Over the past few months we have been tracking the passage of the Cash Restrictions bill, which proposes to restrict cash transactions between companies and individuals over $10,000. Our post on the Real Issues surrounding the Cash Ban is our most watched show, ever.
As we highlighted recently, following the December Senate hearings, there is no clear rationale for the $10,000 dollar limit, it will have limited impact on money laundering and gang finances, and yet will remove a right we currently have to use cash as we please, thus narrowing the definition of legal tender. Some will be effectively debanked. And there is no clear business case at all. See our Post the Cash Ban Cowards Cannot Hide The Truth.
Plus the recent bush fires underscored the need for cash as an alternative to electronic payments see my post “Another Reason to Smash the Cash Ban”, where I argue that cash in a crisis is the only game in town – and the claimed protections proposed in the bill are unsatisfactory.
This bill has already been passed in the lower house, during
a pretty shameful and poorly attended debate, but the Senate determined to
investigate it before allowing it to pass. Good on them. As well as the minor
parties, Labour supported this inquiry which is due to report on the 7th
February. My suspicion is that the report has already been written, ahead of
another hearing which is tentatively scheduled for 30th January in Sydney.
Things have gotten more complex because the Labour party member Senator Gallagher, who asked some important and penetrating questions in the first round of hearings, has announced that he will take no further part in the review due to ill health. We wish him well.
As a result, it is not clear yet whether Labour will offer
up another Senator to continue the investigation, or whether this effectively
marks the end of any attempt to stop its passage. Indeed the 30th
hearing is now not ever certain.
All eyes are now on Labour, who appear from a distance to be
disengaged on the issue, despite their earlier support for the Senate inquiry.
So I wanted to highlight three important points.
First, the reduction of our personal freedoms to use cash as
legal tender is a big deal. The $10,000 limit will be eroded by inflation over
time and may be reduced in a subsequent bill to $2,000 or less, as has been
done in a number of other countries.
Second, the structure of the bill is a total restriction on cash transactions above $10,000 for any purpose, then diluted by a parallel regulation, which excludes for now cash withdrawals and payments from a bank, transactions between individuals for non-commercial purposes, and payments using cryptocurrencies. However, all these exclusions can be changed at a stroke of a pen, without any further direct Parliamentary intervention. This leaves the door open to restricting cash transactions more widely, for example in a banking crisis, including restricting cash withdrawals, as happened in the Bank of Cyprus crisis a few years back. And cryptos could be included later, if their use expands. The $10,000 limit is actually in the bill.
Third, the authorities carefully steer around the recent IMF
papers and blogs, where they discuss the need to take interest rates firmly
into negative territory, to react to a financial crisis. Typically, a cut of
around 4% would be required they say. Given we are already have a 0.75% cash
rate, negative rates may follow. But in a negative rate environment, people
will pull funds from the banking system, and hold cash, as their value will not
be eroded, relative to negative rates, where depositors must pay for the
privilege of keeping money in the bank. The
link to monetary policy was discussed in the Black Economy Task-force papers,
yet has been downplayed since in official circles.
So, the risks of the cash ban being made law are real.
Which begs the question, what can we do if we want to resist
this bill?.
Well, first it is not too late to contact your members and senators and make sure they are aware of your concerns, and I think we should focus on Labour Party members – on two fronts, demanding they nominate a replacement for Gallagher, and that they resist the bill. Make sure they know you are opposed to the bill. Contact details for every member and senator are available in the Government website.
Second, I think it is worth writing to your local newspapers, and highlighting the issues around the cash ban. I made an earlier show when I went through all the main points – see “What I Said to The Senate On The Restrictions On The Use Of Cash Bill” in my video, and on the DFA blog. I included a series of arguments which you can leverage.
Third, please share this post via your social media channels
to widen the awareness in the community of this issue. I still find many people
are unaware of the implications of this bill – and because they never make big
cash payments, do not see it as an issue. But I want to underline that personal
freedoms are being eroded again, on the flimsiest of arguments; that we will be
trapped inside the banking system, and thus forced to pay for banking services;
and that the Senate has the ball but might just hook it if they are allowed to.
We literally have less than 3 weeks now to make a difference. Our civil liberties depend on it….
When the world’s
largest fund manager tells its clients that it plans to swiftly exit its
thermal coal investments over the next six months, this should tell us
something important.
BlackRock
manages around USD$7 trillion of funds on behalf of investors and up to now has
been cautious in its response to climate change and slow to participate in
investor campaigns. But that just
changed, for good economic reasons. Recent analysis published by the Institute
for Energy Economics and Financial Analysis (IEEFA), estimated that BlackRock
lost as much as USD$90 billion in investment value due to poor investments in
fossil fuel companies in 2019. The IEEFA
assessment also found that investments in just four fossil fuel companies,
ExxonMobil, Chevron, Royal Dutch Shell and BP accounted for around
three-quarters of the USD$90 billion loss.
