Category: Economics and Banking

NAB Joins The Mortgage Rate Uplift Parade

Following WBC and CBA, NAB has announced a rate hike today. Effective 12 November, rates on mortgages will rise 17 basis points, so NAB’s standard variable rate will be 5.60%.

Today’s announcement responds to market conditions, as well as regulatory changes that require NAB to increase the amount of capital applied to residential mortgages.

NAB Group Executive for Personal Banking Gavin Slater said the NAB had carefully considered the decision to raise interest rates.

“There are a range of factors that come into consideration in interest rate decisions. The home loan market is dynamic, with multiple changes being seen across the industry,” Mr Slater said.

“Regulatory changes on capital requirements also increase the costs associated with providing home loans. In May this year, NAB took early steps to strengthen our capital position by raising $5.5 billion to begin to address expected changes in capital requirements.

“Today’s decision has not been easy, but we believe this is right decision for the long term. We know we have to balance the interests of our customers with the needs of our more than 550,000 shareholders.

“Interest rates are at historically low levels and NAB remains committed to providing a competitive proposition for our customers.

“We appreciate that price is important, but we also know that customers want us to provide the right help and advice, the right products, and deliver innovative digital capability.”

Same rationale, capital requirements.  Fixed rate home loans and business rates remain unchanged.

Who’s next?

Why Lifting Capital Ratios Is Not Enough

Regulators here and overseas are forcing banks to hold more capital in order to make the banking system “more secure”. In Australia, because of the lack of true competition, this will in practice mean the banks passing additional costs through to borrowers, thus maintaining the high (on an international basis) shareholder returns. Higher capital means higher priced bank products.

However, continuing to lift capital ratios will not alone make banks more secure. There are other strategies which we need to consider if we are truly to have undoubtedly strong banks.  We need, in effect, to broaden the debate.

First, one of the main drivers of higher capital is to ensure that banks, should they get into trouble, would not be bailed out by tax payers via government intervention. In 2007, the UK the government became the major shareholder in a number of banks, which were on the brink. This led in turn to significant public debt, which has yet to be repaid. The FSI estimated that the economic cost of a severe financial sector crisis is around 158 per cent of annual GDP. For Australia, this is around $2.4 trillion. And this is just the annual cost. The question becomes how to handle banks that are too big to fail and get into difficulty. It should be essential for banks to think the unthinkable, and have in the bottom draw a secure exit plan should they get into difficulty, and this resolution plan has to be approved by the banking regulator. It should not simply be “raise more capital”, because as the APRA stress tests highlighted recently, individual banks assumed they could top up their reserves in a crisis, but did not consider the fact that everyone might be trying to do this at the same time (because of a broader crisis) as so might not be successful.

Second, and connected to the work-out plans, we think there is a case to ring-fence the retail bank operations of these large financial conglomerates, from their other operations. Risks in the treasury, wealth management, insurance, and international trade areas are potentially higher than in core retail banking. At the moment, it is all scrambled. The UK for example, to working towards adequate risk separation of core banking operations and the other elements within financial conglomerates. Whilst implementation needs to take account of the structure of individual entities, we think this is important.

Third, the obligations of the top managers in the banks with regards to complying with regulation should be clearly stated and enforced. We have seen  some banks essentially flex lending standards to maintain market share. APRA and ASIC have both highlighted these shortcomings and the RBA have admitted risks were higher than initially thought because of loose lending criteria. The obligations on top managers should have legal force, and in severe cases of non-compliance, regulators should be more overtly holding them to account personally. More broadly, this speaks to the cultural norms within the banks, and the incentives in place. It also balances the obligations of regulators and those managing the banks – at the moment, it appears the onus is too much on the regulators to try and “catch” bad behaviour, rather than having the right behaviours championed by the banks themselves. This balance needs to be recast.

