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

The Dynamics of US Mortgage Debt in Default

Research from the USA highlights the fact that when house prices fall, and household debt is high, the rise in defaults is more correlated to the number of households falling behind in their mortgage payments that the debts of those already in default.

From St. Louis Fed Research

The large decrease in US house prices between 2006 and 2011 led to a dramatic increase in mortgage debt defaults. Since then, the share of mortgage debt in default has decreased significantly and is now close to the pre-2006 level. In this essay, we argue that these fluctuations are predominantly the consequence of changes in the number of households falling behind in their mortgage payments (the extensive margin) and not changes in the amount of debt of those in default (the intensive margin). On average, the extensive margin accounts for 78 percent of the increase in the 2006-09 period and 93 percent of the decrease in the 2011-15 period. This information may be useful in designing prudential policies to mitigate mortgage default.

The analysis is performed using data from the Federal Reserve Bank of New York Consumer Credit Panel/Equifax. In our measure of default, we consider all households with mortgage payments 120 or more days late. Figure 1 shows the share of mortgage debt in default, which fluctuated between 0.7 percent and 1 percent in the 1999-2006 period and then jumped to 7.5 percent in 2009. The figure also shows the evolution of house prices, whose collapse coincided with increasing mortgage defaults. In a recent article, Hatchondo, Martinez, and Sánchez (2015) show how these two series are related: A rapid decrease in house prices causes a sharp increase in mortgage defaults because more households find themselves with negative home equity (“under water”), and some of these households find it beneficial to default after a negative shock to income (i.e., unemployment).

We decompose the changes in the share of debt in default into changes in four different components: average debt in default, number of households in default, average debt, and number of households with debt. Basically, since

we can compute the percentage change (%∆) in the share of debt in default as follows:

Figure 2 shows the results of the decomposition by year; the four colors in each column represent the changes in the four components. The percentage value (shown on the left vertical axis) illustrates the change in the share of debt in default generated by the changes in a particular component. According to the previous equations, the summation of changes in the four components equals the changes in the share of debt in default (represented by the values for the black dots as shown on the right axis). For example, the black dot for 2006-07 has a value of 92, which indicates that the share of debt in default increased by 92 percent in that time period.

There are three interesting findings. First, and most importantly, we find that fluctuations in the number of households in default accounted for most of the fluctuations in the share of debt in default (shown by the size of the orange part of the bars in Figure 2). The share of households in default was very large not only for the years when defaults were increasing (2006 to 2009), but also for the subsequent years when the share of debt in default decreased slowly but steadily. The changes in the number of households in default confirm our earlier claim that the drastic decline in house prices between 2006 and 2009 caused negative home equity for more households. For some of these households a negative income shock triggered default, thus leading to the sharp increase in mortgage debt default. Another reason for this pattern is the delay in foreclosure proceedings that started during the Great Recession. Chan et al. (2015) show that borrowers’ knowledge of a possible long delay between the formal notice of foreclosure and the actual foreclosure sale date affects the likelihood of default: Borrowers who anticipate a longer period of “free rent” have a greater incentive to default on their mortgages.

Second, our results indicate that from 2003 to 2007 the average amount of debt (the gray part of the bars in Figure 2) exerted downward pressure on the share of debt in default. That is, since the average amount of debt was increasing, if the other three components had not increased, the share of debt in default would have decreased.

Finally, we find that the average amount of debt in default (the yellow part of the bars in Figure 2) was important in the 2006-08 period. This finding indicates that part of the increase in the share of debt in default during that period was actually due to an increase in the amount of the debt of households in default. This increase is in line with the fact that the decline in house prices affected households with larger debt (not necessarily subprime loans) that were not falling into default before 2006. When house prices plummeted in 2006, more households from this group defaulted. Later in the recession, the importance of the average amount of debt was overtaken by the number of households in default as more and more households with similar characteristics chose to default.

To summarize, the rapid increases in mortgage debt in default between 2006 and 2011 captured the attention of the public, policymakers, and researchers. It is important to understand the main forces driving the default increase, especially in designing prudential policies that minimize mortgage default such as those analyzed by Hatchondo, Martinez, and Sánchez (2015). The decomposition exercise in this essay suggests that the evolution of the share of mortgage debt in default can be accounted for mostly by changes in the number of households in default rather than changes in the overall amount of mortgage debt and the number of households with mortgages. Changes in the amount of debt in default also played a nonnegligible role, especially during the pre-crisis to early crisis periods.