Now, in a
letter to clients, BlackRock’s Global Executive Committee, led by company
founder and CEO Laurence Fink, explained that the company would be withdrawing
its investments in thermal coal producers, including any company that sources
more than a quarter of its revenue from thermal coal production.
Announcements
of this kind have come out steadily over the past couple of years. Virtually
all the major Australian and European banks and insurers, and many other global
institutions, have already announced such policies. According to the Unfriend
Coal Campaign, insurance companies have stopped covering roughly US$8.9
trillion of coal investments – more than one-third (37%) of the coal industry’s
global assets, and stopped offering reinsurance to 46% of them.
A
separate letter to CEO’s starts with a clear reference to BlackRock’s
‘fiduciary duty’ to its investors. BlackRock’s own analysis shows global
financial markets will be materially impacted by climate change, reflected in
the Bank of England’s analysis of $20 trillion at risk. “BlackRock concludes
that this stranded asset risk is not yet priced into the market, so as a
fiduciary, BlackRock really has no choice but to act.”
“Thermal
coal is significantly carbon intensive, becoming less and less economically
viable, and highly exposed to regulation because of its environmental impacts.
With the acceleration of the global energy transition, we do not believe that
the long-term economic or investment rationale justifies continued investment
in this sector,” the letter says.
“As a
result, we are in the process of removing from our discretionary active
investment portfolios the public securities (both debt and equity) of companies
that generate more than 25% of their revenues from thermal coal production,
which we aim to accomplish by the middle of 2020.
Environmental,
Social, and Governance (ESG) Criteria are coming to the fore – Environmental –
a set of standards for a company’s operations that consider how a company
performs as a steward of nature. Social – examines how a company manages
relationships with employees, suppliers, customers, and the communities where
it operates. Governance – how its deals with a company’s leadership, executive
pay, audits, internal controls, and shareholder rights.
“As part
of our process of evaluating sectors with high ESG risk, we will also closely
scrutinize other businesses that are heavily reliant on thermal coal as an
input, in order to understand whether they are effectively transitioning away
from this reliance.”
The move
will see the investment giant dump around USD$500 million (A$725 million) in
thermal coal investments.
And firms
should note that Blackrock is going to flex its influence. “Given the groundwork we have already laid
engaging on disclosure, and the growing investment risks surrounding
sustainability, we will be increasingly disposed to vote against management and
board directors when companies are not making sufficient progress on
sustainability-related disclosures and the business practices and plans
underlying them,” Fink said.
So,
Blackrock’s Fink seems to have figured out the huge impact that climate change
will have on not just money, but the world.
“Will
cities, for example, be able to afford their infrastructure needs as climate
risk reshapes the market for municipal bonds?” Mr Fink wrote in his letter to
CEOs.
“What
will happen to the 30-year mortgage – a key building block of finance – if
lenders can’t estimate the impact of climate risk over such a long timeline,
and if there is no viable market for flood or fire insurance in impacted areas?
What happens to inflation, and in turn interest rates, if the cost of food
climbs from drought and flooding? How can we model economic growth if emerging
markets see their productivity decline due to extreme heat and other climate impacts?”
he said.
BlackRock
also announced that it would join the Climate Action 100+ initiative, that
supports investors to actively engage with the companies they are invested in
to assess, disclose and address the risk that climate change and the energy transition
poses to the company and the value of investments. The Climate Action 100+
initiative includes the Australian based Investor Group on Climate Change,
which supports Australian institutional
In 2019,
the UK-based think tank InfluenceMap released a report that showed
BlackRock was the leader of the asset management pack in terms of fossil fuel
ownership. As at June 2018, the oil, gas and thermal coal reserves controlled
by fossil fuel producers it holds represented an aggregated 9.5 gigatonnes of
carbon dioxide emissions equivalent, with just under half of these emissions in
thermal coal and equivalent to 30 per cent of total global energy-related
carbon emissions in 2017.
“Among
the 10 asset management groups with the largest aggregate fund AUM,
BlackRock holds the most coal-intensive portfolios,” the report said. A -100%
indicates full divestment while positive values indicates adding coal to the
portfolio during the period 2011-2016.
“However,
there are key differences between BlackRock’s passively and actively managed
funds,” the report noted. “The group’s passively managed funds show a thermal
coal intensity in 2018 of 680 t/US$m AUM, while its actively managed funds show
a much lower TCI of about 300 tons/$m AUM, well below the global fund
benchmark.”
And significantly
ESG investment strategies are growing in profitability, with new geographic
trends adding to their value, according to Amundi Asset Management who analysed
the performance of 1,700 companies across five investment universes. Their
research – ESG investing in recent years: New insights from old challenges
– found that ESG strategies tended to penalise ESG investors between 2010 and
2013, but rewarded investors after 2014. “We have observed a massive
mobilisation of institutional investors on ESG,” they said. The global responsible investment is
estimated to be $30.7 trillion USD, or two fifths of assets under management.
This is a 34% growth in two years.