Fourth, we need stronger, real competition in the banking sector, not the faux competition where everyone marches to the same tune, and follows each other with rate rises and falls. We have some of the most profitable banks in the world, thanks to weak competition, not brilliant management, or super efficiency. Regulators are more concerned with financial stability than competition, though moving the dial on IRB banks from 15-17 to 25 is a starting point, tweaking capital is not sufficient. With so many regulatory authorities involved, from ACCC, APRA, ASIC and RBA, the onus of driving real competition falls through the cracks, at the expense of Australia Inc. The FSI recommended ASIC be given a specific competition mandate.

We should not become myopic about more capital being the total solution to fixing the banking system. Structure, culture, competition and governance must all be on the table.

CBA Lifts Mortgage Rates

As predicted, another major has announced hikes in its mortgage rates. Commonwealth Bank will increase in its variable home loan rates by 15 basis points for both owner occupied and investment variable rate mortgages, partially offsetting costs associated with recent changes to capital requirements.

As a result, for owner occupiers, the standard variable home loan rate will increase to 5.60% per annum. For investment home loan standard variable rate customers, interest rates will rise to 5.87% per annum. The new rates will be effective from 20 November 2015.

The bank cites the higher capital requirements as the driver, and says it has carefully tried to balance the interests of its customers and shareholders in pitching the quantum of the increase.

Matt Comyn, Group Executive for Retail Banking Services said: “The Commonwealth Bank is supportive of an Australian financial system that is strong, stable and competitive. We recently raised $5.1 billion to strengthen our capital position in line with new regulatory requirements implemented in response to the Financial System Inquiry. We have now reviewed our home loan pricing in light of these changes.

“As Australia’s largest home lender, we are committed to delivering competitive products and services to our customers, while maintaining an unquestionably strong capital position.

“Any decision to change interest rates is carefully considered. The cost of the new capital required to make the Australian banking system more secure needs to balance the interests of our customers, as well as the nearly 800,000 households who are direct shareholders and the millions more who are invested through their superannuation funds.”

Fixed rates and business rates remain the same, with the current Owner Occupier Wealth Package 2-year fixed rate remaining at 4.29% per annum.

Expect other lenders to follow, using the capital and financial stability alibis to protect margins.

In addition, some will argue the RBA should now cut rates in November, to adjust for recent home lending rate rises, but given the high growth rates in lending, as APRA highlighted today, we think this would be inappropriate.

Housing Credit Growth Accelerating – APRA

APRA head Wayne Byres made an interesting comment in his opening statement to the Senate Standing Committee on Economics Canberra today. “Based on the latest available data, the rate of growth in credit for housing is, in aggregate, still accelerating. However, within this there is a compositional switch underway, as a moderation in the growth in lending to investors has been offset by somewhat stronger growth and more competition in lending to owner occupiers.”

He also covered recent developments surrounding FSI, Superanuation Governance and the Private Health Insurance Industry.

Good morning. I would like to quickly touch on four issues that have been prominent on APRA’s agenda since we last met with this Committee.

Financial System Inquiry

The first issue is the report of the Financial System Inquiry and, of note this week, the release of the Government’s response to it. As you know, the FSI made 44 recommendations: around half of these were of direct interest to APRA. In some cases, the recommendations – such as those relating to capital requirements for authorised deposit-taking institutions (ADIs) – require specific consideration by APRA, while in others – such as those relating to superannuation, or the regulatory architecture more broadly – the matter is primarily in the hands of the Government, but APRA will likely have a role to play in assisting with implementation.

As to those recommendations that are directed at APRA, we have already made two important announcements. In July this year, we released a study on the relative capital strength of the major Australian banks against their overseas peers1. This study showed that the major banks’ capital ratios were not positioned in the top quartile, as the FSI had advocated in its first recommendation to make ADIs’ capital ‘unquestionably strong’. But we also said that, while this sort of international comparison is a useful sense check, we shouldn’t tie ourselves too tightly to it.

