Economics and Banking – Page 411 – Digital Finance Analytics (DFA) Blog

UK Banks Should Hold More Capital Still

After the financial crisis of 2007/2008 which shook the British economy to its foundations. In the face of what became know as the “credit crunch”, bank after bank found itself stretched. Some would have failed had they not fallen into the arms of the taxpayer – at staggering expense to the public.

New requirements for banks to hold enough capital to prevent them from going under in the event of another financial crisis have been questioned by Sir John Vickers.

Not happy: Sir John has accused the Bank of England of going soft on the banks Credit: PA

In a stark warning Vickers, the author of 2011’s Independent Commission on Banking (ICB) report in the wake of the financial crisis and subsequent bailouts, has called the wisdom of the BoE’s requirements “questionable”. The Bank of England is now in charge of regulating Britain’s banks and, in a rather devastating intervention, Sir John Vickers has basically accused it of going soft on the sector.

The requirement is expected to impose a buffer that equates to 0.5 per cent of risk-weighted assets (RWA) across the banking sector, in addition to existing global ones under Basel II rules from European regulators, but that’s less than the three per cent recommended by the report.

“Some UK banks are so important internationally that they have extra equity requirements to protect global stability. The BoE proposal adds some, but relatively little, further equity to protect domestic stability. The ICB proposal, by contrast, went well beyond global requirements to boost the resilience of the UK banking system,” he said, writing in the Financial Times.

Ring-fencing provides no reason to go easy on capital requirements…the Bank of England should think again.

The systematic risk buffer (SRB) as it’s known, would apply to the UK’s biggest banks such as Lloyds, HSBC, Barclays and RBS, and their soon to be ring-fenced retail banking operations, but not smaller banks and challenger banks to promote competition in the market.

“Given the awfulness of systemic bank failures, ample insurance is needed, and equity is the best form of insurance. The recent volatility in bank stocks underlines the importance of strong capital buffers. The BoE should think again,” Vickers warned.

In September 2011, Sir John’s Independent Commission on Banking (ICB) reported back with a series of reforms designed to make the banking system safer and less dependent on state bailouts.

Back in 2011, two of the ICB’s key recommendations were that:

1) banks “ring-fence” their traditional retail deposits and conventional lending from their riskier operations.

2) that the biggest (and therefore the most risky) ring-fenced banks should be required to hold back an extra layer of capital – known as a “Systemic Risk Buffer” – to offset the risk of the loans they make and, if necessary, absorb losses.

The ICB set the additional Systemic Risk Buffer at 3% of a bank’s Risk Weighted Assets and intended it to apply to six of our biggest lenders. Last month the Bank ofThis is biting criticism. Sir John is basically accusing the Bank of England of failing to implement what the ICB recommended. There’s no suggestion of anything underhand – the Bank has publicly set out its justifications, it’s just that Sir John Vickers believes they are weak.

Bendigo and Adelaide Bank Results Highlight Tough Times

Today Bendigo and Adelaide Bank presented their 1H results to December 2015. It has clearly been a tough half, because they are a small player with high penetration into the mortgage sector, in which competitive pricing has taken its toll. One-offs may flatter, but the underlying trends is the business show there is much to be done.

Statutory profit was $208.7m, while underlying cash earnings were $223.7m, up 2.7% on a year earlier. Cost income ratio remained unchanged at 55.6%. Cash earnings per share were up 1.7% on the prior corresponding period. Return on average ordinary equity was 9.10%.

Total lending growth was 1.5%, much slower than system (8.8%), with business lending falling 1.9% and home lending up 3%. Mortgages account for a significant proportion (66%) of the bank’s business, and they specifically mentioned troublesome competitive dynamics.

35% of loans are investment property lending, 48% via third parties, and 35% fixed rate loans. Overall residential loan arrears (90 days+) was about 1.3% and is creeping higher. High LVR loans are controlled.

Retail banking’s contribution fell 3.7%, to $97.5m, thanks to a fall in NIM and other income, only partially offset by expenses growth. Customers are using more mobile devices for their banking, whilst PC banking is on the decline.

Third party banking’s contribution grew 19.4%, to $80.8m, and NIM grew a little, with around $300m a month, and a portfolio on about $16bn.