But here
is the problem. Most of the money that BlackRock manages is wrapped up in
passive investments, which track indexes. Indexes tend to contain the shares of
the sort of companies that BlackRock’s active arm is now divesting from. So, what
exactly BlackRock can do about that? Is this more than greenwash?
Mr Fink
has said that BlackRock will be doubling its offerings of ESG ETFs and will work
with index providers to expand and improve the universe of sustainable indices.
The company will also simplify the process by which investors can integrate ESG
into their existing portfolios by adding a fossil fuel screen and has also
expanded its impact investment strategy.
But the
contradiction between the company’s new activist stance and the passive
replication of an energy-heavy index such as Australia’s is obvious. One
solution might be for large mining companies such as BHP to dump their coal
assets in order to remain part of both Blackrock’s actively managed (stock
picking) and passively managed (all stocks) portfolios. This was discussed in a
recent “The Conversation” article.
Another
might be the development of index funds from which firms reliant on fossil
fuels are excluded. It is even possible that the compilers of stock market
indexes will themselves exclude these firms.
But once
bond investors follow the lead of Blackrock and other financial institutions,
divestment of Australian government bonds will likely follow. This process has
already started, with the decision of Sweden’s central bank to unload its holdings of
Australian government bonds.
Taken in
isolation, Sweden’s move had virtually no effect on Australia’s bond prices and
yields. But the most striking feature of the divestment movement so far is the
speed with which it has grown from symbolic gestures to a severe constraint on
funding for the firms it touches.
The
effects might be felt before large-scale divestment takes place. Ratings
agencies such as Moody’s and Standard and Poors are supposed to anticipate risks
to bondholders before they materialise.
Once
there is a serious threat of large-scale divestment in Australian bonds, the
agencies will be obliged to take this into account in setting Ausralia’s credit
rating. The much-prized AAA rating is likely to be an early casualty.
That
would mean higher interest rates for Australian government bonds which would
flow through the entire economy, including the home mortgage rates mentioned in
the Blackrock statement.
So the government’s case for doing nothing about climate change (other than cashing in on past efforts) has been premised on the “economy-wrecking” costs of serious action. But as investments associated with coal are increasingly seen as toxic, we run an increasing risk that inaction will cause greater damage. So yes, Blackrock’s announcement is a real wake-up call, like it or not.
The World Economic Forum has just released their 2020 report, the 15th in the series and they highlight ” long-mounting, interconnected risks” driven by their annual Global Risks Perception Survey which was completed by approximately 800 members of the Forum’s diverse communities.
They conclude that the world “cannot wait for the fog of geopolitical and geo-economic uncertainty to lift. Opting to ride out the current period in the hope that the global system will “snap back” runs the risk of missing crucial windows to address pressing challenges”.
At the time of writing, the IMF expected growth to be 3.0% in 2019—the lowest rate since the economic crisis of 2008-2009.
They say that today’s emerging economies are expected to comprise six of the world’s seven largest economies by 2050. Rising powers are already investing more in projecting influence around the world. And digital technologies are redefining what it means to exert global power. As these trends are unfolding, a shift in mindset is also taking place among some stakeholders—from multilateral to unilateral and from cooperative to competitive. The resulting geopolitical turbulence is one of unpredictability about who is leading, who are allies, and who will end up the winners and losers.
The global economy is faced with a “synchronized slowdown”, the past five years have been the warmest on record, and cyberattacks are expected to increase this year—all while citizens protest the political and economic conditions in their countries and voice concerns about systems that exacerbate inequality.
Indeed, the growing palpability of shared economic, environmental and societal risks signals that the horizon has shortened for preventing—or even mitigating—some of the direst consequences of global risks. It is sobering that in the face of this development, when the challenges before us demand immediate collective action, fractures within the global community appear to only be widening.
Global commerce has historically been a pillar and engine of growth—and a key tool for lifting economies out of downturns—but as we warn, significant restrictions were placed on global trade last year. This comes as G20 economies hold record high levels of debt and exhibit relatively low levels of growth. Ammunition to fight a potential recession is lacking, and there is a possibility of an extended low-growth period, akin to the 1970s, if lack of coordinated action continues. In addition, a potential decoupling of the world’s largest economies, the United States and China, is cause for further concern. The question for stakeholders—one that cannot be answered in the affirmative—is whether in the face of a prolonged global slowdown we are positioned in a way that will foster resiliency and prosperity.
On the environment, we note with grave concern the consequences of continued environmental degradation, including the record pace of species decline. Respondents to our Global Risks Perception Survey are also sounding the alarm, ranking climate change and related environmental issues as the top five risks in terms of likelihood—the first time in the survey’s history that one category has occupied all five of the top spots. But despite the need to be more ambitious when it comes to climate action, the UN has warned that countries have veered off course when it comes to meeting their commitments under the Paris Agreement on climate change.
And on global health and technology, we caution that international systems have not kept up to date with the challenges of these domains. The global community is ill-positioned to address vulnerabilities that have come alongside the advancements of the 20th century, whether they be the widening application of artificial intelligence or the widespread use of antibiotics.
