Economics and Banking – Page 442 – Digital Finance Analytics (DFA) Blog

Bank Capital And Liquidity

Philip Lowe, RBA Deputy Governor gave a speech entitled “The Transformation in Maturity Transformation“. He provided a useful summary of the current picture of bank funding. Banks capital has been increasing, as part of this global trend to higher and better quality capital, with an increase in common equity lifting the aggregate capital ratio from around 10½ per cent prior to the crisis to around 12½ per cent at end 2014. The recent capital announcements by some of the large banks will see this ratio rise further.

In terms of liquidity management he discussed two main initiatives.

The first is the introduction of a Liquidity Coverage Ratio (LCR) which, from the start of this year, has required banks to hold enough high-quality liquid assets to meet a stress scenario that lasts for 30 days. The challenge for the Australian banking system has been that the supply of such assets is limited due to the stock of government bonds on issue being small relative to the overall size of the financial system. To overcome this challenge, the RBA has provided banks with a Committed Liquidity Facility (CLF) under which it will make available sufficient liquidity (against eligible collateral) to address the shortfall in required holdings of high-quality liquid assets. The pricing of the CLF is aimed at replicating the cost of holding a sufficient volume of these assets, were they to be available in the marketplace. APRA administers the decisions as to which banks access the program, and the maximum amount available to each bank.

The second initiative is the Net Stable Funding Ratio (NSFR), which has a longer-term focus. It will establish a minimum amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one-year horizon. The new requirement here will not come into effect until January 2018.

This increased focus on liquidity is clearly evident in the balance sheets of the Australian banks. On the assets side, holdings of liquid assets have increased substantially, after they declined for many years. Australian dollar denominated liquid assets are now equivalent to about 7 per cent of banks’ total assets, up from around 1 per cent in early 2008. If the CLF is added in, the current figure is around 15 per cent.

There have also been significant changes on the liabilities side of the balance sheet. The most noticeable has been a shift away from short-term wholesale debt towards deposits. In early 2008, deposits accounted for around 40 per cent of the Australian banks’ total funding. Today, that figure is just a little below 60 per cent. In part, this switch has been driven by the judgement that the risk of a run by depositors is less than the risk of a run by investors in short-term wholesale debt. To the extent that this judgement is correct, this switch has increased the effective maturity of banks’ liabilities in a stress event, even if it has not increased the contractual maturity.

There has also been some lengthening in the average contractual maturity of the various types of liabilities. The share of deposits at the major banks with a maturity of less than three months has declined since 2007, although this share has increased a little more recently as competition for term deposits has waned. Similarly, there has been a noticeable increase in the maturity of banks’ other debt liabilities since 2007. Of particular note, the share of other debt liabilities with maturities of less than three months has declined substantially.

He made that point that taken as a whole, these measures have made the system more resilient. But they have increased the cost of financial intermediation somewhat. They have also increased the likelihood that such intermediation will take place outside the banking sector. After all, to some extent this is what was intended. So we need to keep a close eye on how the overall system responds and make sure that in addressing the very real risks associated with maturity transformation, that we don’t create a new set of risks. This is likely to be an ongoing challenge for us all.

It is also important to point out that while the various measures have made the system more resilient, they do not guarantee stability. Because of the very nature of the business that banks undertake, they can still find themselves in a liquidity crisis. Here the role of the central bank acting as a lender of last resort is critically important.

The Fed and the Global Economy

Stanley Fischer, Vice Chairman, Board of Governors of the Federal Reserve System gave a speech entitled “The Federal Reserve and the Global Economy“. He discusses aspects of our global connectedness, spillovers from the United States to foreign economies and the effect of foreign economies on the United States.

In a progressively integrating world economy and financial system, a central bank cannot ignore developments beyond its country’s borders, and the Fed is no exception. This is true even though the Fed’s statutory objectives are defined as specific goals for the U.S. economy. In particular, the Federal Reserve’s objectives are given by its dual mandate to pursue maximum sustainable employment and price stability, and our policy decisions are targeted to achieve these dual objectives. Hence, at first blush, it may seem that there is little need for Fed policymakers to pay attention to developments outside the United States.