Also in July, we announced a change to the risk weights for mortgage exposures for those banks that are accredited to use internal models to determine their capital ratios. This change – which formally comes into effect from 1 July next year – reflected the second recommendation of the FSI, which advocated that the difference in risk weights between model-using banks and other ADIs using standard risk weights should be narrowed. As an interim measure, we adjusted the risk weight for model-using banks to the bottom of the range recommended by the FSI (ie to an average of at least 25 per cent). We referred to this as an interim measure because it may not be the final calibration: that will ultimately need to wait for more clarity on the full set of reforms to the international framework that are currently being considered by the Basel Committee. But we were comfortable moving ahead on the mortgage risk weight issue, given it was consistent with the direction the international work is taking.

With the major banks choosing to raise capital in response to this change, it also helped substantially close the gap between their current capital ratios and the top quartile positioning that the FSI advocated, providing APRA with more time to consider international developments over the next year before finalising any further changes in Australia. The Government’s response to the FSI suggests we should seek to define ‘unquestionably strong’ by the end of 2016 – notwithstanding all the moving parts, that seems quite manageable at this point in time.

Sound Lending Standards for Housing

The change in mortgage risk weights is a useful segue into the second issue I wanted to mention: the steps we have taken to reinforce sound standards in lending for housing. As the Committee will recall, we wrote to all ADIs in December last year to reinforce the importance of maintaining sound lending standards in an environment of heightened risk. As foreshadowed in our letter, we spent the first half of 2015 engaging with ADIs (particularly the largest lenders) on their lending policies and growth aspirations, in order to assess whether they were prudently managing the risks within the current environment. In many cases, this led to ADIs making changes to their lending policies and growth aspirations to ensure that sound practices were being maintained.

Many of these changes have only recently come into effect, so we are watching carefully to see how they play through the system. Based on the latest available data, the rate of growth in credit for housing is, in aggregate, still accelerating. However, within this there is a compositional switch underway, as a moderation in the growth in lending to investors has been offset by somewhat stronger growth and more competition in lending to owner occupiers. In such an environment, APRA remains very alert to any sign of deteriorating credit standards, and is monitoring that those ADIs identified as needing to strengthen their lending policies do indeed do so.

Superannuation Governance

The third issue I wanted to mention was in relation to superannuation. APRA has been consulting with industry on potential changes to the prudential framework to support implementation of the Government’s proposed changes to governance requirements for the industry, assuming they are passed by the Parliament. As outlined in our recent submission to the Committee on the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, APRA supports the direction of the proposed changes in the Bill as they will more closely align board composition requirements for the superannuation industry with those of other APRA-regulated industries. APRA’s experience, over many years and across all industries, suggests that having at least some independent directors on boards supports sound governance outcomes. Superannuation is fundamentally about investing money on other people’s behalf and therefore strong governance frameworks are critical to protecting the best interests of fund members.

The recent Stronger Super reforms, including the implementation of APRA’s prudential standards, have contributed to a strengthening of governance practices within the superannuation industry, but there remains room for further improvement in a number of areas. The superannuation industry has evolved considerably since the current board composition requirements were introduced into the SIS legislation in 1993. A significant portion of the industry are now public offer funds with broad and open membership, and the industry’s importance, from both a financial system and retirement income policy perspective, continues to increase. It is therefore appropriate for the industry to ensure that it draws from the widest possible pool to ensure that boards have the necessary skills, capabilities and experience to meet the future needs of their members.

Prudential Supervision of Private Health Insurance

The final matter I wanted to note has had far less public attention than the issues I have raised thus far, but has been just as important for APRA: that is, the transition of responsibilities for the prudential supervision of private health insurance funds from the Private Health Insurance Administration Council (PHIAC) to APRA with effect from July 1 this year. That this transition was successfully achieved was due to a great deal of hard work and cooperation involving APRA, PHIAC, Treasury, the Department of Health, and the Department of Finance, and I would like to acknowledge those other agencies for the significant role they played. In the months leading up to the transition, APRA established new prudential standards for the private health insurance industry that, to the maximum extent possible, replicated the standards that had been put in place by PHIAC. Data collections, and the administration of the Risk Equalisation Trust Fund, have also been maintained largely unchanged so that the transition from PHIAC to APRA was as seamless as possible for the insurers themselves.

