Digital Finance Analytics (DFA) Blog – Page 1034

Increasing Competition In Banking – Lessons From The UK

The UK Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) have today published a review of the changes introduced last year which were put in place to reduce the barriers to entry for new financial institutions. The purpose of the measures was to enable increased competition in the banking industry, to the benefit of customers. The changes focussed on two key areas: reforms to and a simplification of the authorisation process for new banks; and a major shift in the prudential regulation, such as capital requirements, for new entrants.

The two areas of focus were:

A new ‘mobilisation’ option where authorisation is granted when a firm has met key essential elements but with a restriction on their activities due to some areas still requiring completion.
Capital and liquidity requirements for new entrants are now lower than before, but are set against a requirement for a firm to show the regulators that it has a clear recovery and resolution plan in place in the event of it getting into difficulty in the future.

In the twelve months following the changes, the PRA authorised five new banks and there has been a substantial increase in the number of firms discussing the possibility of becoming a bank with the regulators. In the twelve months to 31 March 2014 the regulators held pre-application meetings with over 25 potential applicants. These firms have a range of different business models from retail and wholesale banking to FCA-regulated Payment Services firms who are looking to enter the banking market and offer deposits and lending to their current client base (including small SMEs) and others who are proposing to offer a mixture of SME or mortgage lending funded by retail and SME deposits.

The minimum amount of initial capital required by a new entrant bank is £1m compared to £5m under the previous regime. The on-ramp strategies have been helpful for applicant firms that may previously have faced challenges in raising capital or investing in expensive IT systems without the certainty of being authorised.

The PRA intends to publish statistics regarding banking authorisation annually.

In the Australian context, we know from recent client work that potential new entrants face a stiff climb to gain access to the local market. Consideration should be given to given to emulate the UK approach, because we need greater competitive tension in Australian banking.

Why FOFA Matters So Much

Last week, the Future of Financial Advice regulations were tabled in Parliament, following the recently published Senate review. As currently incarnated they have the potential to drive a coach and horses through the original intentions of the FOFA reforms. Today we explore why this is so, and highlight some of the consequences for both the managed funds industry and investors.

First, we need to remember that according to the ABS, as at 31 March 2014, the managed funds industry had $2,338.8bn funds under management, an increase of $31.3bn (1%) on the December quarter 2013 figure of $2,307.5bn. This is the marked to market value of the overall portfolio, helped by the facts that S&P/ASX 200 increased 0.8%; the price of foreign shares, as represented by the MSCI World Index excluding Australia, increased 0.6% and the A$ appreciated 3.1% against the US$. Here is the trend chart from the ABS series.

Looking at the splits by type, superannuation is the largest contributing element, with 74% of the total, or $1.706.1bn. This is not surprising seeing as we have a forced savings scheme for households.

The ABS also show the industry flows in their report. Local Investment Managers have $1,520 bn invested, whilst $828.6 bn are invested with managers overseas, or directly into the market.

There has been considerable consolidation in the managed funds industry, looking at the managers themselves, the financial planners, and the wealth management platforms. The big banks are estimated to have about 80% of the financial planners, and are behind the bulk of the wealth management platforms and fund managers. This significant industry concentration is bad for competition, households and savers. We discussed this at length in our earlier series on superannuation. This is part of a wider consolidation within financial services, and should not have been allowed to happen, because such value chain consolidation allows a small number of players to control the industry, reduce competition and keep fees high. We recently covered the question of wealth management fees, those in Australia are significantly higher than elsewhere, despite the higher savings per capita. There have also been reports of poor or fraudulent advice to investors, where advisors recommended their own solutions, even if they were not the best for the investor concerned. Of course the original FOFA proposals was a response to this. We covered the history of FOFA up to the recent Senate Inquiry here.

