business, but of an entire industry, as it did in 2008/9 with the passing of the National Consumer Credit Protection Act. Eight years on, 2016/17 looks likely to have an equally strong impact on brokers’ businesses, driven by a perfect storm of regulatory and political activity.

At the request of the Assistant Treasurer, brokers’ remuneration is set to be investigated by ASIC, who are themselves the subject of a government ‘capability review’ – just one of many consequences of 2014’s Financial System Inquiry. That’s not to mention debates over user-pays funding, interest-only lending and more.

In short, brokers and ASIC will need to closely engage with each other – more than they have at any time since the NCCP. Yet, a recent poll by MPA sister-title Australian Broker found that understanding between the industry and regulators appears to be at alarming lows. The magazine asked its readers, ‘Do you agree that ASIC understands the mortgage industry?’, and 86% of respondents disagreed. The magazine took the results of the poll to several prominent brokers, who provided suggestions for this lack of trust.

What they found is that brokers have four areas of concern: that ASIC doesn’t understand the technical aspects of brokers’ compliance procedures; that ASIC should instead be investigating the banks; and finally – and crucially – that ASIC don’t communicate enough with brokers or industry associations. Undoubtedly, current debates, such as over interest-only lending, have not endeared the regulator to brokers, and this dissatisfaction appears both more deeply engrained and wide-ranging. Therefore, this article will also look beyond current debates, examining where communication between brokers and their regulator has broken down, and what can be done to repair the relationship.

1 Broking’s industry bodies and ASIC
Beginning with ASIC’s understanding of the industry, it seems that brokers hold a very different view to their own industry associations. MPA put the 86% statistic to the FBAA’s Peter White, whose reply was unequivocal. “Unfortunately, that is the brokers’ problem,” he explained. “ASIC understands brokers, and to say that they don’t is very, very wrong.”

Drawing on his work with regulators from the introduction of the NCCP onwards, White insisted that “ASIC’s got some enormous skillsets and [people] who understand broking very, very well”.

Similarly, the MFAA’s CEO Siobhan Hayden doesn’t believe the statistic is completely fair. “They [ASIC] are fairly well versed,” she said. “They come out to some of our broker events, they talk to brokers, they engage with us regularly. They have a good understanding of how brokers work and how they’re remunerated.”

Indeed, ASIC personnel have attended recent broker events, including the FBAA’s national conference last November, where they addressed attendees and then answered brokers’ questions.

Within ASIC’s corporate structure – illustrated in our box out – there are several individuals of whom brokers should be aware. The MFAA point to Michael Saadat, senior executive leader of deposit takers, credit & insurers (which includes brokers), who is overseen by ASIC deputy chair Peter Kell. In terms of experience, Saadat worked in compliance at ASIC, Citibank and previously PwC, while Kell comes from a consumer protection background, at ASIC, the Australian Competition and Consumer Commission and CHOICE. Both are well established in their jobs – Saadat has been at ASIC since 2005 (excluding a brief two year spell at Citibank), Kell from 1998-2004, rejoining the regulator in 2013.

2 How ASIC relates to other regulators
Saadat and Kell certainly have the experience to understand broking, but they’re not the only decision makers brokers have to deal with. Australia’s regulatory framework has several layers, of which ASIC is just one. As FBAA chief White notes, ASIC isn’t necessarily the decision maker, but instead the ‘policeman’ tasked with enforcing them. The Treasury sets ASIC’s priorities and is thus the cause of much misunderstanding. “We get changes of ministers on a regular basis now,” says White. “Not all the ministers understand brokers on a federal level.” The remuneration inquiry, for instance, was announced by assistant treasurer Kelly O’Dwyer, although the inquiry itself will e carried out by ASIC.

The importance of the Federal Government in fi nancial regulation was underlined by the MFAA’s appointment of a professional lobbyist, GRACosway, which CEO Hayden says at the time was a response to members who believed government needed to be educated about broking. “It is clear from media comments in the past 12 months that some representatives of Reserve Bank of Australia (RBA), Australian Prudential Regulation Authority (APRA) and Treasury do not have a detailed understanding of our industry and this needs to change,” says Hayden.

Indeed, while not the subject of this article, APRA have enormous infl uence over brokers. As Hayden puts it, brokers are not APRA’s ‘direct customers’ – the organisation regulates lenders – but deals with brokers as a distribution channel of those lenders. APRA regularly makes comments about brokerintroduced loans, as they did in 2015, but has a much lower level of engagement – it meets with the MFAA around twice a year, unlike ASIC’s quarterly consultations. The two have clashed, notably in August last year when APRA chairman Wayne Byres warns that broker-originated loans were ‘higher risk’.

While ASIC and APRA co-ordinate through the Council of Financial Regulators, brokers who approach ASIC about APRA policies (or vice versa) will get nowhere, leading to frustration and confusion between the two. “I think sometimes the mandates ASIC and APRA have are not well understood by brokers”, MFAA CEO Hayden tells MPA. “I understand why, when a broker’s business is affected by these changes, they do get a sense of frustration from it, but sometimes it’s not channelled at the correct regulator.” She mentioned complaints by brokers aimed at ASIC about recent bank rate rises and serviceability changes – measures that were driven by APRA.

3 Where communication is failing
Both the MFAA and FBAA see broker misinformation as a cause for their distrust of ASIC, but it’s also a symptom. What it indicates is that a significant number of brokers aren’t being provided with the information so that they can deal with the appropriate regulator at the right time – and it’s not the fi rst time this problem has been raised. In 2013, ASIC commissioned a report into its stakeholders – including brokers – where ‘clearly communicating what ASIC is doing’ was among four key limitations identified by ASIC Chairman Greg Medcraft in his introduction to the report.