Today’s risk landscape is being shaped in significant measure by an unsettled geopolitical environment—one in which new centres of power and influence are forming—as old alliance structures and global institutions are being tested. While these changes can create openings for new partnership structures, in the immediate term, they are putting stress on systems of coordination and challenging norms around shared responsibility. Unless stakeholders adapt multilateral mechanisms for this turbulent period, the risks that were once on the horizon will continue to arrive.
The good news is that the window for action is still open, if not for much longer. And, despite global divisions, we continue to see members of the business community signal their commitment to looking beyond their balance sheets and towards the urgent priorities ahead.
They highlight the economic risks posed by global runaway climate change. Climate change is striking harder and more rapidly than many expected, with the bushfires that have ravaged Australia – as well as floods and droughts around the world – bringing the issue to the forefront of the global agenda.
They say, “alarmingly, global temperatures are on track to increase by at least 3°C towards the end of the century—twice what climate experts have warned is the limit to avoid the most severe economic, social and environmental consequences”.
The economic threat posed
by climate change could impact everything from national economies to
the mortgage and insurance industries. Worldwide economic damage from
natural disasters in 2018 totalled US$165 billion, with that number set
to increase if emissions remain at their current level.
In
the United States alone, climate-related economic damage could reach 10
per cent of GDP by the end of the century, while over 200 of the
world’s largest firms estimate that climate change will cost them a
combined total of nearly US$1 trillion.
But the report says many businesses are still not planning on the physical and financial risks that climate change could have on their activities and value chains.
The WEF warns that avoiding the most severe economic and social consequences of global climate change means limiting global warming to just 1.5 degrees Celsius over pre-industrial levels. This equates to a remaining carbon budget of less than 10 more years of emissions at their current level – and demand for energy is only continuing to increase.
The latest Jolly Swagman podcast is highly recommended. Ex RBA chief argues that the current RBA’s approach of targeting the wealth effect as a channel for monetary policy is “least attractive channel” because it risks igniting housing booms.
Ian Macfarlane was Governor of the Reserve Bank of Australia from 1996 to 2006. He is the author of The Search For Stability and Ten Remarkable Australians.
Westpac has announced that for one year, it will cover the mortgage repayments of home loan customers who lost their principal place of residence due to the bushfires raging across the country, paying up to $1,200 per month per customer. Via Australian Broker.
Westpac’s Bushfire Recovery Support
Package also includes interest free home loans to cover the gap between
insurance payouts and construction costs for consumers who need to
rebuild, as well as $3m in funds allocated to bushfire emergency cash
grants, of which eligible retail customers can claim up to $2,000.
At the time of writing, the bushfires have
claimed the lives of 28 people across the country, with over 3,000
homes destroyed or damaged in New South Wales alone.
“These initiatives are designed to provide
practical, on the ground support for our customers, our people and for
those who are caring for affected communities,” said Peter King,
Westpac’s acting CEO.
The relief package also makes grants of up
to $15,000 available to assist small businesses with the cost of
refurbishing premises that have been damaged or destroyed during the
bushfires.
Westpac has committed to “fast tracked”
credit approvals to provide short-term assistance to businesses impacted
by the fires, as well as offering 2.83% three-year variable rate,
low-interest rebuilding loans.
Further, no foreclosures will be made for
three years on any farming businesses in the affected areas, and all
volunteer firefighters across the nation are able to access the Disaster
Relief Package.
FBAA managing director Peter White has
encouraged brokers to be aware that it’s not only clients who have lost
their properties that are unable to meet their mortgage repayments;
while that subsection may be the most likely to automatically speak to
their lenders and insurers, there are many others whose properties were
not touched by fire but have been impacted in other ways.
“There will be those who have had to
evacuate, or who may operate a small business that has seen a dramatic
drop in revenue because an area has been blocked off. There will be
others who have had to sacrifice their earnings to help friends, family
or their community,” White said.
“Lenders are currently allowing people to
momentarily stop their repayments, and while each situation is
different, they are listening and helping and working with all
borrowers.”
According to White, brokers are ideally positioned to have the most impact on and support damaged communities.
“Chances are the bank won’t come knocking
on our clients’ doors because they don’t know who is being impacted and
who isn’t, but we can knock on those doors,” he said.
“Finance brokers are part of local
communities and we know many of our clients and their families
personally, so this is a great opportunity for us to serve our clients
and repay the trust they have in us.”
Banks have a central role in facilitating activity in modern economies. While that role is just as important today as it was prior to the financial crisis, the nature of banking has changed. And given developments in technology, data and competition, banking will need to continue to evolve. Today, I am going to discuss these changes in banking, past and prospective.
To put these changes in context, first I want to consider the special role that banks play in the
economy. I will then focus on how banks have changed in Australia since the financial crisis, and
outline some of the issues facing banks today that could see banking change in the coming years (my
remarks for Australia apply to all Authorised Deposit-taking Institutions, ADIs, but to fit with the
international literature I will use the term ‘banks’ and also because the word banks rolls
off the tongue more easily). While the Australian banking system remained well capitalised and
profitable through the financial crisis and by and large continued to service the economy, it was still
affected and the lessons learned internationally have resulted in important changes to Australian
banks.