Banks’ Mortgage Books React To Regulator’s Push

APRA has released the quarterly real estate data for the banks in Australia to December 2015. There are some strong signs that the regulatory intervention has changed the profile of loans being written, despite overall significant growth in loan balances on book.

Total loans on book to December were a record $1.38 trillion, of which $1.12 trillion – or 80% are with the big four. Within that, 36% of loans were for investment purposes, the remainder owner occupied loans. The trend shows the significant rise in owner occupied loans being written (explained by a rise in refinances), whilst investment loans have fallen. This is a direct response to the regulators intervention. But note, total loans on book are still rising.

Because the big four have the lions share of the market, the rest of the analysis will look at their portfolio in more detail. For example, looking at loan stock, we see a rise in the proportion of loans with a re-draw facility (75.7%), Loan with offsets continue to rise, reaching 35.8% and interest only loans have slipped slightly to 31.4%, another demonstration of regulator intervention (they have asked banks to tighten their lending criteria and ensure consideration of repayment options for interest only loans). Reverse mortgages remain static as a percentage of book (0.6%), and low-doc loans continue to fall (2.9%).

The loan to value mix has changed, again thanks to regulatory guidance, with the proportion of new loans above 90% LVR falling to 9.1%, from a high of 21.6% in 2009. Loans with an LVR of between 80% and 90% have fallen to 14.2%, from a high of 22% in 2011. Once again, we see a change in the mix thanks to regulatory guidance, and also thanks to a lift in refinance of existing loans, which tend to have a lower LVR. The portfolios are being de-risked.

Another demonstration of de-risking is the lift in new owner occupied loans, and a fall in investment loans to 31.7% of new loans written.

If we look at interest only loans, we see a fall to 39.5% of new loans written (the high was 47.8% just 6 months before), so we see the hand of the regulator in play. However 3.7% of loans were outside normal serviceability guidelines, just off its peak in June 2015. Finally, 47.4% of new loans have been originated from the broker channel, another record. This is also true for all banks, and it shows that brokers are doing well in the new owner-occupied and refinance ridden environment.

So, overall, make no mistake home lending is still growing, despite regulatory guidance, thanks to the rise in owner occupied loans. This means that the banks will be able to continue to grow their books, and maintain their profitability. No surprise then that the big four are all fighting hard for new OO loans, and are discounting heavily to write business. It is too soon to judge whether the portfolios have really been de-risked, given the sky high household debt this represents, and a potential funding crunch the banks are facing.

The International Exposures of Australian Banks

In a Speech “The Evolving Risk Environment”, Malcolm Edey RBA Assistant Governor (Financial System) discussed some of the risks to financial stability, both globally and locally.

Much of the story has been told before, the economic uncertainties surrounding oil, China, Europe, high debt levels and locally the risks (and how they have been controlled) in the housing market, and potential risks in the commercial property sector.

One specific issue he covered was the potential international exposures Australian banks may face. He focussed specifically on the assets Australian banks hold overseas.

Direct exposures of Australian banking institutions to the risk factors I have been describing are quite limited Exposures to the euro area have been scaled back in the wake of the crisis and now represent only around 1 to 2 per cent of Australian banks’ consolidated global assets. Although exposures to the Asian region have been growing quite rapidly over recent years, they are still a relatively small share of consolidated assets – around 4 per cent. Many of these exposures are shorter-term and trade-related, factors that should lessen credit and funding risks. That said, operational and legal risks around these exposures could be relatively high, particularly given the rapid expansion of these activities in recent times.

Fair point. However, there are two other exposures to also consider. First banks here are funding their lending partly via capital markets overseas, because there is a gap between the value of deposits held and loans made. Different banks have different footprints. But this means if the international capital markets froze for any reason this would be a significant risk locally. This was demonstrated during the GFC. In any case, in the current environment, spreads are rising, and funding is becoming more expensive. To an extent, given limited competition here, they can just raise rates to customers. But there will be some limits. Recently we have seen a number of lifts in some mortgage rates and to the SME sector.