But such an inference would be incorrect. The state of the U.S. economy is significantly affected by the state of the world economy. A wide range of foreign shocks affect U.S. domestic spending, production, prices, and financial conditions. To anticipate how these shocks affect the U.S. economy, the Federal Reserve devotes significant resources to monitoring developments in foreign economies, including emerging market economies (EMEs), which account for an increasingly important share of global growth. The most recent available data show 47 percent of total U.S. exports going to EME destinations. And of course, actions taken by the Federal Reserve influence economic conditions abroad. Because these international effects in turn spill back on the evolution of the U.S. economy, we cannot make sensible monetary policy choices without taking them into account.

The Fed’s statutory objectives are defined by its dual mandate to pursue maximum sustainable employment and price stability in the U.S. economy. But the U.S. economy and the economies of the rest of the world have important feedback effects on each other. To make coherent policy choices, we have to take these feedback effects into account. The most important contribution that U.S. policymakers can make to the health of the world economy is to keep our own house in order–and the same goes for all countries. Because the dollar is the primary international currency, we have, in the past, had to take action–particularly in times of global economic crisis–to maintain order in international capital markets, such as the central bank liquidity swap lines extended during the global financial crisis. In that case, we were acting in accordance with our dual mandate, in the interest of the U.S. economy, by taking actions that also benefit the world economy. Going forward, we will continue to be guided by those same principles.

The Future Shape of Banking Regulation

In a speech entitled “The fence and the pendulum“, by Martin Taylor, External Member of the Financial Policy Committee, Bank of England, he discusses the thorny problems of macroprudential policymaking, which very much include the bank capital and too-big-to-fail agenda. It is worth reading in full.

He concludes:

This is a crucial time for the new international order in bank regulation. We are close to agreement on new standards that the industry, in the UK at least, is not too far off meeting. Four years ago that would have seemed a highly desirable outcome but quite an unlikely one. It’s good for our economies, and it will turn out to be good for the financial industry over the next quarter-century. At the same time the emergence – well, they never went away – the increasingly shrill emergence of voices calling for a regulatory softening is both structurally wrong and conjuncturally wrong. It remains the ungrateful job of the supervisors to save the banks from themselves. The shortness of human memory span and the speed with which we forget the ghastly misjudgements of the recent past: these are the enemies, the unresting enemies, alas, of financial stability.

Banking: Australian Banks’ Moves to Curb Residential Investment Lending Are Credit-Positive – Moody’s

In a brief note, Moody’s acknowledged that the bank’s recent moves to adjust their residential loan criteria could be positive for their credit ratings, but also underscored a number of potential risks in the Australian housing sector including elevated and rising house prices, declining mortgage affordability, and record levels of household indebtedness. As a result, they believe more will need to be done to tackle the risks in the portfolio.

Moody’s says the recent initiatives are credit positive since they reduce the banks’ exposure to a higher-risk loan segment. At the same time, it is likely that further additional steps will be required because the growing imbalances in the Australian housing market pose a longer-term challenge to the Australian banks’ credit profiles, over and above the immediate concerns relating to investment lending.

Therefore they expect the banks first to curtail their exposure to high LTV loans and investment lending further over the coming months; and second, they will gradually improve the quantity and quality of their capital through a combination of upward revisions to mortgage risk weights and capital increases. This is likely to happen over the next 18 months or so.

Westpac’s Revised LMI Arrangements Are Credit Negative for Australian Mortgage Insurers – Moody’s

Moody’s says that according to media reports, last Monday, Westpac Banking Corporation advised its mortgage brokers that it had revised its mortgage insurance arrangements so that effective that day, 18 May, all new Westpac-originated loans with a loan-to-value ratio (LTV) above 90% would be insured with its captive mortgage insurer, Westpac Lenders Mortgage Insurance Limited and reinsured with Arch Capital Group Ltd.

