Economics and Banking – Page 415 – Digital Finance Analytics (DFA) Blog

Brokers responsible for more than half of interest-only lending

More than half of interest-only loans come through the third party channel, corporate regulator ASIC has revealed ahead of its forthcoming review of mortgage brokers in regards to interest-only lending.

Speaking at the FBAA conference held on the Gold Coast in November, ASIC senior executive leader – deposit takers, credit & insurers, Michael Saadat announced that the regulator would turn its focus to mortgage brokers following its recent review of banks in regards to interest-only lending.

Saadat has now revealed to Australian Broker that the shift in focus has come after its review of lenders found that interest-only loans through the broker channel increased by 8% over two years.

“Since 2012, the proportion of interest-only loans sold through the broker channel has gone up from 49% to 57% as of the fourth quarter of 2014.”

However, despite writing more than half of the interest-only loans in the market, Saadat said the review found that the average value of an interest-only loan submitted by a broker was less than that of a bank.

“Clearly brokers are involved in arranging interest-only loans but the other thing we noted in our report was the size of interest-only loans also varies by channel, and actually, it is the direct channel rather than the broker channel where the larger interest-only loans have been provided.”

ASIC’s forthcoming review will analyse quantitative and qualitative data of around 10 to 12 large broking groups, according to Saadat. The review will also have a focus on record-keeping practices.

“We will also be looking to get individual customer files to see how brokers are meeting their responsible lending obligations, and how they go about recording the information they obtain and the verification they conduct on the file,” Saadat told Australian Broker.

“One of the findings of our review of lenders’ files was that record keeping practices were not as good as they could be, so we are quite interested to see how brokers are going with record keeping as well.”

APRA Declares Countercyclical Buffer Rate Is Zero

APRA has today announced that the countercyclical capital buffer applying to the Australian exposures of authorised deposit-taking institutions (ADIs) from 1 January 2016 will be set at zero per cent.

The countercyclical buffer was included within the ADI capital framework as part of the Basel III reforms that were introduced by APRA in 2013. Although the minimum Basel III requirements were implemented from 1 January 2013, the buffer component of the framework will take effect from 1 January 2016.

The capital framework requires ADIs to hold a buffer of Common Equity Tier 1 (CET1) capital, over and above each ADI’s minimum requirement, comprised of three components:

a capital conservation buffer, applicable at all times and equal to 2.5 per cent of risk-weighted assets (unless determined otherwise by APRA);
an additional capital buffer applicable to any ADI designated by APRA as a domestic systemically important bank (D-SIB), currently set to 1.0 per cent of risk-weighted assets; and
a countercyclical buffer which may vary over time in response to market conditions. This buffer may range between zero and 2.5 per cent of risk-weighted assets.

The role of the countercyclical buffer within the Basel III reforms is to ensure that banking sector capital requirements take account of the macro-financial environment in which ADIs operate. It can be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. The buffer can be reduced or removed when system-wide risk crystallises or dissipates. For an ADI with international exposures, the countercyclical buffer applicable to its business will be the weighted average of the countercyclical buffers applied by the jurisdictions in which it operates.

APRA Chairman Wayne Byres noted the decision to set the countercyclical buffer for Australian exposures at zero per cent of risk-weighted assets was made following consultation with the Council of Financial Regulators.

‘Based on APRA’s assessment of current levels of systemic risk, including credit growth, asset prices and lending standards, APRA did not see a case for imposing a countercyclical buffer for Australian exposures at this point in time,’ Mr Byres said. ‘APRA will continue to monitor developments in a range of financial risk indicators, and will revise the determination if conditions warrant it in future.’

The consequence of this decision is that ADIs will generally be required, from 1 January 2016, to maintain a minimum CET1 ratio of 4.5 per cent, plus a 2.5 per cent capital conservation buffer (3.5 per cent for D-SIBs) and a buffer for international exposures in jurisdictions that have set a non-zero countercyclical capital buffer rate. For some ADIs, additional capital requirements are also applied via Pillar 2 (i.e. in response to institution-specific risks and issues). All Australian ADIs currently report CET1 ratios above these requirements: the aggregate CET1 ratio for the banking system as at end September 2015 was 10.1 per cent.