Wealth contribution a 4.2% increase to $10m, but again exhibited NIM compression. Funds under management reach about $4.5bn.

Agribusiness’s contribution was up 4.1% to $32.8m, but again NIM was compressed.

Homesafe revenues were up to A$54.5m or 17% of earnings, but this included revaluations, and is probably unsustainable. Margins were down and yet the shared equity portfolio is now $550m (doubled from 2013) and the value is linked directly to house price appreciation, which is slowing.

Deposits grew below system at 2.9%.

Net interest margin fell by 1 basis point on the prior half year, to 2.16%. The bank suggested mortgage pricing was now a little easier, with monthly NIM trending up.

However the longer term data shows the pressure the bank is under.

Bad and doubtful debt provisions were down 46% to $20.6m.Specific provisions were helped by a fall in Great Southern, but there were rises in retail mortgages and the rural bank.

Total capital increased by 9 basis points to 12.66% and CET1 ratio was 8.24%, up 7 basis points. Work continues to move the bank towards the advanced capital management platform. $64.5m of Basel II costs have been amortised.

Global Financial Links, Risks and Safety

The Bank of England just published Financial Stability Paper No. 36 – February 2016 “Stitching together the global financial safety net”. The paper illustrates the highly connected state of banks, central banks and other entities, and discussed some of the consequences of such linkages, and the safety nets which exist to protect these structures. The paper highlights risks from vulnerabilities in external balance sheets which leave countries exposed to volatility in cross-border capital flows and increase potential demands on the safety net. A timely discussion, in the light of current market volatility.

Financial globalisation and the expansion in global capital flows bring a number of benefits — more efficient allocation of resources, improved risk sharing and more rapid technology transfer. But they can also increase the risk of financial crisis. Indeed, the current market volatility is partly a reaction to the global risks.

On a net basis, more gross capital inflows than outflows have allowed many countries to run current account deficits. Global current account imbalances (measured as the sum of the absolute values of all current account surpluses and deficits) tripled from around 2.3% of global GDP between 1980 and 1997 to 5.5% of global GDP in 2006–08 and were 3.5% in 2014. But net flows concealed even larger increases in gross flows.

On a gross basis, the boom in global capital flows has provided additional sources of finance for governments, banks, corporates and households. This may have increased the efficiency of capital allocation, with capital increasingly able to flow to where it is most productive. Gross capital flows increased to over 20% of global GDP in 2007 up from around 3% in 1980. Cross-border banking was one of the main drivers of this increase in cross-border flows.

Borrowing in foreign currency often complicates adjustment. International banks’ borrowing in foreign currency (both domestically and cross-border) has doubled since 2002, despite a 20% reduction since the peak in 2008. There are now over US$20 trillion foreign currency denominated bank liabilities (Chart 3). And since 2008, outstanding US dollar denominated credit to non-banks outside of the United States has almost doubled to US$9 trillion.

There is a flip side to the rapid rise in cross-border capital flows and external assets and liabilities — countries are more exposed to the willingness of foreign investors to continue funding their financing needs. Cross-border capital flows can be fickle, with foreign investors withdrawing funding in the event of an economic or financial crisis. Concerns about an increase in foreign currency borrowing in emerging markets through international bond markets — mainly by the corporate sector — have recently been centre stage in debates about global financial stability.

In recent years, to reduce these risks to stability, countries have reformed financial regulation, enhanced frameworks for central bank liquidity provision and developed new elements, and increased the resources, of the global financial safety net (GFSN).

A comprehensive and effective GFSN can help prevent liquidity crises from escalating into solvency crises and local balance of payments crises from turning into systemic sudden stop crises. The traditional GFSN consisted of countries’ own foreign exchange reserves with the IMF acting as a backstop. But since the global financial crisis there have been a number of new arrangements added to the GFSN, in particular the expansion of swap lines between central banks and regional financing arrangements.

