Is a Central bank-issued digital currency a realistic prospect?

Interesting speech from Carl-Ludwig Thiele, Member of the Executive Board of the Deutsche Bundesbankentitled “From Bitcoin to digital central bank money – still a long way to go“.

He says the Bundesbank actively shapes the ongoing conversation about distributed ledger technology (DLT) by contributing insights of its own, not least because as a central bank, trust is its most precious asset. The stability and efficiency of systems alone is their primary concern.

They wish to neither hype up a “hot topic” nor hinder the development of highly promising innovations.  But, healthy scepticism, coupled with curiosity and critical analysis, is warranted when it comes to both DLT and central bank-issued digital currency. He concludes that a Central bank-issued digital currency, is currently an unrealistic prospect.

“The road to a digital central bank – assuming there would be any benefits in the first place – would be a very lengthy one. At present, there is not even a recognised basic blockchain. Major consortiums are developing different types of basic blockchains, each with their own particular features. Not all of them can be used in the financial sector”.

The original promise of Bitcoin was to forge a “trustless” payment system – that is, one that required no trust. I quote from Satoshi Nakamoto’s paper from 2008 (Bitcoin: A Peer-to-Peer Electronic Cash System): “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”

I feel that too little attention is being paid to Nakamoto’s primary goal of constructing a groundbreaking, trustless electronic payment system which, like cash, would facilitate peer-to-peer (P2P) transactions. At the same time, Nakamoto was looking to create a currency which was not based on trust. This aspect – forging a new currency that does away with central banks – has become a major talking point in the current debate. I have come here today to explain why a trustless currency is not feasible, and I will also argue that the merits of blockchain can be harnessed more readily with trustworthy institutions than without.

To get a grasp of Bitcoin, we need to put our minds to the essence of money. There are two types of money. Money as a commodity, and money as a claim.

Money as a commodity, that could be a commonly used consumer good which is mostly non-perishable. Cigarettes, for instance, were used as a money substitute in Germany after the Second World War.

But equally, money could be a durable good – gold being the most prominent example of this. Gold is extraordinarily durable, and it has an intrinsic value as a sought after industrial metal, say, or as jewellery. Indeed, for centuries, delivering gold was regarded as the ultimate form of settling a claim.

Consumer and durable goods which can be used as money substitutes both have an intrinsic, consumption or utility value.

Virtual currencies, meanwhile, which are transferred much like goods, are a fabrication. That is not to consign them straight to the category of “fraud”. Yet they have no intrinsic value, just an exchange value. You can’t consume or use them, only exchange them.

On the other hand, there is money as a claim. The bulk of our money – central bank money and commercial bank money – is a claim on either the central bank or a commercial bank.

Every euro in cash and every euro in credit balances in TARGET2 represents a liability for the Eurosystem. And the euro is backed by the Eurosystem with its constituent central banks, one of which is the Bundesbank.

Unlike consumer or durable goods, central bank money does not have any consumption or utility value. And the issuing central bank’s credit quality and integrity is reflected in the value of its currency. The value of a currency, then, hinges on trust in the central bank.

Not just that: the issuer – so in the euro’s case, the Eurosystem – takes collateral from its monetary policy counterparties as a “deposit” for providing euro currency. That indirectly anchors the euro in the real economy.

Virtual currencies, by contrast, have no issuer, no footing in the real economy. No one has to redeem them. They are a fabrication and propagate according to a fictitious set-up in virtual systems which, in some cases, can be altered or newly created at the whim of a small group of participants. What is more, their governance regime is opaque, if not to say obscure – not to mention the fact that the identity of the participant or participants – no one knows for sure how many there are – behind the pseudonym Satoshi Nakamoto remains shrouded in mystery.

Virtual currencies are exchanged in the same way as goods, but they have no intrinsic value of their own. That is undoubtedly one reason why their value is highly volatile. Over the long term, that naturally also exposes Bitcoin holders to the risk of total loss. For us, Bitcoin is not money, it is a speculative plaything. The great number of sometimes dubious initial coin offerings is a clear indication that Bitcoin is more of a funding instrument.

To repeat: it is more of a speculative plaything than a form of payment. Hence my repeated warnings against investing in virtual currencies. We are witnessing a remarkable increase in the value of some virtual currencies. But that does not alter the risk of total loss.

2 Blockchain/DLT in the world of payments

For us, Bitcoin’s most important contribution is the underlying blockchain technology, or to put it more broadly, distributed ledger technology (DLT). This technology could help boost efficiency in payment and settlement processes.

That is why we have been looking at this technology from three different perspectives. First, the Bundesbank develops and runs major payment and settlement systems, often in conjunction with other central banks, and in this context we explore innovative technical capabilities which can contribute to their stability and efficiency.