Where an individual ADI does not hold sufficient capital to meet its aggregate buffer requirement, the ADI would be subject to constraints on its ability to make capital and bonus distributions. The distribution constraints imposed on an ADI when its capital levels fall into the buffer range increase as the ADI’s capital level approaches the minimum requirements. This encourages ADIs to maintain a sound capital buffer and provides a mechanism to ensure ADIs conserve capital, and have a strong incentive to restore their capital strength, after a period of loss.

In addition to today’s announcement on the size of the buffer, APRA has also released today:

an information paper, The countercyclical capital buffer in Australia, setting out APRA’s approach to assessing the appropriate settings for the countercyclical buffer;
a revised and final version of Prudential Standard APS 110 Capital Adequacy (APS 110) that clarifies operational aspects of the countercyclical capital buffer, following consultation earlier this year; and
a draft version of Prudential Practice Guide APG 110 Capital Buffers (APG 110) for consultation. The draft APG110 provides additional guidance on the operation of the capital buffers, including some worked examples.

APRA has also informed the Basel Committee on Banking Supervision of the Australian countercyclical capital buffer rate so it can be added to the list of jurisdictions’ buffers that are maintained on the Bank for International Settlements’ website.

The countercyclical buffer information paper, the draft prudential practice guide on capital buffers, and the revised prudential standard APS 110 can be viewed on APRA’s website.

Risk on? Interest rates could stay low for decades

From The Conversation.

When a central bank lifts interest rate targets by 0.5% it expects households and firms to respond. In a crisis, the official target may fall by 3% in order to shock the economy into a positive response. These movements of interest rates by the central bank are an important tool of macroeconomic adjustment

They are also relative to the longer term, or normal rate of interest in the economy. What is interesting now is that rates have been low for quite a long time suggesting the natural rate of interest in the economy has fallen permanently.

A recent research paper from the Bank of England suggests that the global neutral interest rate may settle at or below 1%. To put this in context, the paper suggests that rate was around 5.5% in the 1980s (yes, that is real, so adjusted for inflation).

Central banks will get into a tizz about this because it gives them less room to cut rates to stimulate the economy. It gives the bankers much less room to cut interest rates in a crisis.

The reasons for the fall are broadly that saving has tended to increase and investment to fall; more money is available but fewer people want to borrow, thus driving down rates. The authors of the Bank of England paper argue the trends will not change abruptly so we can expect low rates for a long time.

They suggest savings have tended to increase in part for demographic reasons, because of rising inequality, and from a desire by Asian governments to maintain a financial buffer. The main demographic reason has not been ageing, but a decline in the dependency ratio: as birth rates have fallen, the proportion of people who were not of working age has fallen from 50% to 42% over the last 30 years. With fewer children people have been able to save more.

Piketty and others have pointed out the increase in within-country inequality over the last few decades, and since richer people save more than poor people, this too has tended to boost savings.

At the same time the authors argue that investment has fallen for three main reasons. The most important is the fall in the price of capital equipment which has meant that a given increase in output can now be obtained more cheaply (with a lower investment spend).

Investment by government has also fallen slowly but surely over recent decades, albeit with some uptick in response to the global financial crisis. It is less clear why this has happened but I suspect it is because government revenue growth is limited by sensitivity around taxes, and government expenditure is increasingly directed towards transfer payments. Investment also seems to have fallen because it appears to have become relatively riskier – the return on capital has fallen but not nearly as much as the risk free rate – reducing the inclination of firms to invest.

What does it mean for you and I? Broadly we face a world which advantages investors and disadvantages savers. The returns on our investments in safe assets will be low and investors are likely to take on additional risks in order to boost returns. This makes it hard for Australian investors since banks and miners dominate our exchange: the low interest rate environment is not good for banks, and there is no clear end in sight to the commodity price downturn.