Swap lines are contingent arrangements between central banks to enter into foreign exchange transactions. The liquidity-providing central bank provides its domestic currency for a fixed term at the market exchange rate, in exchange for the currency of the recipient central bank. On maturity, the transaction is unwound at the same exchange rate so, provided each party repays, neither party has direct exposure to exchange rate risk. The liquidity-providing central bank bears the credit risk of the borrowing central bank. In the event that the borrower is unable to repay, the lender is exposed to the exchange-rate risk on the currency taken. Swap lines can also involve the liquidity provider lending to the borrowing central bank in a foreign currency. In this case, the liquidity providing central bank lends its FX reserves in return for the borrower’s domestic currency, providing wider access to hard currency FX reserves.

Since the global financial crisis there has been a proliferation of swap lines. By October 2008, in response to the seizing up of global financial markets, the Federal Reserve (Fed) had extended swap lines to fourteen countries. Many of these have subsequently expired and not been replaced. The peak aggregate usage across all borrowers was US$586 billion in December 2008. The Bank of England drew US$95 billion from the Fed, which was on-lent to UK resident financial institutions. Other notable facilities were euro-denominated swaps by Sweden and Denmark to Latvia in December 2008, which they extended while simultaneously having swap arrangements with the ECB. And a Swiss franc denominated swapline between the ECB and SNB which was introduced in October 2008. Since 2007 the number of non-Chiang Mai central bank swap arrangements has increased from 6 to 118 (Charts 10 and 11), and involve 42 central banks. Those with a formal limit total US$1.2 trillion.

The new look GFSN is more fragmented than in the past, with multiple types of liquidity insurance and individual countries and regions having access to different size and types of financial safety nets. These new facilities provide many benefits, such as increasing the resources available to some countries and providing additional sources of economic surveillance. However, many facilities have yet to be drawn upon and variable coverage risks leaving some
countries with inadequate access.

This paper consider the features, costs and benefits of each of the components of the GFSN and whether the overall size and distribution across countries and regions is likely to be sufficient for a plausible set of shocks. We find that the components of the GFSN are not fully substitutable: different elements exhibit different levels of versatility, have been shown to be more or less effective depending upon the circumstances, have different cost profiles and have different implications for the functioning of the international monetary and financial system as a whole. We argue that while swap lines and RFAs can play an important role in the global financial safety net they are not a substitute for having a strong, well resourced, IMF at the centre of it.

By running a series of stress scenarios we find that for all but the most severe crisis scenarios, the current resources of the GFSN are likely to be sufficient. However, this finding relies upon the IMF’s overall level of resources (including both permanent and temporary) being maintained at their current level.

Our analysis also highlights that the aggregation of global resources can mask vulnerabilities at the country, and even regional, level. In other words, while the current safety net might be big enough in aggregate, there is a risk that, for large enough shocks, gaps in coverage could be revealed. Steps should be taken to ensure the different components of the safety net function effectively together to reduce the risk of gaps appearing.

Policymakers should consider measures which (i) reduce vulnerabilities in external balance sheets which leave countries exposed to volatility in cross-border capital flows and increase potential demands on the safety net; (ii) secure the availability of appropriate GFSN resources, including the IMF’s resource base; and (iii) make more efficient use of the current GFSN resources by ensuring the elements of the GFSN more effectively complement
one another.

DFA Analysis Of Highly Leveraged Households Featured In Nine News Segment

Nine News tonight, using data from the DFA household research programme, highlighted the highly leveraged status of many households who have bought into the property market in the past couple of years.

Our research has shown that in some eastern suburbs within the Sydney area for example, many households would find even a small rise in mortgage interest rates would create significant financial headaches. The most exposed suburbs nationally are listed below.

The analysis is based on responses to our survey which asks whether households feel they could cope with covering the costs of an additional 1% on their mortgage. Given that many have mortgages of more than $500,000, even a small rise is enough to create problems, especially given static income. Note also that more affluent segments are more at risk.

Read more about our research in our recent blog posts.

OO Housing Finance Bounces Back – Refinance Anyone?

The latest ABS data to December 2015 shows that in the month, trend owner occupied lending grew 1.3%, seasonally adjusted, with $21.3 bn of loans being written. Construction loans grew 1.4% ($1.9 bn), purchase of new dwellings grew 1.7% ($1.3bn) and purchase of established dwellings by 1.28% ($18.75bn). Refinance continued to grow, with 33% of loans written in the month churned, up 2.3% to $7.29bn. Overall owner occupied lending, net of refinance grew just 0.8%.