What gives banks their special role?
Four characteristics jointly define why banks have a special role in the economy today:
they accept deposits, which become risk-free liquid assets for households and
businesses
they engage in maturity and liquidity transformation, using (mostly short-term)
liquid deposits and debt to make long-term illiquid loans
they play a central role in the payments system
they have expertise in credit and liquidity risk management, having a long history
and ongoing relationships that generate private information about customers.
The first three of these defining characteristics all relate to three key benefits that come from
public authorities. In particular, banks have: (i) the ability to accept deposits; (ii) an account at
the central bank; and (iii) access to emergency central bank liquidity. The three benefits provide banks
with a special role in the economy.
Bank deposits become a risk-free asset for households and business in Australia because they have an
effective government ‘guarantee’ (up to a limit) and receive the first claim on
banks’ assets.[1] Bank deposits are liquid because banks, in addition to the cash banks hold for
depositors’ physical withdrawals, have accounts at the central bank which enable their customers to
make direct payments to the customers of other banks.[2] It is because banks have accounts at the central bank
that they are central in the payments system. Further, even in tumultuous times, deposits are liquid
because of banks’ access to convert (potentially illiquid) assets into highly liquid deposits at
the central bank and, in the worst case, because the Financial Claims Scheme pays out deposits in a
timely manner. These policies give depositors the confidence that their deposits are safe and can be
withdrawn on demand.
These benefits help to mitigate the core risk of banking: maturity and liquidity transformation creates
the risk of a run. With access to stable deposits and central bank liquidity, banks are able to safely
do more maturity and liquidity transformation.
These three benefits go hand in hand with banks’ critical role in taking deposits and
intermediating and financing economic activity. Because of this role, banks are subject to prudential
regulation. Prudential regulation has benefits and costs. In economics, we typically try to equate
marginal costs and benefits when determining how much of something we should have.
From society’s perspective, prudential regulation has benefits in that it reduces the risks to
depositors and to the economy from bank failures. But there are also ‘costs’ to more
regulation, notably that it makes banks’ intermediation more expensive. To calibrate the optimal
amount of regulation, policymakers try to balance these costs and benefits.
We can also think of the costs and benefits of prudential regulation from the perspective of banks. For
banks, regulation can increase their costs. But it also provides banks with significant benefits. Even
in normal times, because they are prudentially regulated, banks can take in deposits that are a
relatively cheap source of stable funding. But the benefits are even greater in financial turmoil, when
having deposits that are relatively sticky and access to central bank liquidity is particularly
valuable.
The value of banks’ special role
Globally, the financial crisis delivered a severe shock to the banking system, and to the economy, that far exceeded what was generally thought likely or even possible. Before the crisis, it was widely thought that banks had become more sophisticated in managing their risk and that financial and macroeconomic volatility had declined. As a result, a severe financial shock was judged to be exceptionally unlikely. But then the financial crisis came along, which internationally resulted in bank failures and severe recessions. This led to a re-evaluation of how likely and extreme banking shocks could be. Globally, authorities recognised that the benefits of tighter prudential regulation – avoiding banking crises – would outweigh the costs.[3]
Similarly, from the banks’ perspective, it became apparent that the benefits that came with
their special role in the economy were even greater than previously appreciated, because shocks to the
financial system, and hence the impact on their balance sheets, could be more severe than was previously
thought likely. Indeed, in some countries the benefits of being a bank were so great that some non-banks
converted to being a bank to get those benefits.[4]
The international reassessment of banking regulation led to the ‘Basel III’ reforms. The
reforms focused on improving banks’ resilience, limiting banks’ maturity transformation and
ensuring that they improved their credit assessment and management of risk.
Recent changes in Australian banks
Despite the extreme shock globally, the Australian banking system performed remarkably well through the
crisis. In Australia, there was significant fiscal and monetary stimulus, and various measures were
enacted to support the banking system, and there was also a bit of luck. However, the good performance
of the Australian banks, to a large extent, reflected the strength of prudential regulation prior to the
crisis and banks’ own management of risks. But given the lessons learned internationally, it was
apparent that there were still improvements to be made in Australian banking.
The Basel III reforms have been adopted in Australia, on or ahead of schedule, strengthening a
prudential regime that was already tighter than global minimum standards. The reforms encouraged banks
to put greater emphasis on incorporating the cost of capital and liquidity into all aspects of their
operations.