Second, the Bundesbank acts as a catalyst to forge improvements in payment operations and settlement structures. The better the Bundesbank grasps the practical implications of technologies or processes, the more forcefully it will be able to present its arguments, which always aim to preserve the stability and enhance the efficiency of payment and settlement systems.

Third, the Bundesbank monitors the stability of systems and tools used in the field of payments and settlement. Being able to gauge the relative merits of state-of-the-art technology is a key skill in this regard. That is why the Bundesbank – much like other central banks worldwide – has been putting a great deal of thought into DLT, even though this technology is still very much in its infancy.

Potentially, distributed data storage means that DLT can simplify reconciliation processes associated with complex work-sharing value added chains. DLT is seen as having disruptive potential since it generally allows transactions to be carried out directly – that is, without intermediaries.

Developed originally for the virtual currency Bitcoin, DLT will nonetheless require extensive modifications if it is to be adapted to the needs of the financial sector. For one thing, the legal framework as it stands requires participants to be identifiable, transactions to be kept secret from third parties, and transactions to be settled with finality.

For another, transaction throughput needs to be high. That said, some of the consensus mechanisms, as they are known, absorb so much time and energy that efficient settlement seems barely possible. Furthermore, they require substantial additional data transfers, which adds to the costs.

For comparison purposes, the Bitcoin network, at its peak, settles roughly 350,000 transactions worldwide every day, and given its current configuration, appears to be running at almost full capacity. The German payment system alone, meanwhile, processes more than 75 million transactions on average every business day, according to the data for 2016.

The traditional answer to the problem of mounting complexity in the interactions of a multitude of independent participants has been to use a central bank – an institution which centralises the settlement of payment transactions. Hence the name: Central. Bank. This arrangement channels the many different bilateral payment flows and order books into larger flows which are then routed via or by the central bank and posted in a central bank account. That was a huge step towards greater stability and efficiency in the world of payments.

As a matter of fact, that is why we are seeing a trend towards centralisation and hierarchical structures in the development of basic blockchains as well. There are multiple reasons why a pure P2P settlement arrangement does not appear viable.

A pure P2P world appears unfeasible without trusted institutions. I call this factor the lack of a real reference framework. Bitcoins, you see, are merely virtual, and they change hands between virtual participants. They never leave the Bitcoin blockchain, and they will never have a real point of reference until they are exchanged for real currency, which takes place outside the blockchain.

Once real transactions come into play, a real point of reference is needed. You can trade a house on the blockchain in the form of a virtual token. But on the blockchain, that tells you nothing about whether the house even exists, whether it has the features it is said to possess, and whether it belongs to the seller in the first place. To verify all those things, there needs to be a trustworthy outside third party.

The basic matter of a participant’s personal identity needs to be verifiable outside the blockchain. Only then can we conduct real transactions with that participant.

That is why I feel that the purported goal of settling transactions without trustworthy third parties is a pie in the sky proposition.

All in all, we are highly sceptical about the extent to which DLT can be put to use in the financial sector. Given the current state of the art, it is somewhat unlikely that DLT will become a widely used application in individual and retail payments.

In the field of securities settlement, though, the shrinking processing times and reconciliation costs might prove to be a more important factor and suggest that DLT does have its uses.

The Deutsche Bundesbank is analysing the pros and cons of DLT in a project it is running with Deutsche Börse. While this project indicates that DLT does indeed have its functional merits, it is still unclear how far DLT also has the edge over today’s technology in terms of security, efficiency, costs and speed.

3 Central bank-issued digital currency

When using DLT, the question might arise in future as to whether central bank-issued digital currency could be provided for the safe settlement of larger transactions.

Central bank-issued digital currency would rank alongside cash and credit balances with the central bank as another form of central bank money, and it would also need to be posted as a liability on the central bank’s balance sheet.

There are several technical options in terms of the form this would take. Transfers could be value-based (like cash) or account-based (like deposits), anonymous or registered, its use could be restricted – in terms of amount or payment purpose, say – and it could be remunerated or, like cash, earn no interest.

The specific design dictates not just how far the supposed benefits of DLT-based central bank-issued digital currency will come into play, but also the macroeconomic repercussions, which also need to be factored into any overall verdict on its merits.

Arguably, the most important question here concerns who exactly should be allowed to use central bank-issued digital currency, or, to be more specific, whether central bank-issued digital currency should be issued to non-banks as well. Because if that were the case, we would probably see substitution effects between the different forms of money. Confining its use to the settlement of transactions among banks, on the other hand, would not involve any substantial changes over the status quo.