Looking at state trends, VIC led the way, up 1.5%, QLD at 1%, NSW at 0.7%, SA 0.6%, and WA down 0.3%. But startlingly, TAS reported a rise of 1.8% and NT a rise of 1.4%. The ACT was 1.6% higher. So, WA apart, owner occupied lending grew in every state.

Total finance, including investment loans grew by just 0.025%, investment loans fell 2.36% to 11.4 bn. We see the clear focus of lending is to owner occupied borrowers, and a massive focus on churning loans. We also see a significant rise in the number of fixed rate deals, as households lock in low rates, with the number of deals up 17.2%, whilst secured revolving loans fell 9.8%. This reflects the cheap loan special offers which are currently in the market.

First time buyer OO loans grew in December, with a rise of 4.6% on the previous month to make up 15.1% of new loans. This is faster than for non-first time buyer loans, here the number of loans grew 3.1%. The average loan size fell a little in the month, reflecting tighter lending criteria. This is original data, not trend smoothed.

Overlaying first time investors, from our surveys, overall first time buyers were more active, still wanting to get on the property ladder one way or the other. FTB investors grew by 6.5% in the month, after a couple of slow months before. Overall, about 14,000 first time buyer deals were done.

European Bank Debt Under Pressure

According to Moody’s, Global risk aversion has spread to the European banking sector and the debt at the bottom of capital structures is selling off severely. Investors have quickly reassessed the virtues of contingent convertible (CoCo) securities, with which the risk of losing coupon payments is elevated under a diminishing outlook for profits and economic growth. As with other novel classes of financial securities that rapidly expanded, the future of the CoCo will be greatly influenced by its first substantial market stress test.

Weak earnings reports from major European banks ignited a sharp decline in the value of debt and equity across their sector in early February. This shakeout was particularly pronounced for CoCos, with the spread on such debt spiking to the Barclays index record high of 600 bp on February 9 from 497 bp at the end of January (Figure 1). The market value of such debt now trades at 93% of the par value or value at maturity after never having traded below par value until one week prior. Murkiness about the conditions under which these hybrid securities will convert to equity, combined with downwardly revised global growth forecasts, weighs on CoCos valuations.

Issuance of CoCos in Europe was prodded in recent years by the Basel III regulatory accord’s guidelines on bank capital and leverage. Yet while regulators are enamored by the flexibility provided by securities that convert from debt to equity in times of stress, investors must assess the distinct risks of such hybrids. Ranking above only common equity in claims on an institution’s assets, CoCos demand higher coupons compared to more traditional classes of debt. The amount of such hybrids outstanding issued by European banks and tracked by Barclays increased from €55 billion in mid-2014 to €108 billion today, yet only €7 billion of that increase has transpired since mid-2015. That slowing rate of growth for CoCos can largely be ascribed to generally unfavorable capital markets conditions late last year, but greater focus on banking sector fundamentals has further wounded the prospects for future issuance.

Recent rising concerns about the banking sector outlook have centered around Deutsche Bank AG, Germany’s largest lender by assets. Deutsche reported an annual loss of €6.1 billion, weighed down by impairments and legal charges. An extensive reorganization of the bank and losses on legacy assets provide challenges for future returns. Deutsche has a $1.5 billion CoCo issued in November 2014 that was quoted at a price as low as 71 cents on the dollar on February 9 after having been valued at over 97 cents per dollar at the end of last year. The negative sentiments expressed in this price decline prompted statements from the bank’s executives that pointed to ample resources for coupon payments on its hybrid securities over the next two years.

Holders of European banking sector debt can take comfort in the banks’ substantial increase in capital buffers since the financial crisis. In the second quarter of last year, large European banks had an aggregate tier 1 capital ratio (measuring equity as a percent of risk-weighted assets) of 13.1%, up significantly from 8.3% in 2007 before the crisis broke out. Banks have made radical adjustments to their balance sheets, with considerable reductions in assets bolstering their capital firewalls. This transformation has naturally reduced potential profits, with the return on equity (ROE) in mid-2015 for large European banks of 4.0% down sharply from 9.8% in 2007. Lower bank ROE can be seen as credit positive, in that it points to reduced leverage and investment in relatively less risky assets. Yet an especially weak ROE raises concerns about maintaining capital adequacy in the event of a slump, particularly among peripheral European banks still burdened with large amounts of problem loans.