So, now lets look at the latest regulated changes. On 30 June 2014, the Government registered the Corporations Amendment (Streamlining Future of Financial Advice) Regulation 2014. These changes to the FoFA laws were effective from 1 July 2014, and note they are yet to be tested in the Senate, maybe the regulatory amendment approach was seen as a way to avoid scrutiny. The changes are

to remove the Opt-In requirement;
to require Fee Disclosure Statements (FDS) to apply prospectively – for new clients from 1 July 2013 only;
to remove the requirement to satisfy section 961B(2)(g) (the ‘catch-all’ provision) from the best interests duty;
to allow for scaled advice;
to amend the grandfathering regulations in order to remove the current restrictions on trade for financial planners who may change employers/licensees, and enable fair market competition for financial planners selling their business;
to ban commissions on investment and superannuation products, and eliminate the possibility of a re-introduction of these commissions through the previously proposed general advice exemption.

The Governments position is that financial planners will continue to provide advice in the best interests of their clients, without the catch-all provision, and that as commissions have been banned for providing general advice, (despite the fact that advisors may receive other remuneration options and bonuses), they will not be conflicted. Therefore, the changes will reduce the costs of advice, and provide greater access to potential investors.

We are not convinced. In fact, we think that the latest adjustments will lead to confusion in the industry, enable the large banks to continue their consolidation and control of the industry, and will lead to investors potentially being given poor advice.

First, it will be easy to get round the ban of commissions. The original FOFA would have outlawed financial planners working in the banks to receive any reward for suggesting their own products. In addition, any fees or commissions would have had to be disclosed. Now, planners can provide general product advice, and get rewarded. In addtion, bank tellers, and other bank employees are now able to receive bonuses for selling products under general advice, provided they have an appropriate “target” and it is not called a commission. This creates a conflict.

Second, the original FOFA did not really separate specific advice (where a planner takes the history and needs of a client, to work out what their best investment strategy might be) and general product advice, or splitting advice from product sales. Product sales were overlaid with considerable obligations and requirements, more befitting advisors. In addition, people selling products could not be rewarded for achieving sales (as happens in most sales environments). What should have happened was a clear distinction between sales and advice, with sales able to be remunerated, but advisors not. Advisors would never sell products, so could not be conflicted.

The proposed changes which the Senate Inquiry considered were to allow planners to receive a proportion of their income from product sales, with the caveat that it should be in the best interests of the client. However, now in the regulated clauses, this best interest element has gone missing. Because the best interest clause has been removed, financial planners are now able to point potential investors to their own bank products, provided they meet their savings requirements, even if they are not the best products. So, a planner has no obligation to point to the best product in the market, even if that is with a competitor.

So, the amendments as currently in the regulations, work in favour of the big banks, means that planners can remain conflicted, tellers can sell products, and the potential to release real competitive tension into the market as products would have be compared cross market (with an bias towards cheaper?) are all gone.

We can only hope the new Senate will have the chance to review and change the regulations. The really interesting question, is whether the latest round of changes reflect a poor understanding of how the wealth management industry works, or whether the big banks, protecting their own highly profitable enterprises have lobbied successfully. Remember wealth management fees in Australia are three times higher than they should be!

Whilst Bank Margins Improve Significantly, Most Households Do Not Benefit

Using the updated RBA chart pack data, we can see the movements in deposits, lending and funding, all elements impacting bank profitability and their customers. We see that funding costs are down, deposit returns are down, whilst headline lending rates are static. This is creating an opportunity for banks to discount selectively to attract target housing lending. Looking in more detail, margins on personal loans have increased, with no change to the average rate since 2012, despite the fall in funding costs and the target rate since then. Average mortgage rates have not changed since September 2013, again despite falls in funding costs. Deposit rates have been falling recently as can be seen from the chart. Small business lending rates are still very high. This is creating significant profit for the banks.

In addition, wholesale bank funding costs are lower than they have been since 2007, and we are even seeing improvements in the costs of securitisation, as well as debt based funding. We recently published an update to our series on mortgage discounting, and we highlight again the wide range of margins available depending on the particular transaction involved. Large home loans, and investment property loans appear to attract the biggest discounts. Small business on the other hand find it hard to get any reduction in interest rates.