APRA has committed not to make any material changes to the prudential regime for private health insurers in the short term, but over time will look to align supervisory practices and prudential standards with those of other APRA-regulated industries, where it makes sense to do so.

The dark side of free markets

From The Conversation.

It is now not uncommon for 11-year-olds to be diabetic. I see one reason for it every time I check out at my local Safeway in Washington. The candy is right there at the cash register, waiting to be eaten.

But this does not mean that the manager of the store is mean or even irresponsible. If she has qualms about this practice, she would face a real dilemma: she needs to show a profit. The margins at supermarkets are tiny. No matter what her morals, she has almost no choice but to place those sweet impulse buys where customers can see them. In other words, there is an economic equilibrium in which businesses take advantage of every opportunity to increase profits. In such an equilibrium, the candy will be at the checkout counter.

Curiously, while economists understand each and every such instance where people are tempted to buy things that are not good for them, they fail to appreciate that this occurs because of a general principle of economics. They fail to understand that free markets, as bountiful as they may be, will not only provide us with what we want, as long as we can pay for it; they will also tempt us into buying things that are bad for us, whatever the costs.

Markets will deceive

Just as free markets can serve the public good “by an invisible hand” (as Adam Smith saw more than two centuries ago, and is the foundation of the field of economics), free markets will do something else. As long as there is a profit to be made, they will also deceive us, manipulate us and prey on our weaknesses, tempting us into purchases that are bad for us. That is also a fundamental feature of market equilibrium, in which supply and demand balance each other out.

My fellow economists, while they recognize such behavior in individual instances, fail to see this as a general principle. And thus a lot of bad things happen, such as the candy at the checkout counter. Most notably, we economists should have been a chorus warning of the financial crash of 2008. We should have recognized that people should not be buying overrated mortgage-based securities, nor should banks have been creating the insecure loans that backed them. Instead there were at most a few lone voices of protest. We should have been more skeptical.

But this is not just about economists and what we think, because through long chains of reportage and other channels (such as this one), what we say in our faculty lounges affects politicians and the public opinion more generally.

This failure to understand that markets have this downside is then passed on into policy more narrowly defined. The public fails to understand that in the economic equilibrium, if there is a profit to be made, someone will take it up, as long as it is legal and as long as there is no public protest against it.

The consequences of being a ‘phool’

Princeton University Press

A recent book we wrote called Phishing for Phools describes how the fundamental logic of economics, going back to Adam Smith, delivers this conclusion. That is, markets are not benign forces working for the greater good but instead are filled with businesses that “phish” by exploiting our weaknesses to get us to buy their products. We are the subjects of those phishes – the “phools” – when we fall for it.

The onus in the book was on us to show that temptations to make bad decisions really do significantly affect our well-being. Such a demonstration was surprisingly easy.

There are four huge areas of our lives – consumer spending, investment, health and politics – in which we are making decisions that no one (on reflection) could possibly want. Yet we make those decisions, and the free market provides them, just as bountifully as it satisfies our more benign impulses.

First, even in the US, as rich as we are by all historical standards, most of us go to bed at night worried about how to pay our bills. We are continually tempted, and have a very hard time sticking to a budget. Thus, the median American family has on average less than one month’s expenditure in its bank account; half of all US respondents in a 2011 survey said they would have a very hard time raising US$2,000 in a month’s time if an emergency occurred; and my rough estimate suggests that 20% of us will go bankrupt at some point over our lifetimes.

Second, there are financial booms and busts because stories – what we are saying to ourselves and what we say to each other when we make our decisions – spread like epidemics. Those stories lead people into bad investments, and then, when those investments go sour, there are declines in confidence that threaten the whole financial system. Humpty Dumpty has a great fall and only slowly is pieced back together again.

Third, regarding health, the market gives us tobacco, which, according to Centers for Disease Control estimates, is responsible for almost 20% of deaths in the United States. The pharmaceuticals industry sells us drugs with unknown long-term effects, which are sometimes severe. And Big Food serves us sugar and fat, so that two-thirds of Americans are overweight, with more than half of them also obese. The list goes on.