What might upset Australia’s ‘rock solid’ banks?

From The Conversation.

Market volatility has affected banks internationally in the US, UK and Europe but even though Australian banks remain insulated from turbulence abroad it might not be all smooth sailing.

The MSCI index of global banks has fallen by 16% since the start of the year, while the S&P index for US banks has fallen by 20%. The chief executive of Deutsche Bank (one of the world’s largest banks) was forced to announce that his bank was “rock solid” after the share price had fallen more than 30% from the start of the year and rumours circulated of problems with contingent convertible (CoCo) bonds.

Bank stocks and the cost of CDS insurance Datastream

The fall in international bank stocks has coincided with a perception of rising risk levels within the banking sector. The iTRAXX CDS index indicates the cost of insuring debt for a selection of global banks – the index increases as the cost of insurance becomes more expensive, indicating the market perceives that the debt is riskier. So far this year the index has risen 65% – the sharpest increase since the European sovereign debt crisis of 2011-12.

Falling commodity prices are the current focus

The main source of concern for financial markets at the moment is related to the commodity markets. Past high commodity prices encouraged many firms to invest heavily building huge new mines, liquefied natural gas (LNG) plants, and expanding production in shale oil. This investment required large amounts of borrowing, and banks have provided this directly (loans) and indirectly (purchasing bonds).

In the last year, crude oil prices have fallen 54%, LNG prices have fallen 32%, and iron ore prices are down around 30% (according to Datastream). The result is that many of the projects, some of which are still to come online, are not profitable – some may never be profitable – and the debt may not be repaid.

Credit ratings agencies such as Moody’s suggests that much of the debt issued by U.S. energy companies will be downgraded to junk in the near future, while Standard & Poor’s stated that debt at Chesapeake Energy (one of the largest US shale producers) is unsustainable.

Attempts by the Chinese government at intervening in the currency markets have also created volatility for banks. This has served to create a sense of uncertainty within the financial markets – and when this is the case there is often a reduction in the willingness to invest in “risky assets” such as stocks. Unlike in 2008, heavily indebted governments will have much less ammunition to bail out banks that fail this time around.

Longer term, the change in the regulatory environment is affecting the risk-taking ability of banks, and reducing profitability (even viability) of many areas. Increased capital requirements, particularly in areas that regulators deem to be too risky, mean that many banks are exiting equity, fixed income, and currency trading – divisions that have previously generated substantial profits for banks.

Of course, there is also ongoing regulatory investigation into a variety of cases of apparent financial market manipulation such as the recent LIBOR, and Foreign Exchange, fixing scandals that saw heavy fines imposed on US and European banks. This has even spread to Australia, where ANZ appears to be under investigation by ASIC for possible interest rate rigging.

Meanwhile in Australia

In Australia, banks have performed very well over the course of the last five years. At one point in 2012 Australian banks were worth more than the whole of the European banking sector! Record levels of profitability in Australian banks have supported large dividend payments to shareholders and helped push share prices to all-time highs in 2015.

Earlier this week, CBA announced another rise in earnings for the first half of the year – to A$4.8 billion. Much of this profitability is a result of increasing interest margins. As the Reserve Bank of Australia cash rate has fallen, banks have been quick to cut the rates offered to savers, but slow to pass on the rate decrease to borrowers (if they have done so at all). Even a small increase in this margin can boost profits if total assets are measured in the hundreds of billions of dollars.

Interest margins rba.gov.au

However, this profitability may not last as margins are under pressure on two counts. First, tighter lending standards, particularly for investors, have slowed lending in the housing market. The housing market appears to be slowing and this may increase bad debts in the future.

Australian banks are not totally immune to the impact of falling commodity prices, and CBA with ownership of Bankwest may be particularly exposed to a slowdown in Western Australia.

On the other side of the coin, funding is becoming more expensive for banks at the same time that increased capital requirements require them to hold more. Funding through international sources is particularly scarce (the CDS index indicates this is becoming more expensive), and this matters because Australian banks require a substantial amount of offshore funding.

Author: Lee Smales, Senior Lecturer, Finance, Curtin University

Macquarie buys up mortgages in $1bn deal

From Mortgage Professional Australia.