In response, Medcraft proposed four measures, two of which related to ASIC’s MoneySmart fi nancial literacy program for consumers, the others being to improve social media channels and review ASIC’s website. He defended ASIC’s record on communication, noting the organisation sends out around 300 media releases and takes part in 100 interviews a year. With tens of thousands of stakeholders, a large quantity of communication is understandably necessary, yet brokers still don’t appear to be getting the information they need.

ASIC’s communication directly with brokers and the press is generally to the point, relating to the results of individual enforcement actions, bans and other penalties. There are notable exceptions: ASIC’s publicly available corporate plans (which are generalist in scope); Saadat’s talk at the FBAA’s conference; and deputy chairman Kell’s interview with Australian Broker in April 2015, in which he discussed the ASIC’s focus on interest-only lending for the year ahead. Overall, however, ASIC rarely discusses future priorities or coming regulation in public, despite this being exactly the sort of information brokers need.

So how does ASIC consult and communicate with brokers? The answer – or rather the impression brokers get – is almost entirely through the two industry bodies, the MFAA and FBAA.

There are good reasons for a top-down approach, MFAA CEO Hayden explains. “They just don’t have the resources to adequately engage with all the brokers that may seek them out with enquiries or questions to ASIC.” The MFAA invites ASIC personnel to its PD days and relays its messages through its email and LinkedIn networks, in part because ASIC are “defi nitely not resourced adequately to directly support the market”. Indeed, a glance at ASIC’s budget (illustrated in the accompanying sidebar) shows that just five per cent of its budget for credit licensees goes into engagement and education.

Both the MFAA and FBAA told MPA that ASIC involves them throughout the development of regulation, but as White puts it, “What you’ll see when it becomes public domain is nearing the end of the stick”. Until that point, ASIC’s dealings take place not only behind closed doors, but under the understanding that everything discussed is confi dential. That explains why, when consultation papers do appear, the regulation they discuss is relatively fully formed. The advantage of this for brokers is that the consultations are more relevant, both in their subject matter and timing, Hayden explains. “It’s prudent to talk about information when it’s meaningful and you’re wanting feedback.”

There’s another reason why ASIC deals with industry bodies, according to FBAA CEO White. “The whole objective of writing regulation is not about achieving commercial bias,” he notes. “If I’m the head of a major brokerage or aggregator, and I’m pushing hard on the door of a regulator for something, it’s probably because it’s got a commercial advantage for me.” ASIC can deal with industry associations as “representatives of the total marketplace.”

While most major players in broking tend to deal with ASIC through the MFAA and FBAA, ASIC themselves say they also deal directly with major brokerages and aggregators. AFG managing director Brett McKeon revealed in a January letter to brokers that he’d met with representatives of ASIC and APRA, in addition to two senators.

Indeed, as regulation begins to really affect brokers businesses, one would expect an increasing number of aggregators and franchises to directly challenge the regulators. Their arguments are undoubtedly commercially biased, but their insights and data may nevertheless be valid, meaning regulators and legislators will (and indeed already do) listen to them. As ASIC tells MPA: “We are conscious that some perspectives are only available directly from the firms themselves.”

4 Finding a new approach to communication
Practically, the disadvantage of the behind closed-doors approach is that brokers experience new regulation as a fait accompli, with their opinion or expertise seemingly ignored by the regulator. So how can ASIC challenge that perception? MPA looked at the relationship between broking and regulation in New Zealand and how small business stakeholders can be better integrated in the
regulatory process.

Despite being a much smaller market than Australia, regulation of brokers and financial advisors in New Zealand makes for an interesting comparison. The MFAA has been working increasingly closely with New Zealand’s Professional Adviser’s Association, who will be involved in the MFAA’s Darwin and Beyond conference in June, and who, since 2012, represent brokers and financial advisors to the New Zealand regulator, the Financial Markets Authority.

MPA spoke to PAA board member Angus Dale-Jones about the difference between regulator-industry engagement in Australia and New Zealand. Dale-Jones is well equipped to make the comparison, having worked at ASIC for 17 years, including time as WA regional commissioner, before moving to the New Zealand Securities Commission, the predecessor of the FMA. As in Australia, the FMA are looking to strengthen financial services regulation, Dale-Jones tells us, but are doing so in a much more positive way.

Crucially, the way regulation is developed in New Zealand is “superbly better then Australia”, as Dale-Jones puts it. This is thanks to an extra layer in the process – the Code Committee, which is made up of 11 industry figures appointed by the FMA. The committee originally drew up and now periodically reviews the New Zealand code for financial advisors.

“It’s proved to be incredibly flexible and useful in the New Zealand context,” Dale Jones explains. “It’s meant that advisors and their associations have been able to get on board with the committee and understand their objectives and the direction of their thinking.”

According to Dale-Jones, the committee is a way of drawing on the expertise of “current practitioners who understand today’s issues.” It also means that minor changes to the code don’t have to involve changes in legislation, as the committee can make these changes. Moreover, Dale-Jones believes such regulator industry convergence isn’t just a New Zealand phenomenon. “In the past decade, around the world there has been a colossal change in the interaction between professional associations, industry bodies and the regulators,” he says. “Now it is seeking more of a convergence between those players, looking at ways of getting outcomes that makes everybody happy, so you’re starting to see far greater interest in self-regulatory solutions.”

5 Moving towards self-regulation in Australia
With regulatory initiative trickling down from government or even international level – such as the raising of bank capital requirements – Australia doesn’t appear to have a particularly self-regulating financial system, at least in the third-party mortgage space. Indeed, one might presume the level of misunderstanding between brokers and ASIC would stop such an initiative in its tracks. Nevertheless, there are a number of reasons why brokers should make themselves part of the regulatory process.

Whether or not they seek it, ASIC needs brokers’ input. One major changeover in the past 12 months has been ASIC’s use of industry-generated reports, according to MFAA CEO Hayden. “What I’ve tried to bring to the table, with the support of the board, is getting our hands on more data… Things like the Ernst and Young report, which [involved] 700 customers and nine key lenders in our industry, was really well received by ASIC. Michael Saadat and Robert Allen both called me and said, ‘That’s great information – how often will you run it?’”