As voters we should be less concerned about public debt than we were. The case for policy changes which stimulate growth has increased, and increased government investment in productive assets is strengthened.

Author: Rodney Maddock, Vice Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics, Monash University

Fed Lifts Rates For The First Time in Years

Just Announced.

The Federal Reserve raised the Fed funds rate by 25 basis points to 0.25 percent – 0.5 percent, during its FOMC meeting held on December 16th. While the Fed said is “reasonably confident that inflation will rise, over the medium term, to its 2 percent objective” , Fed Governors were also carefully to point that “economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate”. It was the first hike since June 2006 when Ben Bernanke increased the benchmark rate from 5 to 5.25 percent. From 1971 until 2015, Interest Rate in the United States averaged 5.93 percent, reaching an all time high of 20 percent in March of 1980 and a record low of 0.25 percent in December of 2008.

Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Senate Inquiry Says Credit Card Industry Needs Reform

The Senate Inquiry report of Credit Cards was published today. They have made 11 recommendations, which could have some impact on the sector, but they have rejected regulation of card rates. They suggest a focus on easier switching, better disclosure, affordability assessments and tweaks to minimum payments. They also flag the potential for an alternative longer-term credit product.

Two important points come though. First, card rates have not followed cash rates down.

Second, less affluent households, who revolve consistently and maintain high debt balances cross-subside more affluent households who do not. You can read about our analysis of card economics here.

In addition, many who do borrow on a card do not understand the true rates of interest they are paying.

Here are the recommendations:

Credit card advertising and marketing material should disclose clearly the cost of a credit card for a consumer, including the card’s headline interest rate and ongoing annual fee.
Credit card monthly statements should include prominent reminders about a credit card’s headline interest rate and ongoing annual fee.
The government to work with key stakeholders to develop a system that informs consumers about their own credit card usage and associated costs. Initially, historic usage and cost data could be provided in monthly statements. Over time, it would be desirable to provide customer-specific, online, machine readable records that would allow credit card users to compare credit cards using online comparison engines.
The government should undertake a review into technical and systems innovations that might help facilitate switching in the credit card market, and as part of this review consider the feasibility of account number portability for credit card accounts.
Card providers should be required to provide consumers with the ability to close a credit card through an online process (‘click-and-close’).
The responsible lending obligations, as they apply to credit card lending, be amended so that serviceability is assessed on the basis of the borrower’s ability to pay off their debt over a reasonable period. The government should consult with industry, consumer groups and other interested stakeholders to determine what constitutes a ‘reasonable period’ in this regard.
The government consider introducing a credit card minimum repayment requirement and alternative means of reducing the use of credit cards as long-term debt facilities.
Credit card providers should be required to make reasonable attempts to contact a cardholder when a balance transfer period is about to expire and the outstanding balance has not been repaid. In doing so, the provider should be required to initiate a discussion about the suitability of the customer’s current credit card and, where appropriate, provide advice on alternative products.
The government should consider expanding financial literacy programs such as the Australian Securities and Investments Commission’s MoneySmart Schools Program.
Credit card providers should be required to make reasonable attempts to contact a cardholder in cases where a cardholder has only made the minimum payment for 12 consecutive months on interest bearing balances, and thereby initiate a discussion about product suitability and alternative lending products.
The government consider a Productivity Commission inquiry into the value and competitive neutrality of payments regulations, with a particular focus on interchange fees.

There are some separate comments and recommendations from Nick Xenophon, who suggests consideration should be given, in conjunction with consumer groups and experts, to providing appropriate warnings on credit card statements and credit card advertisements.

Finally, Coalition Senators expressed some concerns about the potential impact of some of the recommendations, as being overbearing.

Securitised Loan Pools Tells Us Something

Guy Debelle Assistant Governor (Financial Markets), spoke at the 28th Australasian Finance and Banking Conference – “Some Effects of the New Liquidity Regime“. During his speech he revealed some significant data drawn from Australian securitised mortgages. With the caveat that securitised loans are somewhat cherry-picked, and may not represent the entire market profile, there are some interesting observations. Of note is the higher level of default in WA, and the proportion of loans above 80% and 90% LVR.