Macquarie Group agreed to buy the rest of ING Direct’s unbranded mortgages portfolio in a $1 billion deal with the Dutch lender, The Australian reports.

This will take its mortgage book well above the pre-GFC peak of $25 billion.

In 2013, Macquarie bought a $1.5bn book of non-branded mortgages from ING Direct, then acquired a $1.6bn portfolio in 2014 and in 2015 followed with another $1.5bn deal.

Macquarie chief executive, Nicholas Moore pledged to restore the bank’s pre-GFC grip on the sector back in 2014.

The string of acquisitions from ING means this target has been far exceeded, prompting questions about where the bank’s aspirations in the market now lie.

From Global Savings Glut to Financing Infrastructure

A new IMF working paper investigates the emerging global landscape for public-private co-investments in infrastructure. The creation of the Asian Infrastructure Investment Bank and other so-called “infrastructure investment platforms” are an attempt to tap into the pool of both public and private long-term savings in order to channel the latter into much needed infrastructure projects. This paper puts these new initiatives into perspective by critically reviewing the literature and experience with public private partnerships in infrastructure. It concludes by identifying the main challenges policymakers and other actors will need to confront going forward and to turn infrastructure into an asset class of its own.

Institutional investors such as pension funds, insurance companies and mutual funds, and other investors such as sovereign wealth funds hold around $100 trillion in assets under management. One gets a clearer grasp of the enormous size of this global wealth by comparing it to US nominal GDP $18 trillion in 2015.

Against this backdrop of a largely untapped pool of global savings, estimates suggest that the world needs to increase its investment in infrastructure by nearly 60 percent until 2030. There is a huge infrastructure investment gap in a large number of countries. The average infrastructure investment gap amounts to between $1 to 1.5 trillion per year. Infrastructure investment needs are mostly earmarked for upgrading depreciating brownfield infrastructure projects in the EU and in the US and for greenfield investments in low-income and emerging markets. The future growth in the demand for infrastructure will come increasingly from emerging economies.

There is growing recognition globally that development banks can play an important role in facilitating the preparation and financing of infrastructure projects by private long-term investors. A number of infrastructure platform initiatives have been launched very recently, most of them still at a prototype development stage. We discuss four different models that are currently at various stages of development. These platforms are all different attempts to tap into the vast pool of global long-term savings by better meeting long-term investor needs to attract them to infrastructure assets and by relaxing operating and governance constraints traditional development banks have been facing.

A first obvious lesson from an analysis of these platforms, is that the ability of development banks to leverage public money –committed capital from government contributions—by attracting private investors as co-investors in infrastructure projects is increasing the efficiency of development banks around the world. It is not just the fact that development banks are able to invest in larger-scale infrastructure projects and thus obtain a greater bang for the public buck, but also that these private investors together with development banks can achieve more efficient PPP concession contracts. Development banks are not just lead investors providing some loss absorbing capital to private investors. They also give access to their expertise and unique human capital to private investors, who would otherwise not have the capabilities to do the highly technical, time-consuming, due diligence to identify and prepare infrastructure projects. In addition, they offer a valuable taming influence on opportunistic government administrations that might be tempted to hold up a private PPP concession operator. Private investors in turn keep development banks in check and ensure that infrastructure projects are economically sound and not principally politically motivated. No wonder that this platform model is increasingly being embraced by development banks around the world.

The paper has documented that new platforms of investments have emerged. Notwithstanding, they are confronted with serious structural limitations. These platforms will certainly help on two important fronts namely on financing and origination of infrastructure projects, which this paper has focused on. Formally integrating these dimensions in models of PPP are important avenues for academic research.