The other exposure is from international investors and fund managers who invest in the shares of the banks here, and who are also thinking about risk profiles, local economic performance and other factors. We often get asked to provide a picture of things here by such investors. They will consider levels of returns and risks implicit in these returns. Given that going forwards, it is likely banks will find it harder to maintain current dividends than in the past, we may see a change in the wind here too. If international investors were to jump ship, expect market prices to fall.

So, my simple point is that banks are exposed to global forces, well beyond those risks of default on loans, and these additional should be factored into discussions of financial stability.

I would also highlight that not all banks are equally exposed, as underscored by the batch of results declared in the past couple of weeks.

Our finances are a mess – could behavioral science help clean them up?

From The Conversation.

The first few months of a new year can be a stressful time financially. The Christmas holidays typically lead to depleted savings and higher credit card balances, while tax season is right around the corner.

Unfortunately for most us, this isn’t a seasonal dilemma but a chronic problem that brings anxiety throughout the year.

Indeed, as many as 44 percent of American households don’t have enough savings to cover basic expenses for even three months. Without a savings cushion, even regular seasonal expenses like holiday celebrations may end up feeling “unexpected” and lead households to turn to credit to cover costs.

U.S. consumers currently hold US$880 billion in revolving debt, with an average credit card balance of almost $6,000. The picture is even more dire for lower-income households.

So how can we turn this around? Many tacks have been tried but fallen short for one reason or another. Fortunately, behavioral science offers some useful insights, as our research shows.

What’s wrong with current approaches

Typical approaches to solving problematic finances are either to “educate” people about the need to save more or to “incentivize” savings with monetary rewards.

But when we look at traditional financial education and counseling programs, they have had virtually no long-term impact on behavior. Similarly, matched savings programs are expensive and have shown mixed results on savings rates. Furthermore, these approaches often prioritize the need for savings while treating debt repayment as a secondary concern.

Education and incentives haven’t worked because they are based on problematic assumptions about lower-income consumers that turn out to be false.

The truth is lower-income consumers don’t need to be told what to do. On average, they are actually more aware of their finances and better at making tradeoffs than more affluent consumers.

They also don’t need to be convinced of the value of saving. Many want to save but face additional obstacles to financial health.

For example, these households often face uncertainty about their cash flows, making planning for expenses even more difficult. More generally, they have little room for error in their budgets and the costs of small mistakes can compound rapidly.

Brain barriers

In this volatile context, psychological barriers common to all people exacerbate the problem.

People have difficulty thinking about the future. We treat our future, older selves as if they are strangers, decreasing motivation to make tradeoffs in the present. Additionally, we underpredict future expenses, leading us to spend more than precise budgeting can account for.

When we do focus on the future, people have a hard time figuring out which financial goals to tackle.

In research that we conducted with Rourke O’Brien of the University of Wisconsin, we found that consumers often focus either on saving money or on repaying debt. In reality, both actions simultaneously interact, contributing to overall financial health.

This can be problematic when people misguidedly take on high-interest debt while holding money in low-interest saving accounts at the same time. And, once people have identified building savings or repaying debt as an important goal, they have difficulty identifying how much should be put toward it each month. As a result, they rely on information in the environment to help determine this amount (like getting “anchored” on specific numbers that are presented as suggestions on credit card payment statements).

Unfortunately, the way current banking products are designed often makes these psychological realities worse.

For example, the information on many credit card payment systems nudges consumers toward paying the minimum balance rather than a higher amount. Budgeting tools assume income and expenses stay the same from month to month (not true for most lower-wage workers) and expect us to monitor spending against a long list of separate, complicated budget categories.

On a deeper level, the fact that banks offer credit and savings products separately exacerbates the psychological distance between paying down debt and building savings, even though these are linked behaviors.

Behavioral banking

The good news is that a range of simple, behaviorally informed solutions can easily be deployed to tackle these problems, from policy innovations to product redesign.

For instance, changing the “suggested payoff” in credit card statements for targeted segments (i.e., those who were already paying in full) could help consumers more effectively pay down debt, as could allowing tax refunds to be directly applied toward debt repayment. Well-designed budgeting tools that leverage financial technology could be integrated into government programs. The state of California, for example, is currently exploring ways to implement such technologies across a variety of platforms.

But the public and private sectors both need to play a role for these tools to be effective. Creating an integrated credit-and-saving product, for example, would require buy-in from regulators along with financial providers.