In particular, non-banks could convert their sight deposits at banks into central bank-issued digital currency if storage as an entry on the distributed ledger appears more secure and more convenient than hoarding it as cash.

Significant parts of non-banks’ sight deposits being shifted into a blockchain, however, and no longer being available­ to the credit institutions as virtually unremunerated funding ­might have considerable repercussions for the interest margin, the scale of lending ­as well as the business models in the banking system and the banking system’s structure.

Moreover, simply expanding the monetary base accompanied by sight deposits being shifted into central bank-issued digital currency would require a larger amount of collateral and would thus have a significant impact on the structure and risk profile of the central banks’ balance sheets.

There is a wide variety of potential monetary policy and stability policy implications. And these are currently being investigated by a number of central banks. As things stand, the likely consequences remain to be seen.

In a nutshell, the title of my speech today: “From Bitcoin to digital central bank money – still a long way to go” sums up the status quo of our considerations.

The road to a digital central bank – assuming there would be any benefits in the first place – would be a very lengthy one. At present, there is not even a recognised basic blockchain. Major consortiums are developing different types of basic blockchains, each with their own particular features. Not all of them can be used in the financial sector.

At the same time, applications for payment and settlement systems are being developed on these shifting sands. There is a lot going on in this field. Technology has been advancing at a pace unseen in the past decades.

What we can do once the banks give us back our data

From The Conversation.

Macquarie Bank has started a trial, giving customers access to the data the bank has collected on them. These might include the number and types of account held, average balances, regular payments and income and credit score information. This information helps to determine both the need for products and the risk of a customer.

This idea is called open banking and will see customers use their data in a whole range of ways – to ensure they are getting a good deal on their credit cards or mortgages, to see how they are faring financially against people in similar situations, and even to make paying taxes easier. Until recently our banks have had exclusive access to all of this data. The banks used it for marketing and product design. That is, your data was used to increase their profits.

The absence of sharing meant the data was a hurdle to customer switching. But the Productivity Commission has said consumers should be given a “comprehensive right” to their data.

In fact, you can already see some of use cases for your data in services the banks themselves provide. For example, Ubank has a tool that allows customers to work out a budget, and compare themselves to others of similar ages, household types etc. And many banks and credit card companies allow you to dive into your spending habits, to see where your money is going.

Treasury is currently examining how open banking should work in practice, and the Productivity Commission is looking at competition in the financial services sector. So this Macquarie Bank trial is just the beginning of open banking in Australia.

Is it safe?

You might be worried about how these other services will access you data. You don’t have to share your passwords or bank login, rather the data is shared using a standardised application programming interface or API.

An API creates a standard for connecting to a service, similar to how there is a standard for writing down your home address. To mail a letter you write down a street number, street name, suburb, state, postcode. If you write down the latitude and longitude of the person’s house then the letter won’t get there, because it doesn’t abide by the standard.

API’s have security standards as well, with two elements. One is authentication – making sure that the machine seeking access is the machine it says it is – and the other is authorisation – making sure that the machine is permitted to access the API. In practice, the authentication component could be done by a trusted third party, such as Facebook or Google.

An open banking API would need to allow enough information about a customer to be accessed to allow for service comparisons. However, the data must not contain enough information to identify an individual. This is essential under Australian privacy law and proposed standards would also need to comply with the European General Data Protection Regulation (GDPR).

What will I use the data for?

The fact that all this data has largely been held by the banks until now means there aren’t a lot of services for us to connect to immediately.

The most immediate example is to use your data to make sure you are getting the best deal you can on your loans. This is one of the reasons the British Competition and Markets Authority decided that open banking was necessary.

Under this scheme, if you want to compare service providers, you can download your anonymised data in a standard form and then upload it to a bank, a price comparison website or an app. In the case of the app, it would present to you your best options, given your current banking profile. This would include staying with your current bank or changing one or more accounts to a different institution.

This data could also be used to get approval for a new loan. Your anonymous data, in combination with identity information, includes enough material for a lender to decide whether to give you a loan for a specific purpose.

These tools will foster more competition between banks as customers will find it easier to compare services and switch, but it will also mean customers can make sure they are getting the best product available at the bank they are currently at.

But beyond comparison and switching, there are a number of interesting examples of how you can benefit from the data in your bank.

A budgeting app connected to your bank account, for example, can use your anonymous data to help you plan your finances. Using both your banking and “tap and go” payment history, it can help you analyse your spending and set goals. These services can even tap into outside data, such as interest rates, to help you determine what to do if rates go up. It’s that spooky moment when your phone becomes your conscience.