To enhance the information available to us, since the middle of 2015, mandatory reporting requirements came into effect for asset-backed securities to be repo eligible with the Reserve Bank and also to be eligible collateral for the CLF.

The required information includes key transactional level data, detailed tranche information, and the relationships between trusts and service providers including who is providing various facilities such as a fixed to floating swap. At the loan level, required data for RMBS include: 62 loan fields such as loan balances, interest rates, arrears measures; 18 borrower fields such as borrower income, employment type, whether they are an investor or owner-occupier, whether they are a first home-buyer; and 13 collateral fields (that is, detail on the collateral underpinning the mortgage) including postcode and property valuation.

These requirements include data that are commonly used by ratings agencies and RMBS investors, but the data go beyond that to also include some useful information that has not been commonly compiled before, such as offset balances and borrower income at origination. This allows us, along with other investors in asset-backed securities, to undertake a richer analysis of such securities and more accurately assess their risk and pricing than may have been possible before. In our case, it allows us to undertake our own risk assessment and not be dependent on rating agencies.

In addition to these data fields, issuers are also required to provide a working cash flow waterfall model of the security which can provide useful information about structural aspects of ABS in some cases only previously obtainable through a detailed reading of legal documentation. This innovation has been very useful in standardising information across securities, allowing us to verify structural features of deals and provide more granular haircuts and pricing than was the case previously.

These reporting requirements are standardised for all repo-eligible asset-backed securities, meaning that the same information is required for all securities. As a result, going forward, it will be easier to compare securities. We see this as being of great benefit to the industry as a whole, as does the industry itself, as evidenced by the support of the Australian Securitisation Forum (ASF) through the whole process of introducing these new standards.

The repo-eligibility requirements also direct issuers to make the information available to investors and other permitted users, not just to the Reserve Bank. By and large, the information provided to these groups is the same as that provided to the Reserve Bank; however, there have been some fields where the information provided posed a potential risk to privacy. Hence issuers may redact some particular fields and provide aggregated de-individualised data about these fields instead.

Since the middle of this year, we have received into our securitisation system around 1 600 submissions, covering around $400 billion in assets, including around two million individual housing loans. The information is updated on a monthly frequency so we are gaining not only a much richer view of the ABS market at any point in time, but also a rich time series. With this very large panel data set we can examine how the market, and the underlying collateral, evolves through time.

With the caveat that the data reporting is still in its infancy, it’s already apparent that there are many potential benefits of the data. Let me illustrate some of the summary information that we can glean from the first few months of reporting. As noted earlier, these data cover around 2 million housing loans of the total of the approximately 6 million such loans on issue currently.

Graph 4 shows the loan to value ratio (LVR) at origination and currently. The largest share of loans had an LVR at origination of between 70 and 80 per cent. While that is still the case in terms of the current LVR, the share is noticeably lower. Similarly, there are almost no loans with an LVR greater than 90 per cent, even though around nearly 10 per cent had an LVR greater than 90 at origination. That said, it should be borne in mind that securitised loans tend to be more seasoned than non-securitised loans and are therefore amortising more quickly. The seasoning (time since loan origination) of the securitised loans is shown in Graph 5. It shows that 95 per cent of the value of loans is more than one year old, and nearly 75 per cent is more than three years old.

Graph 4

Graph 5

One issue which is of some interest currently is the extent of the repayment buffer that has been built up by borrowers. This is shown in Graph 6 which shows that two-thirds of borrowing is covered by a repayment buffer of at least one month’s worth of required mortgage payments, and for half of this, that buffer is more than one year. As the time series on this loan feature accumulates it has the potential to be useful information for monetary policy as well as financial stability considerations. Graph 7 shows the level of documentation for loans securitised by different types of lender. It shows that the major banks have a minimal share of low doc loans in their pools, whereas for the non-bank issuers the share is considerably larger.