While these banking solutions may not close the economic inequality gap on their own, behaviorally informed design shifts can be the missing piece of the puzzle in these efforts to fix major problems.

Our research indicates that people already want to be doing a better job with their finances; we just need to make it a little less difficult for them. And making small changes to banking products can go a long way in helping people stabilize their finances so they can focus on other aspects of their lives.

Authors: Hal Hershfiel, Assistant Professor of Marketing, University of California, Los Angeles; Abigail Sussma, Assistant Professor of Marketing, University of Chicago.

In a changing world; is global still good?

In a speech to the Institute of Chartered Accountants of Scotland on 11 February, Dame Clara examines the UK’s position as host to a global financial centre through the lens of the Financial Policy Committee’s two main objectives: its primary objective to maintain financial stability, and its secondary objective to support the Government’s economic policy, including its objectives for growth and employment; productive investment, innovation, competition and the lead role of the City of London in international financial markets.

In the context of financial “de-globalisation” and sharply falling cross-border capital flows, Dame Clara believes that now is a good time to consider the benefits of global markets and financial centres. Historically, Dame Clara notes, the development of global financial centres went hand-in-hand with the integration of international capital markets, because a more complete market can allocate capital with much greater efficiency.

According to an IMF staff discussion note, financial development increases a country’s resilience; mobilises savings, promotes information sharing, improves resource allocation and facilitates diversification and management of risk. It also promotes financial stability to the extent that deep and liquid financial systems with diverse instruments help dampen the impact of shocks.
But at the same time, financial deepening and connected markets can transmit shocks as well as dispersing and absorbing risk and driving growth. “Overall, however, with the right policy framework, choices and institutions, it seems clear that the benefits of financial globalisation are compelling,” Dame Clara observes.

Next, Dame Clara considers why global centres are needed, when advances in technology have made it feasible for the financial system to become decentralised.

On reason why it is good to be global is that a specialised financial centre can yield “agglomeration benefits” – the economies of scale arising from having an industry cluster in a particular location – and which can also improve access to finance for households and businesses.

Another benefit of centralisation is that it allows the authorities to see more. “The more that activity clusters in a small number of centres, the more that regulators and policymakers can take a holistic, systemic view of threats to financial stability,” Dame Clara says.

In the UK context, there are also economic benefits in being a global financial centre. “While the primary objective of financial stability is paramount for the FPC, the UK clearly has an interest in maintaining its strong position as a provider of these services. Provided the financial sector remains resilient – and our new regulatory framework seeks to ensure that it does – this is central to the FPC’s secondary objective.”

Following on from this, Dame Clara considers the conditions for the success or failure of financial centres. Looking back over time, she observes that while financial centres have tended to cluster around centres of economic power, they can remain in place and prosper even after economic power has shifted elsewhere.

“The UK has maintained its position right into this century, even though the days in which Britain was the dominant superpower are long gone.”

That said, the decline of a financial centre can be precipitated by an adverse event, such as war or a policy error that makes the continued provision of financial services impossible, uneconomic or simply destroys confidence in it. As such, one lesson to be drawn from history is that policy choices and institutions matter.

Looking forward, proximity to power may be less important for financial centres such as the UK, thanks to advances in communications technology. However, because moving is easier than it was in centuries past, the same factors that mean the UK can serve the world, allow for a wide range of alternative centres to become established, possibly leading to a decentralisation and fragmentation of the financial system. This would undermine the efficiency of global capital markets and harm global growth.

“To avoid this, authorities need to remain alert to shocks, including those arising from the geopolitical and wider macrofinancial environment, as well as the more ‘bread and butter’ risks that are visible on banks’ balance sheets. This is where the FPC can play an important role,” according to Dame Clara.

An environment where geography and sheer economic scale matter less, means that institutions may matter even more. “We need a clear, prudent, proportionate system of regulation, which is sensitive to the different risks and opportunities posed by different kinds of activity,” Dame Clara says.

Dame Clara concludes that: “International and global financial centres have historically played a crucial role in promoting both growth and stability. But policymakers cannot take their existence for granted. In a world where institutions and policy choices matter more than ever, a prudent and proportionate regulatory framework is essential to sustainable growth. That is what we on the FPC are seeking to achieve.