Online accounting software such as Xero or MYOB allows daily reconciliation of business accounts. These software systems already use APIs provided by the major banks to reconcile current accounts, loan accounts and credit card services. One variant on the open banking API could let customers “mark” transactions that are employment related expenses or health related expenses to simplify tax returns.

Going beyond fintech

But beyond these examples there are any number of possibilities for what we can do with this data. For instance, we could see an app that helps you make shopping decisions to increase the amount of loyalty points you earn. That is, using data on prices, goals and financial history to benefit consumers and not just sellers.

There are already limited examples of such schemes. The Coles “Fly Buys” scheme is connected to Virgin Velocity points. Both Coles and Velocity prompt members to earn points. Adding an overlay of which credit card to use at the checkout is currently up to you. However, it would be perfectly feasible for an app in your phone to choose which credit card the phone uses to pay at the supermarket to give you maximum points.

There’s also an opportunity here to connect your stream of financial data to what might seem like unrelated data. For example, what if your smart watch prompted you to walk home if you’ve spent more on eating out than your budget allowed? That is, open banking might actually improve your fitness, or at least make you feel guilty about overspending.

Author: Rob Nicholls, Senior lecturer in Business Law, UNSW

Long Term Debt Trends – Where Australia Sits

The BIS data-sets on financial trends across countries is a fertile place to go for interesting charts. They recently released several updated series. The one I found most interesting was the ratio of private sector debt from banks, compared with GDP, or formally “Credit to Private non-financial sector from Banks, total at Market value – Percentage of GDP – Adjusted for breaks”. All series on credit to the non-financial sector cover 44 economies, both advanced and emerging. They capture the outstanding amount of credit at the end of the reference quarter. Credit is provided by domestic banks, all other sectors of the economy and non-residents.

Here is a plot from 1971 to present day. I selected some of the more telling data from the 44 available (omitting those in the central range for example).

We see that the strongest rise in the ratio has been in Hong Kong, followed by Denmark, then New Zealand and Australia. Also, look at the impact a recession had on the ratios for Ireland and Spain.

Households and Businesses here hold more debt relative to GDP, and we have moved from the bottom of the range in 1971, accelerating more strongly than many to our current heavily debt ridden state. This degree of leverage highlight the risks in the system, and of course will get worse if growth rates stay low while lending for housing continues at ~6% growth each year. And we know that much of the debt sits with households.

The USA, by comparison is pretty steady over the range, and well below Canada and Denmark.

 

The Great Property Rotation

Today we commence a short series on the results from our latest household surveys, as we examine the drivers of property demand by household segment.

These results, from our 52,000 sample to September 2017 reveals that a significant rotation is underway, with first time buyers seeking to buy, supported by recent enhanced first home owner grants, while property investors are now significantly less likely to transact. We will examine the underlying drivers, initially across the segments, and then later in more detail within a segment.

The segmentation we use is based on the master property definitions as described in our segmentation cookbook. It is essential to look across the segments, as cohorts have significantly different imperatives, which at an aggregate level are lost.

We start with an indication of which segments are most likely to transact over the next year (either buying or selling property).  We can trace the trends since 2013, as displayed below, and until recently both portfolio investors (holding multiple properties for investment purposes) or solo investors (holding one or two properties) led the field. But we are now seeing a marked slow down in investors intending to transact. For example, in 2015, 77% of portfolio investors were intending to transact, today this is down to 57%, and the trend in down. Solo investors are down from a high of 49% to 31%, and again is trending lower. Later we will examine the drivers behind these trends.

In contrast, the proportion of Down Traders is 49%, has been rising a little. Demand remains quite strong, and has overtaken demand from solo investors.  We also see a rise in demand from those seeking to refinance, with around 31% expecting to transact, in 2013, this was 13%. Finally, we see an uptick in First Time Buyers looking to buy, support, as we will see later by the FHOG available. First Time Buyers are also saving harder, with 82% saving, up from a low of 71% in 2014.

Given the rotation we have described, there is a slowing of demand for more finance (relatively speaking) from both Portfolio and Solo Investors, while demand from First Time Buyers, Up Traders and those seeking to Refinance is greater.

Overall the home price growth expectations is lower, and trending down. We see that Up Traders now more bullish than Portfolio or Solo Investors.

Finally, we see that usage of mortgage brokers continues to vary by segment, with those seeking to refinance most likely to use a broker, (77%), then First Time Buyers (64%) and Portfolio Investors (50%)

Next time we will look in more detail and the drivers within each segment.

The results from this analysis will also flow into the next edition of our flagship report The Property Imperative, due out next month.