Similar one-off reports will appear throughout the year, including a study at the major banks’ loan books by accountancy giant Deloitte to counter APRA’s comments about the risks relating to broker-originated loans. In late February, the MFAA released the first in a series of regular reports, the Industry Intelligence Service (IIS), providing regular twice-yearly statistics on brokers, in conjunction with business benchmarking firm Comparator.

In order for their reports to have the most impact, the MFAA has begun consulting with ASIC before commissioning reports. “We’re not an agent of them as such,” notes Hayden. “But we’re trying to ensure that if we’re investing money in this analysis, that we’re meeting the stakeholders’ requirements – not just aggregators and brokers, but ASIC as well… I don’t think they’ve got the time or the resources to do the detailed analysis that we conduct.”

Industry-driven reports have two beneficial effects. Firstly, by dictating the focus of the reports the industry can help influence the terms of the debate at a regulatory level, for example, countering accusations of broker commission distorting the market by showing how much the average broker actually makes (as the MFAA’s abovementioned benchmarking studies reveal). It also helps correct inaccuracies in reporting by external players, such as by consumer advocacy group CHOICE, which talked to just five homebuyers for their report slamming brokers back in May 2015.

Secondly, by showing the willingness to rigorously investigate itself, the industry demonstrates to ASIC it has the right culture. This might sound vague, but ensuring industries have the right culture, rather than simply processes, is the new focus of financial regulators worldwide, and ASIC is no exception.

“Culture is a significant driver of the behaviour of firms,” ASIC chairman Medcraft wrote in ASIC’s Corporate Plan 2015/16 to 2018/19. “Where we find a firm’s culture is lacking, it is a red flag that there may be broader regulatory problems.”

Following from this, ASIC’s 2016 forum is titled ‘Culture Shock’, with culture being the main talking point. The wider financial community is following suit. In January 2016, ANZ bank was roundly criticised for the ‘toxic culture’ of its trading department, leading to major management changes.

Ultimately, the industry doesn’t just have an incentive to report upon itself, it has a responsibility, as FBAA CEO White explains. “ASIC can only police what they see. Some things go under the radar … if no-one’s brought it to attention [but] how can they? They’re reliant on us, the industry, to tell them what’s going on.”

6 What can you do?
By virtue of their size and public profile, the MFAA, FBAA, major franchises and aggregators all have a responsibility to involve themselves in regulation – but what about the individual broker? While acknowledging ASIC’s preference to work through industry associations, the MFAA and FBAA are keen to get their members more closely involved in responding to regulation.

That starts with an engaged broker effectively communicating their opinion on a new piece of regulation, notes White. “It’s one thing to make a momentary stand on a blog site, but the real depth comes from when people send in their submissions to their industry bodies, or write to their parliamentarian, but if people don’t come to us, we can’t express their view.

“You’ve got to be prepared to put some time in to get results. That time may be an email, or it may be getting more involved in the council, or at board level, of an industry body.”

For brokers who want to go further, the FBAA has a number of national and state representative positions, while the MFAA has various panels for different types of brokers and female brokers (i.e. the Women In Mortgage Broking Network). Hayden sends out a CEO column to members of these panels and believes there is definitely more scope for engagement. Although, she said: “Most people are too busy with their own jobs to worry about that and they rely on their industry association to manage it on their behalf.”

It’s this point which is crucial – negotiating regulatory politics is not what a broker is best at, nor what earns them a living. The vast majority who don’t want to get involved rely on ASIC to understand their industry and regulate accordingly, which is why it’s so alarming that 86% of polled brokers don’t believe that is the case.

As an industry, broking is increasingly producing the data and reporting that underresourced industry regulators need, driven by those brokers and industry leaders – often outside the MFAA and FBAA – who do care about the culture of third party channels. In return, these brokers and leaders need a regulator who actively and publicly engages with them and systematically integrates their expertise into its regulation.

ASIC RESPONDS
MPA asked ASIC to respond to the key points in this article. Here’s what they told us:

“ASIC engages in regular and ongoing communication with all sectors of the credit industry. A key way we do this is via industry peak bodies, and with more than 5,000 credit licensees, and more than 25,000 authorised credit representatives, the broker peak bodies play an important role. However, this is not the only way we engage with industry.

“ASIC delivers presentations to national industry events, such as the FBAA National Conference on the Gold Coast and the MFAA National Conference, including from ASIC Deputy Chair Peter Kell . In addition, ASIC staff regularly attend and make presentations at state-based industry functions for both the MFAA and FBAA and use those forums to discuss current industry issues and regulatory priorities.

“We are speaking in all states at the upcoming MFAA Broker 2020 series. We write articles for and engage in interviews with industry publications. And ASIC does have direct discussions and engagement with the larger mortgage broking and aggregator businesses, as we are conscious that some perspectives are only available directly from the firms themselves.”

ASIC advises brokers to look at the regulator guides on their website, including RG 209 on Responsible Lending, RG 205 on General Conduct, and INFO 146 on Responsible Lending. With regard to their regulation of lenders, they point to recent action taken against Bank of Queensland, Wide Bay (now Auswide Bank) and CUA in addition to their interest-only and low doc lending reviews.

They then conclude: “We do, however, believe that brokers play a very significant role in arranging lending, and that it is critical that consumers have trust and confidence in the broking industry, as well as lenders… ASIC’s job is to enforce the laws that are passed by Parliament so that, ultimately, consumers benefit from a safe and well-functioning market. There may be disagreement in some parts of industry about these laws, but that does not mean ASIC doesn’t understand the industry.”

Further Insights Into Mortgage Brokers Via LTI and LVR

My post yesterday “The Truth about Mortgage Brokers” created quite a a number of requests for more information, especially around my comment that broker originated loans tend to have higher loan-to-income and loan-to-value ratios compared with bank originated loans.