Graph 6

Graph 7

Finally, in terms of credit risks, Graph 8 shows arrears rates by states and shows that the current distribution of arrears are consistent with the variation in economic conditions across the states, though at the same time all arrears rates are relatively low.

Graph 8

Of course, credit risk is not so much about the averages but the distributions. Having the loan level data enables an insight into the characteristics of the loans in the various tails of the distribution that warrant closer attention. It will also allow an assessment of the correlations between the various drivers of risk that may lead to credit deterioration.

In sum, there is very rich potential in these data for many purposes for the RBA and other market participants. From our point of view, the data provide us with a great deal of insight into the contingent risk that might at some point reside on our balance sheet. But clearly, the data are also very useful for financial stability and monetary policy considerations too.

DFA Household Finance Security Index Lifts – For Some

The latest edition of the DFA Household Finance Confidence Index (FCI) is released today, using data from our household surveys up to the end of November 2015. The index moved up a little, from 90.73 to 91.46, but still below the neutral setting of 100. So overall households remain cautious about their financial state in the run up to Christmas.

The results are derived from our household surveys, averaged across Australia. We have 26,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. We discuss the findings in the video below.

To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

One of the more interesting aspects of the research highlights that households who are property investors continue to have their overall confidence eroded, driven by the higher costs of finance and doubts about the prospect of future capital growth. This echoes the fall-off in investment lending we have been tracking in recent weeks. The downturn in investor confidence is most marked in NSW. On the other hand, owner occupied property owners have become relatively more confident, thanks to continued low interest rates. Those households who are property inactive (renting, or seeking to buy) remain the least confident sector.

Looking at the elements which drive the index, we find that 35.5% of households say their costs have increased in the past year, up by 0.6% from last month, whilst 5% say their costs have fallen. 59% say there has been no net change, thanks to lower mortgage interest costs over the year, helping to offset other rising costs. Low inflation levels are helping.

Income growth remains under pressure, with 5% saying their income has rising in the part year (after inflation), and 37% saying their real incomes have fallen, whilst 57% said there was no change. Many have not received any rise in pay over the past year, and are relying on more overtime to lift take-home wages. One respondent said ” we are simply running harder, just to stand still”.

Looking at debt levels, 61% said they had more debt than last year, 23% said there was no change, and just 15% said their debt was lower (up by 1.6% last month). Mortgages continue to be the main burden, and some households (those generally more affluent) are continuing to reduce their credit card and loan debt. We did also note a continued rise in small loans, from households under financial stress.

Many households have little money in the bank for a rainy day, but of those who are saving, 14% said they were more comfortable with their savings than a year ago which is down 1.5%, and linked directly to continued low rates of return available on many bank deposit accounts. Around 30% were less comfortable, because they had to dip into their savings to pay the bills, and in the run up to Christmas, down a little from last month. Several commented on recent stock market falls, and the risks to their investments running into 2016.

Job security was quite varied, depending on region and industry. Those employment in (lower paid) service industry jobs – for example in healthcare in NSW, were the most confident, whilst those in mining, agribusiness and construction, especially in WA and SA were more concerned. 17% felt more secure than a year ago, 62% felt about the same, and 20% felt less secure. Younger households felt less secure than more mature households.

Finally, 60% of households said their net worth was higher than a year ago, down a little from last month, thanks to recent stock market adjustments, and property coming off in several locations. 15% said their net worth was lower (a rise of 1.6% compared with last month), and 23% said there was no change.

We think it quite likely we will see continued improvement in coming months, although if house prices start to tumble, or interest rates were to rise, this would have an immediate negative impact. We would also observe that households remain cautious, and whilst we expect something of a spending boom over Christmas, it looks like it will be tempered by limited increases in personal credit, and lack of available savings.

ANZ Launches Australia’s first Home Loan Centre

ANZ today continued its expansion in NSW opening Australia’s first dedicated Home Loan Centre. Located at Westfield in Parramatta, the centre will provide customers with a specialist service to improve the process of obtaining a home loan.