Westpac’s decision to shift its mortgage insurance policies away from domestic third-party lenders’mortgage insurance (LMI) providers is credit negative forGenworth Financial Mortgage Insurance Pty Ltd and QBE Lenders’ Mortgage Insurance Limited. Westpac accounted for around 14% of Genworth Australia’s gross written premium during 2014, and potentially a meaningful, albeit undisclosed, proportion of QBE LMI’s business. At the same time, existing policies will not be affected and the effect o nthe insurers’ net earned premium should only become material beginning in 2016. LMI customer contractual relationships are long term in nature and any further erosion of the customer base, when and if it occurs, remains contingent on market and individual customer developments.

Westpac’s move follows its earlier disclosures and the Genworth Australia announcement in February 2015that Genworth’s contract for the provision of LMI to Westpac was being terminated. Our understanding from Westpac’s disclosures and media reports is that Westpac’s LMI arrangements with QBE LMI have also been affected. Moody’s says that Westpac’s move is indicative of a longer-run trend towards reduced usage of the domestic mortgage insurance product. Australia’s major banks are not currently deriving regulatory capital benefits from using LMI. Similarly, product innovation, such as the use of self-insured low-deposit mortgage products, will affect the need for third-party LMI. Diminished third-party LMI usage elevates the insurers’ risk of losing pricing power and reducing their customer base, putting downward pressure on the firms’ profitability and volumes.

Loan Types By Lender

Completing the analysis of the residential APRA Property Exposure data, we look at selected loan type data across the different ADI lender categories. This analysis is based on relative numbers of transactions, not value.

First we see that the proportion of loans approved outside normal serviceability criteria has drifted lower, though Building Societies, Credit Unions and the Smaller Banks are still most likely to bend the rules to get a loan written. Perhaps they have tighter rules in place to begin with?

The proportion of low doc loans written is miniscule and now consistently low. Most low doc borrowers would now be knocking on the door of the non-ADI’s as they do not have the same heavy supervisory oversight and are tending to be more flexible – but there is little public data on this.

Turning to interest only loans, the Majors, and Other Banks are most likely to write this type of loan. However, we note the rising proportion of Credit Unions, Building Societies and Foreign Banks who will consider the proposition.

Finally, looking at the use of the broker channel, Foregin Banks originate the highest proportion this way, with the smaller Banks also in on the third party origination game. Credit Unions and Building Societies are less inclined to use Brokers, though there have been some increase in recent years.

LVR Data By Lender Type

Continuing our analysis of the latest APRA data, we are looking at the LVR mix by type of lender by analysis of the relative ratio of LVR over time, (understanding that some lender categories are relatively small). APRA splits out the ADI data into sub categories, including Major Banks, Other Banks (excludes the Majors), Building Societies, Credit Unions and Foreign Banks. There are some interesting trend variations across these.

In the above 90% LVR category, we see a general drift down, Credit Unions took a dive last year, whilst Building Societies have the highest share of new 90%+ LVR loans, though we see this falling a little now. The Major Banks sit in the middle of the pack. Note that in 2009, Other Banks were writing more than 30% of their loans in this category, today its below 10%.

In the 80-90% LVR range, the Foreign banks, and Other Banks (ie not the big four) showed an uptick, though this may now be reversing. Building Societies and Credit Unions are below the Major Banks.

In the 60-80% range, we see the Building Society mix rising in this band, whilst the others have been relatively static.

Finally, the loans below 60% LVR. Here the Building Society have drop a few points, as they move into the higher LVR bands, though that may be reversing a little now. Foreign Banks share in this band dropped recently, after a spike in 2009.

Home Loans Up, Mix Changing, APRA

The Australian Prudential Regulation Authority (APRA) today released Quarterly Authorised Deposit-taking Institution Property Exposures for the March 2015 quarter.