So today, I am posting further data on these two dimensions, drawing more data from our household surveys.

First, here is a plot of the average loan to income (LTI) bands separated by bank direct and broker channels of origination, which clearly shows that broker loans have a relative distribution of higher LTI loans.

Running the same analysis on loan to value (LVR) bands, we also see a higher distribution of broker loans above 85%.

We can take the analysis a little further by comparing interest only loans and principal and interest repayment loans. The LVR distribution analysis shows that interest only loans have a higher LVR, and those with a third party channel of origination are the highest.

The LTI picture is not so clear cut, though there is a slightly higher distribution of interest only loans via brokers across the LTI bands.

It is worth thinking about what may be causing this. First, we know that different customer segments have different propensities to use brokers, and possibly those looking to borrow more, at higher LVR and LTI are more naturally inclined to go to a broker. Interest only loans have lower repayments, so for a given level of income, should allow access to a larger loan amount as the repayments only cover interest (though of course the principal will need to be repaid eventually). In addition, brokers will know from their panel lists where the higher LVR and LTI deals can be done. The data in the surveys includes bank and non-bank lenders.

However, irrespective of the channel of origination, lenders still need to complete their underwriting analysis. So it would seem different criteria are being applied depending on the origination channel.

Also, we should say that the data in the survey comes from loans written in the past 12 months, and there have been some changes to underwriting in that time.

Nevertheless, the additional analysis reinforces the view that broker originated loans are on average more risky, supporting APRA’s statement.

Suncorp Intensifies Focus On Mortgage Brokers

From Australian Broker.

Suncorp Bank has launched a new reward program designed to reward loyal brokers of all business sizes and support their relationships with their customers.

The Elevate program offers brokers priority service and preferential turnaround times and is accessible to brokers at all business levels.

Suncorp Bank head of intermediaries, Steve Degetto, says Elevate doesn’t just favour the top loan writers and big broker businesses, making it one of the most equitable reward programs in the market.

“This new, innovative approach to reward and recognition means brokers don’t need to be big writers or have an enormous portfolio to realise the benefits, with all levels of business being rewarded.

“The program focuses equally on quality and volumes of business written, with the aim to provide strengthened customer relationships at every tier which is essential in such a competitive market.”

Degetto says the non-major is committed to investing in its third party channel and will continue to consult its broker network on how to invest further in the channel this year.

“Suncorp Bank is committed to developing sustainable long term relationships with brokers, and
Elevate is just one of the ways we aim to recognise and reward our broker partners.

“The program also demonstrates our focus on continuous improvement of our own business to fulfil broker needs.”

The program currently features three tiers: gold, silver and bronze. Each tier has access to unique special offers and dedicated support teams.

Bank Profits Up 6.9% To $36.8 bn At December 2015

APRA released the quarterly banking performance statistics today, to December 2015. On a consolidated group basis, there were 157 ADIs operating in Australia as at 31 December 2015, compared to 159 at 30 September 2015 and 166 at 31 December 2014.

The net profit after tax for all ADIs was $36.8 billion for the year ending 31 December 2015. This is an increase of $2.4 billion (6.9 per cent) on the year ending 31 December 2014.The cost-to-income ratio for all ADIs was 49.4 per cent for the year ending 31 December 2015, compared to 49.2 per cent for the year ending 31 December 2014. The return on equity for all ADIs was 13.8 per cent for the year ending 31 December 2015, compared to 14.3 per cent for the year ending 31 December 2014.

The total assets for all ADIs was $4.58 trillion at 31 December 2015. This is an increase of $241.3 billion (5.6 per cent) on 31 December 2014.The total gross loans and advances for all ADIs was $2.95 trillion as at 31 December 2015. This is an increase of $206.4 billion (7.5 per cent) on 31 December 2014.

The total capital ratio for all ADIs was 13.9 per cent at 31 December 2015, an increase from 12.5 per cent on 31 December 2014.The common equity tier 1 ratio for all ADIs was 10.2 per cent at 31 December 2015, an increase from 9.1 per cent on 31 December 2014.The risk-weighted assets (RWA) for all ADIs was $1.87 trillion at 31 December 2015, an increase of $120.6 billion (6.9 per cent) on 31 December 2014.

For all ADIs, impaired facilities were $13.6 billion as at 31 December 2015 (chart 7). This is a decrease of $2.3 billion (14.6 per cent) on 31 December 2014. Past due items were $11.7 billion as at 31 December 2015. This is an increase of $317 million (2.8 per cent) on 31 December 2014. Impaired facilities and past due items as a proportion of gross loans and advances was 0.86 per cent at 31 December 2015, a decrease from 1.00 per cent at 31 December 2014. Specific provisions were $6.4 billion at 31 December 2015. This is a decrease of $543 million (7.9 per cent) on 31 December 2014; and specific provisions as a proportion of gross loans and advances was 0.22 per cent at 31 December 2015, a decrease from 0.25 per cent at 31 December 2014.

Turning to the big four major banks, we see that 62% of all of their lending is for housing (either owner occupied or investment), so they are highly concentrated in this sector of the market. Note the rise from mid-fifties in 2004, the peak in 2011, and the new upward trend in recent quarters. Banks have their eggs firmly in the residential property basket.

If we look at their ratios, we see capital rising, under the direction of the regulators, with the ratio of share capital to gross advances rising from 4.9% to 5.3%, but you can still see the highly leveraged state of the banks, and their absolute reliance on profits from home lending. For every $100 lent on housing, shareholders are risking $5. Not a bad proposition (for them).

The Truth About Mortgage Brokers

Recent media coverage about mortgage brokers has been quite negative, with allegations of poor ethical standards and false application data being used by some to bolster loan applications. So in this post and in our latest video blog we look at data from our household surveys to portray the current state of play.