Finally, the political system in a democracy is like a market system: there is a competition for votes. But that too has a “phishing equilibrium.” To keep their jobs, politicians have to raise money from “the interests” and use it for TV ads that show what nice folks they really are.

Casinos are another example of how free markets tempt us into doing things we shouldn’t do. Reuters

Prosperity at a steep premium

Free markets may lead to prosperity, but they also deliver more than the unalloyed benefits ascribed to them. This unwillingness to acknowledge their dark side undergirds the basic fundamental thinking of economists and leads to bad government policies. A grownup’s view of the economy that incorporates the downsides of capitalism is a prerequisite for sane policy.

The economic system works as well as it does not just because of individual incentives, but also because a whole raft of individual heroes, social agencies and government regulation puts limits on this downside of markets to phish us for phools. Such policy is a balancing act, to filter out the bad sediment while allowing through the true benefits of free markets.

This view of a phishing equilibrium thus challenges current economic thinking in a new way. There is a huge payoff to incorporating it into our view of the economy. Just as we love our children, we should love free markets; but as with our children, it would be a mistake to think that they can do no wrong.

Authors: George A Akerlo, University Professor, Georgetown University; Robert J Shiller,Professor of Economics, Yale University.

Bank of England publishes approach to stress testing the UK banking system

The Bank of England has today published its approach to stress testing the UK banking system. This approach aims to provide clarity for firms and the wider public about our plans for stress testing for the next three years until 2018. Stress testing is a core part of the capital framework which sits alongside risk-based capital and leverage requirements. Stress tests provide an integrated forward-looking assessment of resilience and aim to ensure that banks can continue to support the real economy even in difficult economic conditions.

Key features of the Bank of England’s approach are:

  • The introduction of an annual cyclical scenario that will link the severity of the test to the financial cycle systematically. This scenario will include domestic, global and markets elements.  Its severity is likely to be greater in an upswing, for example when growth in credit is rapid or asset prices unsustainably high.
  • A biennial exploratory scenario covering risks unrelated to the financial cycle that policymakers’ judge to be emerging or latent threats to financial stability or individual banks.
  • A systematic and transparent hurdle rate framework with clear hurdle rates for each firm reflecting minimum capital requirements and additional requirements for globally systemic banks.

The stress test will include banks with total retail deposits greater than £50 billion – at present this covers the same set of firms included in the 2015 stress test. Among this group of firms, coverage may vary for the exploratory scenario if that scenario is unlikely to impact some firms. UK subsidiaries of foreign-owned investment banks will not be brought into scope at this time, but this will be kept under review. The Bank of England will develop its own modelling capabilities further, to enhance its ability to challenge aspects of firms’ own results and to include in the test results the impact of feedback mechanisms across the banking system. The approach will ensure there continues to be a range of modelling input into stress testing.

Mark Carney, Governor of the Bank of England said “The United Kingdom needs banks than can weather shocks without cutting lending to the real economy. Our first concurrent stress tests run in 2014 – centred on the housing market – gave us assurance that the banking sector as a whole was well-placed to withstand such a severe scenario. We have also recognised however the need for our approach to evolve. The Bank of England is taking steps to ensure we can assess a range of future risks from a number of different sources to inform our micro- and macro-prudential policy decisions. Our approach embodies a comprehensive and detailed approach, a desire to deepen and strengthen our analysis, and the flexibility to respond to changing risks.”

The Bank of England will publish further information in due course on its approach to stress testing beyond 2018. The Bank of England’s stress testing framework is likely to evolve further to reflect regulatory developments, including structural reform of the banking sector.

What is stress testing? – YouTube video.

 

Government to act against businesses exploiting credit card charges

From The Conversation.

The Turnbull government will ban businesses from charging consumers excessive surcharges on their credit cards, and move to inject more competition into the superannuation industry, responding to the Financial Systems Inquiry headed by businessman David Murray.

Under planned legislation, the surcharges will not be allowed to be more than the cost to the business of accepting payment by card.