Tier 1 capital ratios have increased by 50 per cent since 2006, with most of this being
CET1 capital (Graph 1). At current levels, banks’ Tier 1 capital ratios are
estimated to be well within the range that research has shown would have been sufficient to withstand
the majority of past international banking crises.[5]
Graph 1
A consequence of this has been a reduction in risk-taking. Banks sold some of their higher risk assets that were not providing sufficient rates of return. Notably, Australian banks have pulled back from international banking activity in the United Kingdom and Asia, where the returns had been disappointing and had often not met banks’ cost of capital (Graph 2). They also expanded their exposure to mortgage lending, which requires much less capital because of the collateral protecting these loans.[6] Most of the major banks have also sought to divest their life insurance and wealth management operations. These divestments were precipitated by changes in capital rules that required more capital to be held to support intra-group investments. But they also reflected that these investments had failed to deliver the anticipated benefits, including from cross-selling, and an appreciation of the non-financial risks that they involved.
The introduction of liquidity regulations – the Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR) – contributed to a substantial rise in the banks’ liquid asset
holdings, to around 20 per cent of total assets (from 15 per cent pre-crisis)
(Graph 1). The vast majority of this increase has comprised High Quality Liquid Assets (HQLA), in
particular, government securities.
The liquidity regulations contributed to a reduction in liquidity and maturity transformation. This has
substantially changed the composition of banks’ liabilities. Banks have significantly reduced their
use of (more flighty) short-term debt, while increasing their use of (sticky) domestic deposits
(Graph 2). By applying transfer pricing across their whole businesses, banks are now seeking to
ensure that all lending decisions take account of the extent of liquidity or maturity
transformation.
Graph 2
The regulatory changes and banks’ better recognition of financial risks and returns have restricted growth in Australian banks’ (headline) profits since 2014. The divestment of their wealth management businesses reduced total profits. However, even focusing on return on assets (ROA), profitability has declined by more than one-fifth since the financial crisis (Graph 3). Two important contributors have been the increased holdings of (safer but lower yielding) HQLA and a more general decline in risk-taking and hence reward. The fall in profitability has been even larger (about one-third) when measured by return on equity (ROE), because of the increase in banks’ equity outstanding.
However, the decline in profitability does not equate to reduced costs of financial intermediation for
customers. Rather, the spread between lending rates and funding costs (or the cash rate) has increased a
little. This combination of higher costs to customers and lower profits to banks reflects the
(anticipated) costs of tighter prudential regulation.[7]
Graph 3
Banks’ absolute cost of equity (COE) has also declined. The decline in absolute COE has, however,
been less pronounced than the fall in risk-free rates (Australian Government Security (AGS) yields). So
the risk premium on banks’ equity has actually risen. This is consistent with equity investors
having revised up their assessment of the riskiness of investing in banks, even as banks have been
forced to deleverage and hold more liquid assets.
Since ROE has fallen by more than COE, banks have become less valuable. One way to think about this is
that, since banks are now obliged to hold more equity (that is, they are less leveraged), they generate
a lower expected return on equity in excess of the risk-free rate. If the cost of financing a bank were
independent of the mix of debt and equity, that is, we lived in a world where the Modigliani-Miller
theorem held,[8] then issuing more equity would reduce the cost of the bank’s debt and equity, so
keeping the total cost of funding unchanged. There are many reasons why the Modigliani-Miller theorem
may not hold, including government protection of banks’ deposits. This means that deposits
don’t become less risky as the banks issue more equity, and so the cost of debt doesn’t
decline. But with the bank issuing more relatively expensive equity, the cost of funding banks rises
overall, which explains why they become less profitable when they are obliged to reduce their
debt-equity ratios.
Despite the decline in ROE, Australian banks continue to generate ROE well in excess of their
risk-adjusted COE. They trade at price-to-book ratios exceeding one, higher than banks in many other
countries around the world, highlighting the value that investors still see in Australian banks.
Prospective drivers of further change in Australian banks
While the past decade has seen substantial changes in banking in Australia, there are several issues
facing banks that could potentially lead to even greater change in coming years. The first is the
general increased access to, and ability to process, vast quantities of data. This is facilitating the
emergence of new, technology-driven competitors to banks which could potentially impact their dominant
position in the financial system.[9] A second is the impact of tighter regulation on banks. A third is
expectations for banks’ obligations to the community.
A substantial influence on banking at the moment is the rapid pace of technological change. We are
currently seeing a massive increase in the availability of, and ability to process, data. This could
erode, or maybe even eradicate, banks’ historical advantage in credit risk assessment. There are
two parts to this: regulatory changes mean that banks’ private customer data can be made available
to others and, second, that non-banks have some data that is useful for banking business.
The first part is the Consumer Data Right (CDR) and Open Banking. The CDR makes it clear that the
consumer owns their own data and Open Banking provides bank customers with the ability to share their
account data with other institutions, including non-banks.[10] Using these data, a non-bank could,
for example, suggest accounts or cards that better suit a customer’s needs or use the information
for detailed credit assessment. In addition, Comprehensive Credit Reporting (CCR) will provide (bank
and) non-bank lenders with greater information about potential borrowers’ credit history.[11]
The second part is non-banks’ data that are becoming more valuable for ‘banking’
services. Much of this data is collected by ‘big tech’ firms such as Google, Apple and
Facebook. For example, PayPal and Amazon have substantial data on the sales of their merchant customers,
while social networking interactions can be used to predict borrowers’ commitment to repay their
loans.[12] Technology firms for which collecting and analysing data is in their DNA are a new
type of competitor for banks that have historically struggled to take full advantage of the private data
they hold. How well individual banks respond to technology challenges will no doubt influence their
relative success.