To begin, mortgage brokers have become a significant feature in the mortgage industry landscape. Indeed almost half of new loans are now originated by brokers. Different household segments have different propensities to use brokers. Those seeking to refinance, first time buyers and property investors are most likely to use a mortgage broker.

We expect this growth to continue, thanks to the current appetite for refinancing, and the broker focus now apparent among major banks. For example CBA, in their recent results reported to December 2015 that 45% of their loans came via the broker channel, up from 40% a year earlier. In addition regional players and credit unions are using brokers, alongside foreign banks operating here and the non-bank sector.

Commissions have been tweaked recently, and the industry commission take is now back up to pre-GFC levels, (after adjusting for inflation) because whilst overall commissions were trimmed, volumes have grown.

Remember that brokers get a commission payment at the start of the loan, as well as a trail paid in subsequent years. The bigger the loan, the bigger the commission. Very few aggregators normalise actual commissions paid – although Mortgage Choice does, so they claim their brokers are less influenced by commission structures.

“At Mortgage Choice we pay your broker the same rate, no matter which home loan you choose from our wide choice of lenders. That means you can tap into a Mortgage Choice broker’s expertise at no charge, with peace of mind that they have your best interests at heart”.

Some brokers refund a proportion of the commission from the lender back to the borrower. For example Peach Home Loans says:

“When we arrange your loan we are doing quite a bit of the work that the lender’s staff would otherwise have to do and as a result the lenders pay us a commission on the upfront (loan amount) – this is typically around 0.6% or $600 per $100,000. We try to recover our costs from this commission and then share what is left over with you. Lenders also pay us a small trailing commission typically from 0.15% to 0.25% pa paid on the outstanding loan balance … and this is where we try to make our profit.. after all we are in business to make a profit.”

Consider next who is the broker working for? Whilst some are directly employed by banks or aggregators, others are self employed businesses. They are mostly aligned to aggregators or banks to get access to the lender lists and access to various tools and calculators. As a broker, they want to do a deal and the legislation controlling their conduct says they need to consider the financial status of an applicant to ensure the loan is “not unsuitable.” From ASIC’s responsible lending provisions:

“As a credit licensee, you must decide how you will meet the responsible lending obligations. RG 209 sets out our expectations for compliance. Meeting your responsible lending obligations will require taking three steps:

make reasonable inquiries about the consumer’s financial situation, and their requirements and objectives;

take reasonable steps to verify the consumer’s financial situation; and

make a preliminary assessment (if you are providing credit assistance) or final assessment (if you are the credit provider) about whether the credit contract is ‘not unsuitable’ for the consumer (based on the inquiries and information obtained in the first two steps).

In addition, if the consumer requests it, you must be able to provide them with a written copy of the preliminary assessment or final assessment (as relevant)”.

This is quite weak protection, because suitability may depend on many factors, including financial sophistication of the potential borrowers, income and expenditure assessments and other elements.

The list of lenders a broker may consider will depend on the lender panel they have access to. Most brokers will access a restricted list of potential lenders, and cannot offer a “whole of market” view of options. Quite often they will use on-line tools with a client to come up with the best deals, although often the basis for selection and lender recommendation is vague and is often not fully disclosed.

Some brokers are very proactive when it comes to shepherding the loan application through to funding, others less so. Some brokers will also keep a diary note to instigate a possible refinance conversation down the track.

But, to be clear, whilst many brokers will give good advice, they are in an area of potential conflict thanks to commissions, and limitations thanks to the panel. Brokers should be disclosing potential commissions and also their selection criteria.

The alleged poor conduct where brokers falsify applicant data is in our view a marginal activity of a “few bad apples.” That said, consumers should be using a mortgage broker with their eyes open. Ask yourself if the broker is truly working in your best interests.

APRA recently said that they considered loans written via brokers to be more risky than loans written direct by the banks. APRA chairman Wayne Byres said:

“Third-party originated loans tend to have a materially higher default rate compared to loans originated through proprietary channels.”

So we decided to analyse our current household survey data, looking at relative risks between third party (broker) and first party (bank) loans. We tested risks by asking households about their perceived sensitivity to interest rate rises on mortgage loans. You can read about our approach here.

The results show that households who originated loans via brokers have less headroom and more exposure to potential interest rate rises (should they occur). For example, among owner occupied first time buyers, 28% of those who got a loan direct from a bank said they would have difficulty if rates rose at all from their current levels, whereas for owner occupied borrowers via a broker this rose to 43%, a significantly higher proportion. Further analysis showed that on average loans via brokers was at a higher loan to value and loan to income ratio than those direct via the bank.

There was a similar, though less extreme shift in risk across all owner occupied portfolios, with 40% of borrowers direct from a bank saying they could cope with more than 7% rise, compared with 20% of those via a broker.

Looking at refinanced owner occupied loans we again saw a higher proportion less able to cope with a rise in rates among households who got their loan via a broker channel.

On the investment property side of the ledger, among portfolio investors – those with multiple properties in a portfolio, there was a higher proportion who would be exposed by any rate rise among those going direct to a bank, compared with a broker – but the difference is quite small and combined more than 40% of portfolio investors would have issues if rates rose.

When we looked at all investment loans, we found that households who obtained a loan via a broker were slightly more likely to be under the gun if rates rose, and a significantly higher proportion of borrowers who went direct to a bank were confident of handling a rise of more than 7% from current levels.

Consolidating all the results, we conclude that households who accessed loans via brokers have on average less head room to accommodate rate rises compared with those who went direct. APRA is correct.

ADI Housing OO Loans Grew 0.9% In January

The APRA Monthly banking statistics for January 2016 came out today. Whilst overall ADI lending for housing grew 0.6%, lending for owner occupation grew 0.9%, from $898 bn in December to $906 billion in January. Much of this will be refinancing of existing loans, and some first time buyer activity. Investment lending grew very slightly. However, there was a $1.4 bn adjustment between OO and investment loans, so the splits are not that reliable. So, whilst lending may be slowing a little, there was significant momentum in the market in January. Total lending reached $1,424 bn, up by $8.1 bn.