Those with the capacity to switch have the potential to negotiate quite a discount, but those unwilling or unable to switch are unable to take advantage of the lower rates, so continue to be locked into high rates, which flow direct to the bank’s bottom line. And remember, according to the BIS, we have some of the most profitable banks in the western world. Clearly competitive tension is insufficient to drive down margins for most households. I will be interested to see if the current Financial Sector Inquiry discusses the question of completion in banking as it looks to me to be a major issue, which is costing Australia Inc, dear. Banks were quick to put their rates up when needed, but the reverse is not true.

Banco Santander to refer small UK businesses to peer-to-peer lender

Further evidence of the continued importance of peer to peer lending is highlighted by the news that Spanish based bank, Banco Santander will start referring small UK businesses to peer-to-peer lending service Funding Circle as part of a new partnership between the two firms. As we highlighted in our recent review of the development of peer to peer lending, Funding Circle is an online marketplace for business loans aimed at small companies. Funding Circle, as a quid pro quo will point customers to Santander for day-to-day banking services such as advice, cash management or expertise.

“SMEs need access to multiple sources of finance, and Santander’s partnership with Funding Circle is a good example of how traditional and alternative finance can work together to help the nation’s SMEs prosper,” said Santander UK CEO Ana Botin. “Peer-to-peer financing is also a useful way to introduce people to the concept of investing in entrepreneurs; an important element in a healthy enterprise economy.”

So far Funding Circle has lent £306m to more than 5,000 businesses. The company says the opportunity is still massive, citing research estimating that some 250,000 businesses could qualify for alternative funding in the UK each year. The model has piqued the UK government’s attention, with the British Business Bank, which it backs, investing GBP60m (USD101m) to fund 10% of all business loans made on Funding Circle. This offers an alternative channel to funding to businesses which find it difficult to obtain financing through traditional channels. The traditional British banks seem unwilling to provide sufficient credit to small and medium-sized enterprises (SMEs) and the UK government is considering making it compulsory for them to direct failed loan applicants to alternative institutions, such as peer-to-peer lenders.

Funding Circle include the following facts on their web site (correct as at 1 May 2014):

~30,000 active investors registered with Funding Circle
The average amount an active investor has in their account is £6,000
Average net return is 6.1%* after fees and bad debt but before tax
Investors recently exceeded a total lending of £270 million
£130 million of this total was lent in 2013 alone
4,000+ businesses have borrowed via Funding Circle
More than £20 million lent to small businesses every month

Average loan amount is approximately £60,000
Approximately 1.4% bad debt ratio
The peer-to-peer lending industry is tripling in size each year, and has the potential to become worth over £12 billion per year within a decade according to independent research by Nesta
The top three platforms alone have already completed almost £1 billion of lending to date and will help lend another £1 billion over the next 12 months

Detailed Funding Circle Statistics are available here.

Will The Next Rate Movement Be Down?

Today Glen Stevens spoke at The Econometric Society Australasian Meeting and the Australian Conference of Economists in Hobart. He gave an economic update, and included a number of messages which when taken with economic data from the ABS today, suggests that interest rates may be cut later in the year.

Here are a few of his points:

“the most recent set of GDP figures, while certainly encouraging, probably overstate somewhat the true ongoing pace of growth in the economy. The Bank’s forecasts from early May, which we have not materially changed, embody ongoing growth but, in the near term, probably a little below trend”.

“The cash rate measured in ‘real’ terms is approximately zero. In either nominal or real terms the cash rate is well below ‘normal’ levels, and comfortably below even the mooted lower ‘new normal’ levels. Moreover, we still have ‘ammunition’ on interest rates – we have not got close to the zero lower bound that has afflicted some other countries”.

“Now, the terms of trade are falling, and the investment part of the boom has peaked. Mining investment, as a share of GDP, has probably already declined by about 1 percentage point, and is expected to fall by another 3 or 4 percentage points over the next few years”.