The Australian Competition and Consumer Commission (ACCC) will enforce the regulations to ensure consumers are treated fairly and not overcharged.

The government is also promising action to improve the standards of financial advice, an area that in recent years has been subject to extensive malpractice and controversy, amid deep concern especially from retirees.

The government’s response to the Murray inquiry, which reported last year, was announced by Prime Minister Malcolm Turnbull, Treasurer Scott Morrison, and Assistant Treasurer Kelly O’Dwyer at a joint news conference. Most recommendations have been accepted, and several measures have been added.

The report and response cover the resilience of the financial system; superannuation and retirement incomes; innovation; consumer measures; and the regulatory system. Measures to improve the resilience of the banking system are already in train.

Turnbull said the surcharge issue “has been the subject of considerable consumer concern”.

“Quite plainly, where a merchant says if you use a credit card it’s an extra 2% or 3%, that carries with it an absolutely crystal clear, irrefutable representation that the merchant is seeking to recover his or her costs,” he said.

“In some cases they may be, in other cases they’re not.

“We think that consumers are entitled to a very fair deal here … in other words, to get exactly what they are being represented to be getting, which is an additional charge that recovers no more than the merchant’s costs.”

Morrison said that in some cases surcharges could be more than 10%. In future merchants would have to pass the “fair dinkum test” – “the fair dinkum cost of what someone is actually absorbing and passing on”.

To improve the financial advice industry, advisers will have to have a degree, pass an examination, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year before they can advise clients. There will be some transitional arrangements as the tougher requirements are put in place.

“These higher standards will, for the first time, place financial advising on a similar footing to other professions and in doing so increase consumer trust and confidence in the sector”, the ministers said in a statement.

The Abbott government had its regulations watering down the Labor government’s more stringent rules thwarted by the Senate.

The superannuation measures are to improve competition, efficiency and transparency – which the government says will improve after-fee returns for fund members. The Coalition believes that industry funds have too much of an advantage under present arrangements.

The Productivity Commission will be asked to develop and release criteria to assess the efficiency and competitiveness of the superannuation system. It will “develop alternative models for a formal competitive process for allocating default fund members to products”.

The government says it will work with industry to provide retirees with more flexible and reliable retirement income products and “to extend the choice of fund arrangements to more employees as recommended by the inquiry”.

Last month legislation was introduced to alter super funds’ governance arrangements, requiring at least one-third of trustee boards to be independent directors, including an independent chair.

Morrison said the government was putting “Australians in the driver’s seat of their own money and no-one else, and that’s as it should be.

“It does end the closed shop when it comes to mandatory superannuation contributions and how they are directed off into funds, and it will give Australians greater choice about where they invest their own money for their own retirement.”

Morrison described the Murray report as “a common sense report. It has common sense recommendations, a health check on where our financial system is at.”

In terms of the financial system itself, it makes it stronger by embedding deeper protections within the system, whether it’s on capital adequacy, improved governance and standards right across the system and empowering our regulators to be able to enforce the protections that are in that system, protect consumers and Australians and our economy at the end of the day.

“It does provide Australians with greater choice and greater control over their own money, whether it’s their superannuation or anything else.”

Turnbull acknowledged work done by former treasurer Joe Hockey and former assistant treasurer Josh Frydenberg but stressed “this response is a response of the Turnbull government to this inquiry”.

Author: Michelle Grattan, Professorial Fellow, University of Canberra

Super members the winner in sensible financial inquiry response

From The Conversation.

The government has accepted virtually all of the recommendations of the expert panel behind last year’s Financial System Inquiry. Clearly we can argue about some, and people would prefer to pick and choose depending on their predilections, but rather than allow the reform process to be unpicked by stealth, the government has opted to support its experts. That is a welcome change.

The inquiry had three main issues to deal with: the safety of our banking system in the light of the global financial crisis, the increasing importance of the superannuation industry to our financial system as a whole, and how new technologies and related innovations might impact the system. While the banking issues are well understood the other two pose new challenges for Australia.