Looking at the individual banks, the market shares did not change that much, with CBA holding 27.6% of owner occupied loans, whilst Westpac holds 26.13% of investment loans.

The portfolio movements (which are not adjusted for reclassifications between OO and investment loans) highlights growth in OO loans across the board. Movements in investment loans is more patchy.

For what it is worth (and we have consistently used the monthly data, adjusted where we can), we see that market growth in investment loans is now sitting at 2.14%, for the 12 months to January 2016. The big four are all below the APRA 10% speed limit. Others, for various reasons are still speeding.

The splits between OO and investment lending varies by lender, with HSBC, Bank of Queensland and NAB holding the larger proportion of investment loans, expressed as relative market shares.

Tuning to credit cards, total balances fell $747m in the month, to $41 billion. CBA is growing its relative share of cards, with 27.8% of the market. NAB also grew slightly in relative terms, whilst ANZ and WBC fell a little.

Looking at the monthly movements, we see that households are paying down loans they took over the Christmas.

Turning to deposits, total deposits grew 0.8% to $1.92 trillion. CBA grew its share a little, from 24.6% to 24.8% and remains the largest holder of deposits in Australia.

ANZ lost a little share in the month as it attracted less money in than the other three majors. CBA lifted net balances by $7.3 bn, compared with WBC’s $3.9 bn and NAB’s 3.6 bn.

Given the higher margins on overseas funding at the moment, with speads elevated thanks to a range of global uncertainties, local deposits are more valuable, and we expect to see some strong competition for balances in the months ahead.

Housing Lending Still Grows – Now $1.53 Trillion

The RBA credit aggregates released today to end January 2016, shows that there is still momentum in home lending – centered of course around refinancing.

Total home lending was up 0.53% in the month, and $8bn was for owner occupied lending. Investment lending went sideways, but note also though that there were further adjustments between OO and investment loans.

“Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $35.3 billion over the period of July 2015 to January 2016 of which $1.4 billion occurred in January. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes”.

As a result, the proportion of loans for housing investment purposes has fallen a little further, from 35.98% to 35.8%, but this is still a big number.

Turning to the overall aggregates, home lending was up 0.53%, business lending rose 0.63% and personal credit fell 0.79% as households paid off their Christmas binge.

Business investment remains at a relative low level, with one third of all lending going to business, once again showing how debt to households is being relied on to grow the economy.

We know from our own analysis that significant numbers of households would find any rise in interest rates a big problem, and loading up households further with ever more debt is a flawed strategy. When are we going to get serious about getting real long term growth via business investment?

We will discuss the parallel APRA data, also released today, later.

Subprime gets bad rap in ‘Big Short’ but is key to easing housing affordability crisis

From The Conversation.

Anyone who’s dug into the 2008 financial crisis knows the role that bundling and selling subprime housing loans played in bringing the world to the brink of economic collapse – out-of-control behaviors well-depicted in the movie “The Big Short.”

But one thing I hope “The Big Short” doesn’t do is further tarnish the image of subprime lending.

Despite their poor reputation, such loans remain a key tool in easing the housing affordability crisis and expanding the availability of mortgages to low-income Americans seeking to realize the dream of homeownership. They also can help policymakers cope with the growing ranks of the homeless.

I’ve been studying the world of subprime in recent years, and these are some of the lessons from my current and past research. First, we need to fix the subprime mortgage market, so that the ways in which it contributed to the financial crisis aren’t repeated.

Shocking levels of homelessness

Los Angeles, New York and other cities in America are struggling to cope with the problem of homelessness and the lack of affordable housing.

On a single night in January 2015, more than 560,000 people nationwide were homeless – meaning they slept outside, in an emergency shelter or in a transitional housing program. Almost a quarter were children. Meanwhile, homeownership is hovering at 20-year lows, while about half of renters struggle to pay their landlords.

Last fall, Los Angeles Mayor Eric Carcetti asked the City Council to declare “a state of emergency” on homelessness and committed US$100 million to solving the problem, suggesting that subsidies would play a role.

But a focus on rental subsidies to solve homelessness and other affordable housing issues has adverse consequences, as evidenced by New York’s experience.

Its cluster-site housing program, in which privately owned apartment buildings are used to house homeless families when the city’s shelters are full, relies on such subsidies. But because the city typically pays market rents (or more), many landlords responded by pushing out regular (and low-income) tenants in favor of this steady stream from the government.

Such programs reduce the overall supply of affordable units, crowding out other groups in need. As more affordable housing units are allotted to the homeless, there are fewer available for low-income residents who don’t qualify for those programs and are at risk of becoming homeless themselves.

Fortunately, Mayor Bill de Blasio aims to phase out the costly program over the next three years.

While there are many other approaches to tackling homelessness, they rely on addressing an important underlying problem: the housing affordability crisis. It may seem improbable, but subprime lending could help ease the housing affordability crisis.

The role of subprime lending

The relationship between homelessness and the strains in the housing rental market is well-known: when there are more rental vacancies available, homelessness decreases (I survey the academic findings on the topic here).

This suggests that if we reduce home affordability problems, we can effectively reduce homelessness.

A powerful tool to help ease the housing affordability crisis is subprime mortgage lending – defined as loans made to borrowers with credit scores below 640.

The idea is simple: by helping more low-income tenants qualified to take out a subprime mortgage become homeowners, there’ll be more affordable rental housing available for everyone else. More supply on the market helps reduce average rents, which in turns helps more of those pushed to the streets afford a roof over their heads with less government aid. Thus this makes the policies still based on rental subsidies more effective.

However, this idea cannot be implemented until we fix the subprime mortgage market. As you can see from the graph below, the market has not yet recovered from its collapse in 2008.