“Consumer demand has been rising moderately, even if recently perhaps a little more slowly than it did over the summer. Residential construction is moving up strongly, and intentions to invest outside the resources sector have started to improve, from very subdued levels. The labour market has also shown some early indications of mild improvement. But these signs remain early ones”.

“the exchange rate remains high by historical standards. There is little doubt that significant parts of the trade-exposed sectors still find it quite ‘uncomfortable’: it continues to exert acute pressure for cost containment, productivity improvement and business model change. When judged against current and likely future trends in the terms of trade, and Australia’s still high costs of production relative to those elsewhere in the world, most measurements would say it is overvalued.”

” if we think there is a need for higher construction, which we do, an environment of declining prices is probably not conducive to that outcome. Some pick-up in housing prices as a result of lower interest rates was to be expected; it shows that monetary policy is working and is part of the normal transmission process”.

“investors should take care in the Sydney market, which is the main area where a large increase in borrowing has been occurring. The total value of credit approvals for investor loans in New South Wales as a whole is about 130 per cent higher than in 2008, and it is in the investor segment where there has been evidence of some increase in lending with loan-to-value ratios above 80 per cent in the past couple of quarters”.

“in forming expectations about future price gains and deciding their financing structure, people should not assume that prices always rise. They don’t; sometimes they fall”.

“banks and other lenders need to maintain strong lending standards. APRA has helpfully been reinforcing this point directly with bank boards, as well as stressing the importance of having adequate, higher, interest rate buffers in place, given the current very low level of rates in the market.”

“Overall, the Bank has not seen developments in the housing market as warranting higher interest rates than the ones we have had, in the current circumstances.”

So the bank is happy with the housing market, concerned about the exchange rate, and thinks growth will be below trend. The ABS data today showed Retail spending down a tad, and building approvals were down in current terms. Given the comment that there is room to cut further, a reduction in the benchmark rate looks quite likely.

But then the BIS Annual Report contained a waning that ultra low interest rates are not necessarily effective, and may themselves lay the foundations on the next global financial crisis. If rates were to be cut further, the case for deploying macroeconomic measures to control house prices would become even stronger.

Building Approvals Fall Again In May – ABS

According to the ABS, in data released today, the number of dwellings approved fell 1.7 per cent in May 2014, in trend terms, and has fallen for five months. However, the seasonally adjusted estimate for total dwellings approved rose 9.9% in May after falling for three months. Approvals for units increased. The seasonally adjusted estimate for private sector dwellings excluding houses rose 27.2% in May after falling for three months. The seasonally adjusted estimate for private sector houses rose 0.5% in May after falling for three months.

Dwelling approvals increased in trend terms in the Northern Territory (8.2 per cent) and Tasmania (6.5 per cent). Dwelling approvals decreased in trend terms in the Australian Capital Territory (9.5 per cent), Queensland (3.2 per cent), New South Wales (3.0 per cent), South Australia (1.6 per cent), Western Australia (0.5 per cent) and Victoria (0.2 per cent). In trend terms, approvals for private sector houses fell 0.2 per cent in May. Private sector house approvals rose in Queensland (0.3 per cent), Victoria (0.2 per cent) and Western Australia (0.2 per cent). In trend terms, approvals for private sector houses fell in New South Wales (2.1 per cent) and South Australia (0.6 per cent).

The value of total building approved fell 3.3 per cent in May, in trend terms, and has fallen for six months. The value of residential building fell 1.1 per cent, while non-residential building fell 7.6 per cent in trend terms.

However, the seasonally adjusted estimate of the value of total building approved rose 26.1% in May after falling for four months. The value of residential building rose 13.5% after falling for three months. The value of non-residential building rose 59.5% after falling for four months.

So depending on your point of view, building approvals are either up or down in May! DFA’s view is that the seasonally adjusted data is probably a better read, indicating that the effects of low interest rates and the demand for property in a rising price market is stimulating approvals.