Quarterly ADI Property Exposures contains information on ADIs’ commercial property exposures, residential property exposures and new housing loan approvals. Detailed statistics on residential property exposures and new housing loan approvals are included for ADIs with greater than $1 billion in housing loans.

ADIs’ commercial property exposures were $234.2 billion, an increase of $15.1 billion (6.9 per cent) over the year. Commercial property exposures within Australia were $193.3 billion, equivalent to 82.5 per cent of all commercial property exposures.

ADIs’ total domestic housing loans were $1.3 trillion, an increase of $107.1 billion (9.0 per cent) over the year. There were 5.3 million housing loans outstanding with an average balance of $243,000.

ADIs with greater than $1 billion of residential term loans approved $82.3 billion of new loans, an increase of $8.5 billion (11.5 per cent) over the year. Of these new loan approvals, $51.9 billion (63.0 per cent) were owner-occupied loans and $30.4 billion (37.0 per cent) were investment loans.

Looking in more detail at the data, looking first at the portfolio data, we see the rise on the value of home lending across the ADI’s and the rise in the proportion of investment loans in the mix. High LVR’s fell a little.

The mix of loan type shows a continuing slow rise in interest-only loans (28.9% of all loans) and offset loans (32.3%), and a slight fall in loans with redraw (77.1% of loans).

Across the portfolio, the average balance on interest-only loans is the highest, at $315,000, whilst reverse mortgages sat at $94,000.

Turning to approvals by quarter, we see a steady rise in approval volumes, with 37% by number investment loans. Remember that earlier APRA showed that more than 50% of loans by value were for investment loans, so we again see evidence that investment loans are larger by value.

Looking at LVR bands, we see a slight fall in loans over 90% LVR (from 14% to 11%) a slight rise in the 80-90% band, (from 16% to 22%). So the regulators influence is showing though to some extent.

Finally, we see that third party loans by volume (not value) fell from 45% to 42% this quarter. Interest only loans accounted for 42% of approvals. Low doc and loans outside serviceability were low.

So overall, we see buoyant loan growth, supported by rises in investment lending and interest only loans. We will be watching the data next quarter as the Regulators tighten the screws. We think the property worm is about to turn.

Cold Hand Of The Regulator On Bank’s Investment Lending

Following the disclosures in the recent bank results that many were above the APRA target of 10% portfolio growth, and their statements they would work to fall within the guideline, we have seen a litany of changes from the banks, which marks an important change in tempo for investment home lending. Regulatory pressure is beginning to strangle investment lending growth. Better late then never.

In the past few days, ANZ has stated it would no longer offer interest rate discounts to new property investor borrowers who did not also have an owner-occupied home loan with the bank; Westpac is cutting discounts to new investment property borrowers according to the AFR; and Bankwest has imposed a loan-to-valuation ratio cap of 80 per cent on investor Mortgages. Changes that took effect on Friday will mean Macquarie customers taking out fixed-rate investor or interest-only loans will pay higher rates than owner occupied borrowers. Recently the Commonwealth Bank, scrapped its $1,000 investment home-loan rebate offer and reduced pricing discounts for investment home loans. In addition more broadly, Bank Of Queensland has changed its underwriting practices. NAB has also changed its instructions brokers, and as of May 13, NAB would only consider pricing below advertised rates for owner-occupiers or personal loans. “Investment loans will not be eligible for any pricing discretions. Advertised rates will apply to investment loans,” the note said. Suncorp plans to pare down discounts for investor property loans while boosting incentives for homeowner lending, in reaction to the regulatory crackdown on housing markets.

Last week we showed that currently discounts are at their peak, so will we see overall discounts cut, or reinvigorated discounts on selected owner-occupied lending? Banks need home loan lending growth to make their business work. We think the focus will be on a drive to accelerate refinancing of existing loans, so expect to see some amazing offers in coming weeks to try and fill the gap.