Inquiry chair David Murray and his colleagues focused heavily on superannuation. This is appropriate since the superannuation sector is now a major part of the financial system. By the time of the next inquiry it may even manage more assets than the banks.

The one recommendation which was rejected by the government in its response to the inquiry, Recommendation 8, was intended to limit the ability of superannuation funds to borrow. The FSI approached this as a prudential issue, worrying about potential risks from leverage within the superannuation sector. The government has rejected the argument saying it may be an important issue in the future but is not now, preferring to monitor what is happening rather than prohibiting it.

The choice not to reject any other recommendations on superannuation is far more important.

The government supports the FSI’s concerns about the efficiency and competitiveness of the superannuation system. It has charged the Productivity Commission with reviewing the current system and suggesting ways in which the system might be made more competitive. This will be a major challenge of the superannuation sector and involve them in a lot more policy analysis over the next couple of years.

On the management of retirement income streams, the approach is more nuanced. It will require funds to develop products and then leave members with the right to choose between these new products and their current choices. The approach will be fleshed out as part of the two ongoing reviews in the area.

Industry funds will struggle with the next two recommendations: on choice of fund and on governance.

The government has committed to extend choice of fund by removing the deemed choice provisions of some industrial agreements. This does seem sensible policy although it will be criticised. Since most people have choice of which funds their savings will go into, it seems inappropriate to lock other people into a restricted set. It is hard to argue that having more choice will hurt anyone and it could lead to greater competition between funds.

The issue of strengthening governance is also going to be disputed but should be inoffensive. Rotating directors and having independent directors are normal requirements in the corporate world and, with many funds managing tens of billions of dollars in savings, it seems sensible to allow funds to find the best directors possible. It may also be easier for independent directors to recommend the amalgamation of funds which is badly needed and should produce significant benefits for savers.

Can the government make the superannuation more competitive in the expectation that it will produce better outcomes for savers? Clearly the answer is yes. The superannuation system has evolved over time, driven by rules and by changes in rules. Its size is a product of rules and regulations. Steps to make the system more transparent, to allow greater choice, and to enhance the professionalism of management can all be expected to produce better outcomes for savers.

The politics of the government’s response is sensible. The Productivity Commission will be cheering. It will have a whole new stream of work and be brought back into the centre of government policy analysis. This is a very healthy development.

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

UK business finance since the crisis – moving to a new normal?

At a speech given at Bloomberg in London, Ian McCafferty, external member of the Monetary Policy Committee, argued that the tight credit conditions which followed the financial crisis have now “diminished markedly” for firms – a fact which has important implications for monetary policy.

McCafferty’s analysis indicates that both large and small firms have been broadening their sources of finance away from banks. While large firms have turned increasingly to capital markets, with growing bond and equity issuance, SMEs have been drawing on new alternative sources of lending, including ‘crowdfunding’ and peer-to-peer lending platforms.

McCafferty warned that it was important to recognise that this form of finance is still small compared to bank lending, on which SMEs remain heavily reliant, but added: “alternative finance is growing, and is likely to be a developing feature of the market in future years.”

McCafferty noted that the UK economy continues to face headwinds – notably fiscal consolidation and sub-par growth in the world economy. However, he argued that the reduction the headwinds in business finance is now supporting the normalisation of the economy. With that, he said: “it is reasonable to expect the neutral interest rate – the level of interest rates consistent with full employment and inflation at target – to also move towards more normal levels”.

He concluded: “If we on the MPC are to achieve our ambition of raising rates only gradually, so as to minimise the disruption to households and businesses of a normalisation of policy after a long period in which interest rates have been at historic lows, we need to avoid getting ‘behind the curve’ with respect to the neutral rate. And for me, that provides an additional justification not to leave the start date for lift off too late.”

RBA Minutes For October

The minutes released today included comments on the housing sector.