Credit Card Lending Portfolio Data to May 2014

Continuing our analysis of the APRA monthly banking statistics, today we execute a deeper dive into the credit card portfolios. The $40.5 billion portfolio is relatively static, fluctuating by about $200m in recent months. As we highlighted, previously, CBA has the biggest share, and Citigroup is the 5th largest player.

We can show the relative share trends as a percentage of total book. CBA has 28% of the market, and Westpac 23% – together holding more than half the market. Macquarie is a small, but growing player, as we will see in a moment. Citigroup’s share dropped just a little.

So. lets look at the changes in more detail. Here are the movements by percentage change of individual portfolios. Thanks to Macquarie’s acquisition of HSBC’s Woolworths white label credit card portfolio for $362 million in May, we see a significant swing away from HSBC, to Macquarie, who more than doubled their portfolio in the transaction. HSBC released a statement saying it was still committed to the Australian market, but the Woolworth agreement would terminate, although they would continue to provide card services through to 2015.

Looking at the data another way, in portfolio dollar terms, we see CBA growing a little, whilst nab, ANZ and Citigroup fell in May. The Macquarie transaction also shows up clearly. Overall in May the total across all banks fell just over $200 million.

So, we see household card debit is quite constrained at the moment. We also see Macquarie extending its reach across retail banking, including mortgage lending, and credit cards.

RBA Leaves Cash Rate Unchanged; Again.

At its meeting today, the Board decided to leave the cash rate unchanged at 2.5 per cent. “Monetary policy remains accommodative. Interest rates are very low and for some borrowers have edged lower over recent months. Savers continue to look for higher returns in response to low rates on safe instruments. Credit growth has picked up a little, including most recently to businesses. Dwelling prices have increased significantly over the past year, though there have been some signs of a moderation in the pace of increase recently. The exchange rate remains high by historical standards, particularly given the declines in key commodity prices, and hence is offering less assistance than it might in achieving balanced growth in the economy. Looking ahead, continued accommodative monetary policy should provide support to demand and help growth to strengthen over time. Inflation is expected to be consistent with the 2–3 per cent target over the next two years”.

“A strong expansion in housing construction is now under way. At the same time, resources sector investment spending is starting to decline significantly.”

Home Lending Portfolio Analysis To May 2014

Following on for our analysis of the APRA monthly banking statistics, today we explore some of the detail in the home loan statistics. The data shows the net monthly movement by lending institution, split by owner occupation and investment lending. We dropped a few of the smallest players from the data to make the picture clearer. We see some interesting segmental trends. First, lets look at the major changes amongst the main lenders between April and May. The most significant element relates to the CBA portfolio where there appears to be a big swing to investment lending (is this changes in policy, or a data coding issue?). Westpac continues to grow its investment portfolio so, We think CBA may be hunting investment loans more aggressively, but its a big monthly swing.

Now looking at the loan portfolios from January to May, we see again Westpac leading the investment lending, and we see CBA’s uptick in May, offset by a fall in owner occupation lending.

Another way to look at the data is by percentage movement, this view shows the change at the portfolio level, the sum of investment and owner occupied loans. It is worth highlighting the Macquarie Bank growth, much higher than system growth. Bendigo had quite a spike, and AMP had a bad March. What we do not know is how much is a data problem, and how much is a real response to business strategy and execution.

We can also split the data by loan type. This the owner occupation trend, note that at a marker level, it fell slightly overall in May. We see the fall at CBA in May, the spike at Bendigo, the consistent growth at Macquarie and the AMP hiccup.

Turning to the Investment Loan portfolio, the CBA spike shows clearly, the Macquarie Bank growth spurt, the growth at Members Equity, and strong overall spike in investment lending.

We should await the next months data, because the CBA data movements would mask, or change the outcomes. Our own data suggest investment lending is not as strong as suggested by the APRA data.