Technological changes in payments are also challenging banks’ core role in facilitating payments.
To date, this erosion has been most apparent in emerging market economies where payments systems were
not meeting customers’ needs. For example, in China and several African countries, online
marketplaces or mobile phone companies have come to dominate payments (largely bypassing the banks).
However, in Australia, and other developed economies, existing electronic payment systems (including new
real-time payment systems such as Australia’s New Payments Platform (NPP)) are already meeting
customers’ needs. Still, new payments providers engaging with banks and card companies could reduce
the banking systems’ revenue from the payments system.
Where banks have provided poor service, such as in cross-border transfers, new competitors may capture
market share. This is already occurring with specialist firms undercutting the banks’ very wide
spreads in cross-border payments. Cross-border payments are also a potential entry point for
‘stablecoins’ which could be used to make low-cost payments across borders, completely
bypassing the banking system.[13]
A second issue for banks is the impact that tighter regulation has on the cost of intermediating
borrowing and saving. Tighter prudential regulations, such as holding more capital and liquid assets,
was anticipated by regulators to increase the cost of intermediation.[14] These expected higher costs were
taken into account in calibrating regulations and are judged to be appropriate given the reduced chance
of financial crises. But higher costs for banks can push more borrowing to non-bank financial
institutions or into capital markets. The share of credit intermediated by non-banks is currently small
in Australia and so there are limited implications for financial stability. But if it were to grow
significantly, we would have to carefully assess what this might mean for financial stability.
A third issue for banks comes from expectations in terms of their obligations to the community. Banks
will need to adapt to a range of reforms designed to strengthen governance and culture at financial
institutions. These should lead to less and better-managed non-financial risk. The measures include the
Banking Executive Accountability Regime (BEAR), the Australian Prudential Regulation Authority’s
(APRA) proposed standards for how variable remuneration is structured and the response required to
shortcomings identified by the Financial Services Royal Commission. While these measures require banks
to adapt, they will make banks more resilient, increasing their chance of responding to new
competitors.
Final remarks
Summing up, while banks are facing various challenges, their special role in the economy gives them
several advantages. Deposits are overall a lower cost, and stable, form of funding. And providing
depositors with a liquid asset puts banks at the centre of the payments system and gives them a
connection to customers.
Banks have adapted following the financial crisis. And they will need to continue to evolve given the
challenges they will continue to face in the coming years. Greater availability of data reduces one of
banks’ advantages. And changes in technology introduce a different type of competitor. For now, the
banking system remains core to modern economies. Australian banks in particular serve critical functions
in the Australian economy by providing credit intermediation and more generally facilitating economic
activity. Australian banks are profitable and resilient and a strong banking sector has contributed to
Australia’s extended run of economic growth. It’s hard to imagine a modern economy without a
banking sector. The eight largest Australian banks can trace their history back, on average, over
140 years. But what role today’s individual banks play in the provision of banking services in
the coming decades will depend on how they adapt to the challenges they face today.
We are releasing the latest data from our household surveys to January 2020 relating to segmented buying intentions and home price expectations. This is using data from our rolling 52,000 households nationally.
In overview, households have got the memo from the Government, that home prices are expected to rise – and this is influencing their forward expectations and buying intentions; to an extent. However, high prices and the significant debt burden, along with no income growth, and overall financial pressures are working against this intent. And property investors remain on the side-lines while first time buyers are lining up to take advantage of the Government scheme which has just commenced. There are 10,000 guarantees available now, and a further 10,000 in the next financial year. Not enough to meet demand.
As normal we will begin with our cross segment comparisons, before looking in more detail at the highlights of specific groups.
The intention to transact in the next 12 months is supported by two segments, first time buyers and down traders. The former are trying to get into the market for the first time, the latter are trying to exit the market to release capital. There are net more exits than entrants, so this suggests a supply demand disequilibrium. Investors remain sidelined.
We find that first time buyers and want-to-buys are savings hard, though lower interest rates are making the task harder. Up traders (people planning to up-size) are also saving, but at a slightly slower rate.
The intention to borrow is an important measure as it drives prospective mortgage growth ahead. The survey results suggests demand will be anemic and be driven by first time buyers and up traders, rather than investors. Not enough to suggest a significant lending recovery, yet.
Price growth expectations are rising, led by property investors, up 14% from September, and first time buyers up 10%. Other segments appear less convinced however.
Across the segments, the preference for using a mortgage broker remains close to longer run averages.
Now, looking in more detail at the segments, those 500,000 households wanting to buy are largely limited by access to finance (37%) (often because their incomes are insufficient or uncertain), that prices are too high (26%), high costs of living (25%) and transaction costs, like stamp duty, LMI premiums, and legal costs (7%).
In trend terms, the availability of finance has eased, down from 43% to 37%, while high home prices and rising costs of living have become a more significant barrier recently.