Besides financing and origination, there are other important challenges to complete the broader task that lie ahead, such as in making infrastructure investment an asset class of its own. Two important directions are needed to further the agenda. First, the lack of standardization of underlying infrastructure projects is an important impediment to the scaling up of investment into infrastructure-based assets. Large physical infrastructure projects are indeed complex and can differ widely from one country to the next. In that respect, making use of securitization techniques such as collateralized bond obligations (or CBOs) or collateralized loan obligations (or CLOs) allow for better price discovery which will enhance the efficiency of the market and allow a more effective pooling of risk. It would also allow to “bulk up” the bond offering by addressing the problem of insufficient large sized bond issues. Overall, securitization will provide many advantages such as diversification for investors, lower cost of capital by allowing senior tranches to be issued with higher credit ratings, as well as higher liquidity. At the same time, securitization also creates debt instruments of variable credit risks to match the different risk appetites of investors. Second, there are important complementarities between actors participating in the “value chain” created by platforms including host countries, financial investors, guarantors and financial intermediaries. For all these reasons, the EIB has recently launched a renewable energy platform for institutional investors (REPIN) to offer repackaged renewable energy assets in standardized, liquid forms to institutional investors15. Although interest from institutional investors has been limited so far, the new carbon footprint disclosures and regulations of institutional investors that are expected be implemented after the Paris COP 21 climate summit, could nudge more pension and sovereign wealth funds to take on these securities.

Finally, host countries may put forth viable long term infrastructure projects but without the provision of guarantees to address construction, demand, exchange rate risks or without the securitization of underlying assets by financial intermediaries, those projects will not be funded, thus leaving everyone worse off. There is obviously also a need for enhanced coordination and cooperation across the various platforms in existence and for the creation of a global infrastructure investment platform. Part of the coordination should lead to risks being assumed by those best placed to hold them. Governments are the natural holders of political, regulatory and governance risks. The private sector for obvious incentive reasons should take on most of the construction risk, and demand risk should probably be shared, depending on the sector and type of project.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate.The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board,or IMF management.

CBA Profit Up 2% HY to Dec 2015

In CBA’s results, announced today, we see a well managed portfolio, with no surprises on either capital or dividends. They had the benefits of higher home loan pricing, and deposit rate management helping to offset some pressure in returns from the Institutional Banking arm. CBA’s early moves into digital banking continue to pay off, with 40% of retail banking sales now via mobile devices. Exposure to the resources sector is controlled, and the bank is well capitalised (on a relative and absolute basis), with a lift in key ratios. Earning per share decreased a little.

Statutory net profit after tax (NPAT) for the half year ended 31 December 2015 was $4,618 million, a 2 per cent increase on the prior comparative period (‘pcp’). Cash net profit after tax increased 4 per cent to $4,804 million, 6 per cent higher on the prior half. Return on equity was 16.6% and earnings per share was 273.6 cents, a decrease of 1% on the prior comparative period.

The Board declared an interim dividend of $1.98 per share, unchanged from the 2015 interim dividend. The dividend payout ratio is 70.8 per cent of cash NPAT. The interim dividend, which will be fully franked, will be paid on 31 March 2016. The ex-dividend date is 16 February 2016. The Dividend Reinvestment Plan (DRP) will continue to operate, but no discount will be applied to shares issued under the plan for this dividend. The Group is also considering the issue of a Tier 1 capital instrument to replace PERLS III should markets be receptive.

In summary, operating income growth was solid across most businesses, relative to both the prior comparative period and prior half but operating expenses increased due to underlying inflationary pressures, the impact of foreign exchange, increased investment spend and higher amortisation, though partly offset by the incremental benefit generated from productivity initiatives. Also loan impairment expense increased mainly due to higher provisioning in Institutional Banking and Markets, Retail Banking Services, and IFS.

Group transaction balances grew 21 per cent and above-system growth was achieved in household deposits (up 10.6 per cent) and business lending (up 6.8 per cent, excluding Bankwest). A balanced approach to margin over volume in home lending produced growth of 6.5 per cent, slightly below system. ASB saw 12 per cent growth in business and rural balances.

Other banking income increased 4 per cent, due to higher profits from associates and solid growth in fees and commissions, partly offset by derivative valuation adjustments.

Growth in insurance and funds management income of 17 per cent and 6 per cent, respectively, led to a 10 per cent increase in underlying profit after tax for the Wealth Management division.

Operating expenses increased 6% to $5,216 million, including a 1% impact from the lower Australian dollar. This reflects higher staff costs from inflation-related salary increases, increased investment spend and higher amortisation. This was partly offset by the continued realisation of incremental benefits from productivity initiatives

Ongoing investment spend, inflation and unfavourable foreign exchange movements resulted in a 6.1 per cent increase in total operating expenses. On an underlying basis, expenses grew 3.8 per cent as a result of cost discipline in business units. Total investment spend increased 14 per cent, with the majority earmarked for productivity and growth initiatives.