ANZ Managing Director Retail Distribution Australia Catriona Noble said: “We understand that buying a house is usually the single biggest investment people make and we want to remove some of the stress associated with organising a home loan.

“By creating a dedicated space for home loans, customers will have access to a team of specialists in an environment not usually associated with a bank. We’ve designed this to look and feel like a typical home and we’re confident this will resonate strongly with our customers.

“Our two Home Loan Centres in New Zealand have been incredibly successful helping thousands of New Zealanders into a new home since late 2014. We expect our centre in Western Sydney to be equally well received,” Ms Noble said.

BIS Capital Proposals Revised Again, LVR’s and Investment Loans Significantly Impacted

The second consultative document on Revisions to the Standardised Approach for credit risk has been released for discussion.

There are a number of significant changes to residential property risk calculations . These guidelines will eventually become part of “Basel III/IV”, and will apply to banks not using their internal assessments (which are also being reviewed separately).

First, risk will be assessed by loan to value ratios, with higher LVR’s having higher risk weights. Second, investment property will have a separate a higher set of LVR related risk-weights. Third, debt servicing ratios will not directly be used for risk weights, but will still figure in the underwriting assessments.

There are also tweaks to loans to SME’s.

These proposals differ in several ways from an initial set of proposals published by the Committee in December 2014. That earlier proposal set out an approach that removed all references to external credit ratings and assigned risk weights based on a limited number of alternative risk drivers. Respondents to the first consultative document expressed concerns, suggesting that the complete removal of references to ratings was unnecessary and undesirable. The Committee has decided to reintroduce the use of ratings, in a non-mechanistic manner, for exposures to banks and corporates. The revised proposal also includes alternative approaches for jurisdictions that do not allow the use of external ratings for regulatory purposes.

The proposed risk weighting of real estate loans has also been modified, with the loan-to-value ratio as the main risk driver. The Committee has decided not to use a debt service coverage ratio as a risk driver given the challenges of defining and calibrating a global measure that can be consistently applied across jurisdictions. The Committee instead proposes requiring the assessment of a borrower’s ability to pay as a key underwriting criterion. It also proposes to categorise all exposures related to real estate, including specialised lending exposures, under the same asset class, and apply higher risk weights to real estate exposures where repayment is materially dependent on the cash flows generated by the property securing the exposure.

This consultative document also includes proposals for exposures to multilateral development banks, retail and defaulted exposures, and off-balance sheet items.The credit risk standardised approach treatment for sovereigns, central banks and public sector entities are not within the scope of these proposals. The Committee is considering these exposures as part of a broader and holistic review of sovereign-related risks.

Comments on the proposals should be made by Friday 11 March 2016.

Looking in more detail at the property-related proposals, the following risk weights will be applied to loans against real property:

which are finished properties
covered by a legal mortgage
with a valid claim over the property in case of default
where the borrower has proven ability to repay – including defined DSR’s
with a prudent valuation (and in a falling market, a revised valuation), to derive a valid LVR
all documentation held

If all criteria a met the following risk weights are proposed.

For residential real estate exposures to individuals with an LTV ratio higher than 100% the risk weight applied will be 75%. For residential real estate exposures to SMEs with an LTV ratio higher than 100% the risk weight applied will be 85%. If criteria are not met, then 150% will apply.

Turning to investment property, where cash flow from the property is the primary source of income to service the loan

Commercial property will have different ratios, based on counter party risk weight.

But again, those properties serviced by cash flow have higher weightings.

Development projects will be rated at 150%.

Bearing in mind that residential property today has a standard weight of 35%, it is clear that more capital will be required for high LVR and investment loans. As a result, if these proposals were to be adopted, then borrowers can expect to pay more for investment loans, and higher LVR loans.

It will also increase the burden of compliance on banks, and this will likely increase underwriting costs. Finally, whilst ongoing data on DSR will not be required, there is still a need to market-to-market in a falling market to ensure the LVR’s are up to date. This means, that if property valuations fall significantly, higher risk weights will start to apply, the further they fall, the larger the risk weights.