We know from our surveys there is still significant demand for housing finance out there. We also know that some of the non-ADI players are playing an increasing role in the investment lending sector, and these players are of course not regulated by APRA. Securitisation of Australian home loans was up last quarter, and most were purchased by Australian investors.

Mortgage brokers, who have been enjoying the recent growth ride may suddenly be finding their world just changed.

Whilst its a change in tempo, its not necessarily the end of the mortgage lending boom. It may however be the tipping point on house prices in Sydney and Melbourne, where investment loans have been responsible for much of the rise.

Release of the Spectrum Review Report

The Minister for Communications and the Parliamentary Secretary announced the release of the Spectrum Review Report, prepared by the Department of Communications.

In May 2014, the Minister for Communications announced a review of the spectrum policy and management framework. Established in 1992, the current framework led the world in how it dealt with the complexities of spectrum management. But today, more than 20 years later, the fast changing nature of technology has dated the framework. It needs to be modernised to reflect changes in technology, markets and consumer preferences that have occurred over the last decade and to better deal with increasing demand for spectrum from all sectors.

The purpose of the review was to examine what policy and regulatory changes are needed to meet current challenges, and ensure the framework will serve Australia well into the future.

Under the Terms of Reference, the review was to consider ways to:

simplify the framework to reduce its complexity and impact on spectrum users and administrators, and eliminate unnecessary and excessive regulatory provisions
improve the flexibility of the framework and its ability to facilitate new and emerging services including advancements that offer greater potential for efficient spectrum use, while continuing to manage interference and providing certainty for incumbents
ensure efficient allocation, ongoing use and management of spectrum, and incentivise its efficient use by all commercial, public and community spectrum users
consider institutional arrangements and ensure an appropriate level of Ministerial oversight of spectrum policy and management, by identifying appropriate roles for the Minister, the Australian Communications and Media Authority, the Department of Communications and others involved in spectrum management
promote consistency across legislation and sectors, including in relation to compliance mechanisms, technical regulation and the planning and licensing of spectrum
develop an appropriate framework to consider public interest spectrum issues
develop a whole‐of‐government approach to spectrum policy
develop a whole‐of‐economy approach to valuation of spectrum that includes consideration of the broader economic and social benefits.

The Spectrum Review Report highlights the need to simplify the current framework to remove prescriptive regulatory arrangements and to support the use of new and innovative technologies and services across the economy.

The report recommends simplifying processes for new and existing spectrum users and increasing opportunities for market-based arrangements, including spectrum sharing and trading.

The three main recommendations are:

Replace the current legislative arrangements with streamlined legislation that focusses on outcomes rather than process, for a simpler and more flexible framework.
Better integrate the management of public sector and broadcasting spectrum to improve the consistency and integrity of the framework.
Review spectrum pricing to ensure consistent and transparent arrangements to support the efficient use of spectrum and secondary markets.

The report is the outcome of a review conducted by the Department of Communications in conjunction with the Australian Communications and Media Authority, and included extensive stakeholder consultation.

The legislative reforms would:

establish a single licensing system based on the parameters of the licence, including duration and renewal rights
clarify the roles and responsibilities of the Minister and the ACMA > provide for transparent and timely spectrum allocation and reallocation processes and methods, and allow for allocation and reallocation of encumbered spectrum
provide more opportunities for spectrum users to participate in spectrum management, through delegation of functions and user driven dispute resolution
manage broadcasting spectrum in the same way as other spectrum while recognising that the holders of broadcasting licences and the national broadcasters would be provided with certainty of access to spectrum to deliver broadcasting services
streamline device supply schemes
improve compliance and enforcement by introducing proportionate and graduated enforcement mechanisms for breaches of either the law or licence conditions
ensure that the rights of existing licence holders are not diminished in the transition
to the new framework.

Implementation stages would commence following the passage of legislation. This would again include ongoing consultation with stakeholders and progress over a period of some years.

The Government is currently considering the report and will prepare a response in due course. Stakeholder feedback on the report is welcomed.

The report is available at: www.communications.gov.au/spectrumreview