The subprime market has yet to recover from its collapse. Inside Mortgage Finance, Author provided

One of the reasons the market collapsed was that investors lost confidence in the ability of loan originators and regulators to use credit scoring models to accurately assess a borrower’s creditworthiness – remember the NINJA loans (no income, no job, no assets)?

This market won’t be back up and running at full strength – and able to help address the affordability crisis – until these credit-scoring models improve and mechanisms are put in place to ensure loan quality remains adequate.

The FHFA sets new goals

There has been some movement to get the subprime market moving again.

The Federal Housing Finance Agency (FHFA), an independent federal agency that regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks, recently set goals for the next two years meant to expand the availability of mortgages to low-income buyers.

This policy will keep its focus on helping a small segment of borrowers with incomes no greater than 50 percent of their area’s median income to purchase or refinance a single-family home.

But many affordable housing advocates expressed concern that these targets do not go far enough. The Woodstock Institute – a leading research and policy nonprofit organization focused on fair lending, wealth creation and financial systems reform – for example, argued that the policy won’t do enough to promote affordable and sustainable home ownership for low-income families.

How to bring back subprime

Even with the FHFA embracing the idea of expanding the availability of subprime mortgages to low-income buyers, their perceived role in the 2008 crisis and bringing down the housing market may cause justifiable resistance from the general public as a means of tackling the affordability crisis.

And one cannot blame this reaction, as it was the average American taxpayer who bailed out the reckless financial system, brought down by greedy bankers and weak politicians and regulators.

So how we can encourage more subprime lending while avoiding a repeat of 2008? In my recent research, I suggest a few ways to do this.

One of the reasons subprime loans became such a problem in the run-up to the crisis is just the sheer volume (see the boom in subprime lending from 2001 to 2005 in the above graph). This expansion was fueled by the generous homeownership subsidies given to low-income households.

One way to help prevent this is to vary the size of the homeownership subsidy countercyclically to control the amount of credit flowing into the economy and prevent overborrowing during expansionary periods. It would be higher at times when the housing market contracts, and lower when it’s booming.

Another problem was that lenders had an incentive to originate mortgages to borrowers who couldn’t afford them because all the risk was passed along to banks and other investors through collateralized mortgage obligations (CMO) and other sophisticated financial instruments.

The Federal Reserve in conjunction with other regulators could reduce this risk by carefully monitoring how many mortgages lenders keep in their own portfolios. When the share lenders hold increases, they have more incentives to better screen borrowers and thus originate better mortgages.

Lastly, the so-called adverse selection problem on the part of the mortgage originator in the secondary market should also be taken into account. This problem occurs when the mortgage originator has more information about the quality of mortgages that are securitized than the secondary market investors who snap up the CMO. That allows the originator to keep the low-risk mortgages in its own portfolio while distributing the high-risk mortgages to investors.

Improving existing credit scoring models is crucial to ameliorating this problem. Also, the Fed should more carefully monitor the quality of mortgages that are sold to investors and share its information with them. At the very least, that would reduce the investors’ information disadvantage with respect to originators.

Accompanied by the right means to regulate the housing market, we can support subprime while avoiding the disastrous outcomes highlighted in “The Big Short.“ And we can create an environment in which making low-cost mortgages available to people helps resolve the problem of unaffordable housing and homelessness.

Author: Jaime Luque, Assistant Professor, Real Estate & Urban Land Economics, University of Wisconsin-Madison

What Happened to the Great Divergence?

Governor Lael Brainard, spoke at the 2016 U.S. Monetary Policy Forum, New York, New York. The speech highlighted that whilst there was a phase when different economic centres were diverging, now there are more common elements, including low growth, low interest rates and low inflation. Global shocks are being transmitted via the financial system, creating volatility and spillover effects.

To the extent that we are observing limited divergence in inflation outcomes and less divergence in realized policy paths than many anticipated, this could be attributable to common shocks or trends that cause economic conditions to be synchronized across economies. The sharp repeated declines in the price of oil have been a major common factor depressing headline inflation and are also likely feeding into low core inflation, although to a lesser extent. As noted previously, these price declines have led headline inflation across the globe to behave quite similarly over this time period. Even so, most observers expect this source of convergence in inflationary outcomes to eventually fade and thereafter not affect monetary policy paths over the medium term.

In contrast, a more persistent source of convergence may be found in an apparent decline in the neutral rate of interest. The neutral rate of interest–or the rate of interest consistent with the economy remaining at its potential rate of output and inflation remaining at target level–appears to have declined over the past 30 years in the United States and is now at historically low levels. Similarly, longer-run interest rates appear also to have fallen across a broad group of advanced and emerging market economies, suggesting that neutral rates are at historically low levels in many countries around the world and near or below zero in the major advanced foreign economies. Although the reasons for the declines in neutral rates are not perfectly understood and may differ across countries, there are some common drivers, such as slower productivity and labor force growth and a heightened sensitivity to risk.

The very low levels of the shorter run neutral rate reflect in part headwinds from the crisis that are likely to dissipate over time. However, if many of the common forces holding down neutral rates prove persistent, then neutral rates may remain low through the medium term, implying a shallower path for policy trajectories.

The global economy is also experiencing a downshift in emerging market growth momentum led by China, which may prove somewhat persistent. Whereas earlier in the recovery there was a striking divergence between the relatively buoyant growth in major emerging economies and depressed growth in advanced economies, lately the extent of divergence has diminished noticeably. China is undergoing a challenging set of economic transitions. Trend growth has slowed substantially and is expected to slow further, and the composition of growth is shifting away from resource-intensive manufacturing and exports toward a greater share for consumption and services. China’s investment has slowed sharply recently after accounting for nearly one-third of global investment over the past three years and about one-half of global consumption in certain metals such as iron ore, aluminum, copper, and nickel. Commodity exporters and close trading partners in Asia will be most affected, but the changes in the composition and rate of growth in a country that has accounted for about one-third of the growth in world output and trade will likely ripple through the global economy much more generally.