Dwelling investment had increased strongly over the year to June, despite recording a decline in the June quarter. Building approvals had declined a little from their recent peak, but remained at levels that implied further growth in dwelling investment, albeit at a gradually declining rate. Loan approvals for construction of new dwellings had also fallen over the past year. Growth in housing prices in Sydney appeared to have eased slightly in recent months and auction clearance rates in Sydney and Melbourne had declined a little from their recent peaks. However, it was too early to be confident that these signs of slowing in housing price inflation would be sustained.

In relation to lending for housing, members noted that the data on the split of lending to owner-occupiers and investors were of questionable quality at present. The available data suggested that there had been a modest decline in the growth of credit extended to investors in housing of late, which was consistent with the tightening in banks’ lending standards in response to actions of the Australian Prudential Regulation Authority (APRA). With housing credit growth overall remaining steady over the past year, there had reportedly been a slight pick-up in the growth of housing credit to owner-occupiers.

Comments on financial stability risks, highlight risks in the residential AND commercial property sector.

Global financial stability risks had been shifting from advanced country banking systems to China and other emerging market economies. Partly in reaction to this, financial market volatility had picked up following a lengthy period of low volatility and compressed risk premia. Members noted the possibility of a sharp repricing in markets where investors for years had been ‘searching for yield’.

Members noted that domestic sources of risk to financial stability in Australia continued to revolve mainly around developments in local property markets. In the context of recent developments in the housing market and household credit, members discussed the findings from the enhanced scrutiny of housing lending practices undertaken by APRA and the Australian Securities and Investments Commission since the end of 2014. This scrutiny and related work had shown that investor activity was considerably higher – and lending standards in some parts of the market weaker – than had originally been thought.

Members further observed that the risks in commercial property and the property development sector were rising. Building approvals for new apartments remained very strong over 2015, even though rental markets appeared soft in some areas. The divergence between commercial property valuations and rents had widened further, with strong domestic and foreign investor interest for new and existing office buildings in particular, even though vacancy rates were quite high. At the same time, falling commodity prices were weighing on the profitability of many resource-related companies. The rest of the business sector seemed to be in relatively good shape, in contrast, with both gearing and failure rates at relatively low levels.

Members were also briefed on the risks in the New Zealand housing market and dairy sector, given the sizeable exposures of Australian banks through their New Zealand subsidiaries.

While Australian banks continued to perform well, they were taking steps to enhance their resilience. Banks’ asset performance continued to improve, profitability remained high, and the large banks had raised substantial amounts of capital in advance of forthcoming prudential requirements. Most banks had strengthened the serviceability metrics used in their mortgage lending and taken steps to slow the pace of growth in investor lending towards the prudential regulator’s expectations. Banks were also reportedly becoming increasingly wary of lending to property developers in markets that were thought to be at risk of becoming oversupplied. Nonetheless, competition among lenders had intensified in the owner-occupied segment of the housing market and had continued to do so in parts of the business lending market. Members observed that a key challenge would be to ensure that lending standards at both Australian and foreign-owned banks did not weaken from this point.

So, no change to rates:

Members noted that reductions in the cash rate earlier in the year continued to provide support to aggregate demand, particularly dwelling investment and household consumption. Members also noted that conditions in the labour market had strengthened further over recent months and were somewhat better than had been expected earlier in the year. Nevertheless, spare capacity remained in the economy, domestic cost pressures were very low and inflation was expected to remain consistent with the target over the next one to two years.

The key domestic sources of risk to financial stability, and stability of the Australian economy more broadly, revolved around developments in local property markets. Members noted that growth in lending for housing had been steady over recent months and that there were some signs of an easing in the strong rate of increase in dwelling prices in Sydney, in particular, although trends had been more varied in a number of other cities. At the same time, members judged that there were signs that the response of the banks to supervisory measures implemented by APRA were helping to manage risks in the housing market. Credit growth overall had been moderate.

Given these considerations, the Board judged that it was appropriate to leave the cash rate unchanged at this meeting. Information about economic and financial developments, both domestically and abroad, would continue to inform the Board’s assessment of the outlook and whether the current stance of policy remained appropriate to foster sustainable growth and inflation consistent with the target.