Net interest income increased 6 per cent to $8,364 million, reflecting 9 per cent growth in average interest earning assets driven by solid volume growth and revenue momentum across the business. This increase includes a 1% benefit from the lower Australian dollar. Net interest margin excluding Treasury and Markets decreased five basis points on the prior comparative period to 2.06%.

However, overall, 2.06% is the same as Jun 15 Half. This was helped by higher home lending margins, due to investor and variable rate pricing; and stable deposit margins, driven by a benefit from a change in deposit mix, offset by the lower cash rate environment. In addition, better margins from lending to business, and lower business deposit rates contributed. However, at BankWest, net interest margin decreased on the prior half, due to lower business lending margins and the lower cash rate impact on deposit margins, partly offset by increased home loan margins resulting from repricing.

Loan impairment expense increased 3 per cent on the prior half to $564 million, and the loan loss ratio remained stable at 17bpts.

Various elements contributed to this including higher collective provisions and a lower level of writebacks in Institutional Banking and Markets; an increase in IFS as a result of provisions in the
commercial lending portfolio; partly offset by reduced expense in Retail Banking Services driven by seasonally lower arrears across all portfolios; increased write-backs and lower collective provisions in Business and Private Banking; and decreased expense in New Zealand resulting from lower home loan impairment expense, and an increased level of write-backs in the business lending portfolio.

Consumer arrears were well controlled, though whilst the arrears for the home loan and credit card portfolios are relatively low, personal loan arrears remained elevated, driven primarily by Western Australia and Queensland.

Commercial troublesome assets increased 2% during the half to $3,123 million. Gross impaired assets were lower on the prior half at $2,788 million. Gross impaired assets as a proportion of GLAAs of 0.41% decreased 3 basis points on the prior half, reflecting the improving quality of the corporate portfolios.

There was no change to the economic overlay.

The Group’s balance sheet and conservative positions on capital, funding and liquidity have been strengthened in the first half. Growth in customer deposits of 9 per cent to $500 billion increased deposit funding to 64 per cent of total funding, up 1 per cent. The Group’s liquidity coverage ratio increased to 123 per cent as at 31 December 2015, up from 120 per cent at the end of the prior half, with the Group continuing to benefit from a strong position in more stable deposits.

Basel III Common Equity Tier 1 (CET1) capital increased 100bpts to 10.2 per cent on an APRA basis (14.3 per cent on an internationally comparable basis), reflecting organic capital growth and the proceeds of the rights issue.

They say this puts the Group in the top quartile of banks globally for capital adequacy.

CBA-2016-6 Customer satisfaction rankings continued to improve.

They reported a strong uptake of digital and mobile services in the half with Tap & Pay card numbers more than doubling on the prior half, Cardless Cash transactions grew 96 per cent, and the value of transactions via the CommBank app was up 27 per cent. The volume of transfers via mobile now exceeds BPAY volumes through Netbank. They are also seeing customers increasingly turn to mobile for product purchases with mobile now accounting for 40 per cent of Retail Banking Services sales.

In the half, CBA made additional future-focused investments in technology and skills. This included $10 million to help Australian researchers build the world’s first silicon-based quantum computer, committed $1.6 million to develop a centre of expertise for cyber security education with the University of New South Wales. They also launched a series of blockchain workshops for industry and regulators, and are collaborating with other international banks on blockchain trials.

Looking in detail at home lending in Australia, CBA provided some interesting insights. For example, looking at the core Australian Bank portfolio, 45% of new home loans are originated via brokers. 38% of new loans are interest only, and the current serviceability buffer has been lifted by 75 basis points in the past year. Those customers paying in advance, including offsets, was 76%.

They also show that 90+ arrears are growing fastest in WA.

On the other hand, portfolio is much stronger in NSW and VIC.

Finally, they reported exposures to Mining, Oil and Gas at $18.9bn – or 1.8% of Group TCE. They argue much of the portfolio is investment grade. Within the portfolio, impaired assets have risen from 0.8% in Jun 15 to 1.9% in December 15.