Amplified Spillovers
Of course, policy divergence among major economies could be limited by rapid and strong transmission of foreign shocks across borders. In particular, although the U.S. real economy has traditionally been seen as more insulated from foreign trade shocks than many smaller economies, the combination of the highly global role of the dollar and U.S. financial markets and the proximity to the zero lower bound may be amplifying spillovers from foreign financial conditions. By one rough estimate, accounting for the net effect of exchange rate appreciation and changes in equity valuations and long term yields, over the past year and a half, the United States has experienced a tightening of financial conditions that is the equivalent of an additional increase of over 75 basis points in the federal funds rate.10

The transmission of divergent economic conditions across borders typically occurs though a couple of different channels. First, a decline in demand in one country reduces its demand for imports from other countries. Second, the fall in economic activity would be expected to trigger a more accommodative monetary policy, which helps offset the effect of the shock by both supporting domestic demand and weakening the exchange rate. The weaker exchange rate in turn leads domestic consumers to switch their expenditures away from more expensive foreign imports to cheaper domestic products while increasing the competitiveness of exports. The extent to which monetary policy offsets the shock by dispersing it to trade partners as opposed to strengthening domestic demand depends on the responsiveness of domestic demand relative to the exchange rate. The exchange rate channel, by raising the price of imports in domestic currency, also pushes up domestic inflation and exerts downward pressure on foreign inflation.

The strength of spillovers across countries and the extent to which that affects policy divergence across countries depend on a foreign economy’s openness to these different channels. The recent experience of Sweden suggests that for highly open economies, the effect of foreign shocks can be extremely powerful. Sweden’s economic growth has been relatively rapid recently, reaching nearly 4 percent over the most recent four quarters. Moreover, the employment gap is estimated to be nearly closed, and there are signs of financial excess in the housing market. In ordinary times, these conditions would be consistent with relatively tight monetary policy. However, inflation has run persistently well below the central bank’s 2 percent inflation target. Given the relative openness of Sweden’s economy, moving the inflation rate back up to target has been greatly complicated by the sensitivity of Sweden’s exchange rate and financial conditions to developments in the euro area, where domestic economic conditions are consistent with much more accommodative policy. As a result, the Riksbank has been pursuing extremely accommodative monetary policy, most recently lowering the interest rate on deposits to minus 0.5 percent and authorizing the Governor and Deputy Governor to intervene in foreign currency markets.

Even in the much larger United States economy, with imports accounting for a little over 15 percent of gross domestic product (GDP), spillovers can be quite strong, in part reflecting the international role of U.S. financial markets and the dollar. Since the middle of 2014, with a reassessment of demand growth in the euro area and subsequently in emerging markets and other commodity exporters, the real trade-weighted value of the dollar has increased nearly 20 percent. As a result, in 2014 and 2015, net exports subtracted a little over 1/2 percentage point from GDP growth each year, and econometric models point to a subtraction of a further 1 percentage point this year.12 In addition, the dollar’s appreciation is estimated to have put significant downward pressure on inflation: Non-oil import prices fell 3-1/2 percent in 2015, subtracting an estimated 1/2 percentage point from core PCE inflation.

Financial channels can powerfully propagate negative shocks in one market by catalyzing a broader reassessment of risks and increases in risk spreads across many financial markets. Since the beginning of the year, U.S. financial markets have reacted strongly to adverse news on emerging market growth, even though the news on the U.S. labor market has remained positive. In this regard, although China’s direct imports from the United States are modest, uncertainty about changes to its exchange rate system and financial imbalances, together with changes in the composition of its growth, have had broader global spillovers that may pose risks to the U.S. outlook.

Recent events suggest the transmission of foreign shocks can take place extremely quickly such that financial markets anticipate and indeed may thereby front-run the expected monetary policy reactions to these developments. It also appears that the exchange rate channel may have played a particularly important role recently in transmitting economic and financial developments across national borders. Indeed, recent research suggests that financial transmission is likely to be amplified in economies with near-zero interest rates, such that anticipated monetary policy adjustments in one economy may contribute more to a shifting of demand across borders than a boost to overall demand. This finding could explain why the sensitivity of exchange rate movements to economic news and to changes in foreign monetary policy appear to have been relatively elevated recently.

Financial tightening associated with cross-border spillovers may be limiting the extent to which U.S. policy diverges from major economies. As policy adjusts to the evolution of the data, the combination of heightened spillovers from weaker foreign economies, along with a lower neutral rate, could result in a lower policy path in the United States relative to what many had predicted.

Policy
In circumstances where many economies face common negative shocks or where negative shocks in one country are quickly transmitted across borders, it is natural to consider whether coordination can improve outcomes. Under certain conditions–such as flexible exchange rates, deep and well-regulated financial markets, and flexible product and labor markets–policies designed for the domestic economy can readily offset any spillovers from economic conditions abroad, and policies designed to address domestic conditions can achieve desirable outcomes both within the national economy and more broadly.

In some circumstances, however, cooperation can be quite helpful. If, for example, economies face a common challenge, coordination can communicate to markets that policymakers recognize the challenge and will work to address it. Reducing uncertainty about the direction of policy and addressing concerns about policies working at cross-purposes can boost the confidence of businesses and households. With intensified transmission effects in the vicinity of the zero lower bound, there is a risk that uncoordinated policy on its own could have the effect of shifting demand across borders rather than addressing the underlying weakness in global demand. The difficult start to the year should be a prompt for greater policy coherence and clarity. This might be a good time for policymakers to reaffirm their commitment to work toward the common goal of strengthening global demand.

Similarly, with anemic global demand and interest rates near zero, in some economies there is scope for monetary policy to be more effective with fiscal policy working in the same direction. With potential growth and nominal borrowing rates both low, public investment that increases potential in the longer run and demand in the shorter run could make an important contribution. A joint determination by policymakers across major economies to better deploy policy tools to provide support for global demand could be beneficial.