Turning to first time buyers, there are around 350,000 households who are actively saving with an intention to buy when they can, and the count has been rising in the past few months, partly thanks to the announced Government-back deposit scheme, which is discussed recently in our post: First Time Deposit Scheme: Fish Or Fowl? Loan approvals are running around 10,000 per month, so only a small proportion of the first time buyer pool will be able to take advantage of the scheme, which may put upward pressure on property in the target zones! 22% intend to use the scheme, so more than the guarantees available.
First time buyers are motivated by needing a place to live (26%), with greater security than renting (13%) and to capture future capital growth (16%), or tax advantages (11%). Around 10% transact as part of a newly formed family.
The trends highlight the impact of the new Government scheme, and the rising expectations of future capital gains, compared with a few months ago.
But first time buyers are still facing considerable barriers, including availability of finance (40%), prices too high (26%) and pressure from costs of living rises (24%). Property availability and fear of rising interest rates have both dissipated.
The trends highlight how finance availability remains an issue, and home price concerns are rising again, while there has been a big spike in costs of living in recent times. So many will struggle to buy.
We also see a greater focus on purchasing houses rather than units, a reflecting on the bad publicity in recent times relating to the poor quality of construction and flammable cladding issues.
Turning to refinancing, we see the primary motivation is to reduce monthly costs (50%) , capital extraction (19%) and seeking a better rate (19%). Intention to lock in a fixed rate has fallen to 5%, on the expectation that rates will fall further ahead.
Among those seeking to sell and release capital – and perhaps buy a smaller place – our down trader segment, with more than 1.2 million are in this category, and 56% are hoping to transact. The main drivers are to release capital (56%), increased convenience (30%) and illness or death of spouse (11%).
In trend terms, interest in investment property remains at a low 6%, compared with 23% back in 2017.
Up traders remain active but there are around 500,000 actively in this category. The main motivations are a desire for more space (39%), life-style change (20%), and job change (16%). 24% are driven by the expectation of future capital growth.
The trend tracker shows the property investment driver is weaker now, while more space and life-style are stronger drivers.
Turning to property investors, tax efficiency features as the strongest driver at 41%, down from 50% back in 2018. Better returns than deposits rose to 27%, reflecting the recent cash rate cuts. Low finance rates also feature at 11% and appreciating property values at 17%, higher than a few months ago. Within the investor segments, portfolio investors (those with multiple investor properties) are most hopeful of capital growth.
Barriers for investors include they have already bought property (30%), they cannot get financing (38%), down 2% from September, and changes to regulation (13%), including tighter rules on income and cost assessments.
There are around 1.3 million property investors, and many remain on the sidelines, due to low rentals, higher vacancy rates, and financial pressures. Of course the switch from interest only loans continues to bite too.
So, in summary, while there are some signs of interest in property, the segments really active are primarily first time buyers, and those trading down and up. There are more sellers than buyers in these groups, so if investors remain on the sidelines, we doubt prices can continue to drive higher, unless mortgage lending really accelerates (who would borrow?) or rules on loan serviceability are loosened further. The first time buyer deposit scheme will not be sufficient to turn the market around, though it may help some builders to shift newly completed or vacant property in the short term.
Nevertheless, households appear more bullish about future home price growth than a few months back – despite the fact the levers of growth appear disconnected from reality judging by these survey results.
According to a Moody’s report, just out, the near-term credit implications for Australia and the states are limited given a likely contained economic impact and the availability of ample fiscal buffers.
Taking into account both the direct costs and indirect loss of revenue, Moody’s estimate that the cost of the bushfires will reduce Australia’s general government’s fiscal balance overall by around 0.1% of GDP per year in the next two fiscal years.
The bushfires are mainly concentrated in rural areas, predominantly in national parkland. As a result, the economic cost has been limited, says Moody’s, who revised their forecast for 2020 GDP growth to 2.1% from 2.3% in 2020.
Although fires have burnt across the country, they say the bushfires have been concentrated in NSW, covering an area more than six times larger than that affected by the 2018 Californian fires, for an economy that is seven times smaller than that of California. Predictions by the Australian Bureau of Meteorology indicate that the fires are likely to continue and could even intensify over the coming months.
The Commonwealth government bears some of the direct containment and repair costs – such as for the deployment of military resources for firefighting – as well as the ultimate costs through transfers to the states. The government also incurs some expenditure on relief for affected areas, with AU$2 billion already announced to support affected farmers and businesses. Moreover, Commonwealth tax revenue from affected areas will be hit by temporarily weaker economic activity.
In 2020, reconstruction will boost economic activity, partially offsetting the initial losses from the areas which are being rebuilt.
Over the longer term, if bushfires of this severity were to become more frequent, they would expect tourism and investment, especially in rural areas, to be affected:
…over time, increasingly frequent and severe natural disasters related to climate change are likely to result in rising and recurring costs for Australia’s general and local governments, which will test their capacity – currently strong – to mitigate these costs