Finally, it continues the divergence between the relative risks of investment and owner occupied loans, the former demanding more capital, thus increasing the differential pricing of investment loans.

The Committee notes that the SA is a global minimum standard and that it is not possible to take into account all national characteristics in a simple approach. As such, national supervisors should require a more conservative treatment if they consider it necessary to reflect jurisdictional specificities. Furthermore, the SA is a methodology for calculating minimum risk-based capital requirements and should in no way be seen as a substitute for prudent risk management by banks.

Now, some will argue that in Australia, this will not impact the market much, as the major banks use their own internal models, however, as these are under review (with the intent of closing the gap somewhat with the standard methods used by the smaller players) expect the standard models to inform potential changes in the IRB set. Also, it is not clear yet whether banks who use lenders mortgage insurance for loans above 80% will be protected from the higher capital bands, though we suspect they may not. Non-bank lenders may well benefit as they are not caught by the rules, although capital market pricing may well change, and impact them at a second order level. We will be interested to see how local regulators handle the situation where an investment loan is partly serviced by income from rentals, and partly from direct income, which rules should apply – how will “materially dependent” be interpreted?

ACCC takes action against Woolworths for alleged unconscionable conduct

The Australian Competition and Consumer Commission has instituted proceedings in the Federal Court against Woolworths Limited, alleging it engaged in unconscionable conduct in dealings with a large number of its supermarket suppliers, in contravention of the Australian Consumer Law.

The ACCC alleges that in December 2014, Woolworths developed a strategy, approved by senior management, to urgently reduce Woolworths’ expected significant half year gross profit shortfall by 31 December 2014.

It is alleged that one of the ways Woolworths sought to reduce its expected profit shortfall was to design a scheme, referred to as “Mind the Gap”. It is alleged that under the scheme, Woolworths systematically sought to obtain payments from a group of 821 “Tier B” suppliers to its supermarket business.

The ACCC alleges that, in accordance with the Mind the Gap scheme, Woolworths’ category managers and buyers contacted a large number of the Tier B suppliers and asked for Mind the Gap payments from those suppliers for amounts which included payments that ranged from $4,291 to $1.4 million, to “support” Woolworths. Not agreeing to a payment would be seen as not “supporting” Woolworths.

The ACCC also alleges that these requests were made in circumstances where Woolworths was in a substantially stronger bargaining position than the suppliers, did not have a pre-existing contractual entitlement to seek the payments, and either knew it did not have or was indifferent to whether it had a legitimate basis for requesting a Mind the Gap payment from every targeted Tier B supplier.

The ACCC alleges that Woolworths sought approximately $60.2 million in Mind the Gap payments from the Tier B suppliers, expecting that while many suppliers would refuse to make a payment, some suppliers would agree. It is alleged that Woolworths ultimately captured approximately $18.1 million from these suppliers.

“The ACCC alleges that Woolworths’ conduct in requesting the Mind the Gap payments was unconscionable in all the circumstances,” ACCC Chairman Rod Sims said.

“A common concern raised by suppliers relates to arbitrary claims for payments outside of trading terms by major supermarket retailers. It is difficult for suppliers to plan and budget for the operation of their businesses if they are subject to such ad hoc requests.”

“The alleged conduct by Woolworths came to the ACCC’s attention around the time when there was considerable publicity about the impending resolution of the ACCC’s Federal Court proceedings against Coles Supermarkets for engaging in unconscionable conduct against its suppliers,” Mr Sims said.

“Of course, the allegations against Woolworths are separate and distinct from the Coles case.”

The ACCC is seeking injunctions, including an order requiring the full refund of the amounts paid by suppliers under the Mind the Gap scheme, a pecuniary penalty, a declaration, and costs.

These proceedings follow broader investigations by the ACCC into allegations that supermarket suppliers were being treated inappropriately by the major supermarket chains.