Lending Finance To Dec 2015 Shows Business Loans Up Ex. Investment Housing

The ABS data to December 2015 of total lending by category shows that the total flow value of owner occupied housing commitments excluding alterations and additions rose 1.3% in trend terms (to $21.9 bn), and the seasonally adjusted series rose 0.9%.

The trend series for the value of total personal finance commitments fell 0.7% (to $6.9 bn). Fixed lending commitments fell 1.0% and revolving credit commitments fell 0.3%. The seasonally adjusted series for the value of total personal finance commitments rose 2.1%. Fixed lending commitments rose 2.6% and revolving credit commitments rose 1.5%.

The trend series for the value of total commercial finance commitments fell 0.3% (to $44.1 bn). Revolving credit commitments rose 2.4%, while Fixed lending commitments fell 1.2%. The seasonally adjusted series for the value of total commercial finance commitments fell 7.3%. Revolving credit commitments fell 18.3% and fixed lending commitments fell 3.3%.

The trend series for the value of total lease finance commitments rose 0.1% in December 2015 (to $602m) and the seasonally adjusted series rose 1.7%, after a fall of 3.8% in November 2015.

Commercial finance includes lending to individuals and other for investment property purchase. We see that lending for investment property purchase slid to 15% of all lending in December, having reached a high of nearly 20% in late 2014. In addition, the proportion of commercial lending which related to investment property purchase fell to 25% of all commercial lending, having reached a peak of 31.4% in late 2014.

However, bearing in mind total commercial lending fell in the month, we see that owner occupied lending is now growing considerably faster (1.3%), compared with investment lending (down 2.4% and $11.4 bn) and commercial lending in aggregate is down 0.34%, but the non-investment housing segment rose 0.38% (to $32.7 bn).

If investment lending continues to slow, this will put more pressure on commercial lending growth, or create space for other lending to business, depending on your point of view. Or will the banks simply continue to chase owner occupied refinancing, the easy option? That said, lending to business ex. investment housing did grow, if but a little in the month. We need much stronger movement here to drive productive growth.

RBA Banking On Household Spending Growth

In the latest minutes, released today, there was interesting commentary on their perspective of household consumption growth, savings ratio, and housing activity. They are expecting a growth in household consumption. However, this does not necessarily jive with DFA’s Household Finance Confidence Index, which reported a fall in the most recent results.

Turning to developments in the household sector, members noted that growth in household consumption had increased in the September quarter to be close to its decade average in year-ended terms. Growth was expected to be similar in the December quarter, based on recent retail sales data, indications from the Bank’s retail liaison that trading conditions had improved in the Christmas and post-Christmas sales period, and surveys suggesting that perceptions of households’ own finances remained above average. Household consumption growth had been supported by low interest rates, lower petrol prices and increasing employment, despite relatively subdued household income growth. These factors were expected to support a further increase in consumption growth over the forecast period.

Members observed that although the saving ratio had been declining, recent revisions to national accounts data suggested that this decline was not as pronounced as previously thought. As a result, the saving ratio had remained close to 10 per cent over the past five years, which was a significant step up from its average over the previous two decades but not particularly high from a longer-run perspective.

Dwelling investment had increased strongly over the year to the September quarter and further growth was anticipated, albeit at a gradually declining rate. This was consistent with building approvals, which were at a high level, although lower than in early 2015. Members noted that some other indicators of dwelling investment, including loan approvals for new construction, had been more positive in recent months. Information from liaison contacts indicated that demand for high-density housing in Sydney, Melbourne and Brisbane had been sufficient to absorb the increase in the supply that had come onto the market, whereas demand had been somewhat weaker in Perth, which had experienced a decline in prices and rents for apartments over the past year. To date, there had not been any substantive signs of financial distress from developers, but there had been an increasing number of projects put on hold, particularly in areas where there were concerns about potential oversupply. Conditions in the established housing market more generally had eased in recent months. Housing prices had declined a little from September 2015 and auction clearance rates had fallen from very high levels to around their long-run averages.

Housing credit growth overall had stabilised at around 7½ per cent, following a period of rising growth since late 2012. Growth in credit to investors in housing had declined, offset by an increase in growth in credit to owner-occupiers. This was consistent with the larger increase in mortgage rates for investors and the strengthening of banks’ non-price lending terms in response to earlier supervisory actions.

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.