 

CUA Profit Up, But Mortgage Lending Down

CUA, the largest Credit Union, reported an annual Group Net Profit after Tax (NPAT) of $55.87 million for the 12 months to 30 June 2017, an 8.1 per cent increase on last year’s result. But within that, their banking business achieved a full-year NPAT of $49.65 million, down 6.4 per cent from the FY16 result of $53.03 million. This was a reflection of intense home lending competition in the first half, with $2.81 billion in new loans settled during the year ($1.64bn originated in the second half), down 4.0 per cent, despite retail deposits up 5.2 per cent to a record $8.76 billion and 13,409 additional CUA banking members, taking total members to 453,122.

After curtailing investor mortgage lending earlier in the year, they subsequently opened the door again, with fixed rate investor lending to new-to-CUA investor loan applications, where the application was accompanied by an owner-occupied loan application. Now, taking this further, CUA has dropped fixed rate investor interest rates by between 10 and 20 basis points. As a result, the basic fixed rate investor loans range from 4.34 per cent to 4.74 per cent for one-year to five-year terms, respectively. On a comparison rate basis, this is 5.32 per cent for one-year basic fixed rates and 5.16 p.a. for five-year basic fixed rates.  They says this will apply to “all applicable CUA fixed rate investor home loans” approved from 19 September. Around 41% of mortgages came via the broker channel, similar to last year.

CUA Chief Executive Officer Rob Goudswaard said the result was underpinned by net member growth of 13,409 members for the year, CUA’s strongest growth in recent years and almost 70 per cent higher than member growth in the prior 12 months.

“Over the past year, we helped nearly 10,000 members to buy or refinance their home or an investment property. We also assisted more than 12,000 members with things like buying a new car, taking a holiday or undertaking a renovation, setting a new CUA record for personal loans,” he said.

The financial result also reflected higher net interest income, record levels of personal loans and the benefit of CUA’s diversified business, with strong CUA Health NPAT of $7.51 million helping to offset the impact of challenging market conditions on the banking business.

“Investing in sponsorships, like the Brisbane Heat cricket team, is helping lift awareness of CUA, with market awareness of CUA increasing more than 4 per cent off the back of the Big Bash League (BBL) season,” Mr Goudswaard said.

“Positive member growth and a strong financial position means we can continue to work towards our goal of being available to our members ‘anywhere, anytime’ by investing in innovation and improved digital experiences.

“Enhancing our digital channels and innovating are essential to attracting new members and evolving our service to respond to changing member preferences. But more than that, our digital journey is about building deeper, more personalised relationships with our CUA members by bringing a human, interactive approach to digital banking.”

CUA significantly lifted its investment in community initiatives by almost 50 per cent this year to $2.28 million, up from $1.54 million. The investment supported diverse national and local community organisations.

Mr Goudswaard said CUA had increased its commitment to Red Nose and their quest to save the lives of babies and children, and to the indigenous financial literacy work of the First Nations Foundation, signing on as Mission Partner to both organisations for the next three years. CUA rolled out the first round of its Mutual Good Community Grants, helping support local not-for-profit groups to make a positive social impact in communities. CUA team members also stepped up their contribution to community, with more than 500 days devoted to volunteering.

The community investment represents 2.8 per cent of CUA’s Net Profit before Tax & Community (NPBTC) of $80.22 million, consistent with the organisation’s promise to invest up to 3 per cent of NPBTC to community over the coming years.

Mr Goudswaard said CUA’s strong financial performance meant it was also well placed to continue to invest in innovation and digital opportunities, with the potential to deliver significant improvements to how members engage with CUA for their banking, health and insurance needs.

“This year, we made a significant investment in innovation by joining global banking innovation collaboration, Pivotus Ventures. This enables CUA to supplement our involvement with the Australian fintech and startup communities by tapping into international banking expertise, to explore and develop new digital banking opportunities. We are already planning for a pilot of the first digital initiative from the international collaboration during FY18 – an app which will be an Australian first in personalising members’ digital interactions with CUA.

“Looking ahead, our innovation and digital priorities will build on the investment we’ve already made in our technology systems this year, which has included bringing Apple Pay, Android Pay and Samsung Pay to members, and building a new mobile banking app which will go live in the coming months. We are also looking forward to bringing our members the benefits of real-time payments when the New Payments Platform goes live.”

Mr Goudswaard said CUA’s success this year reflected its commitment to working together with members to support their financial needs through changes in their lives. He noted that Hatch – the initiative launched by CUA in April for parents planning, expecting or raising a baby – was already driving member growth and positive feedback.

“As a member-owned organisation, CUA’s profits are reinvested back into our business so CUA can help even more Australians to buy their own home, or support them to achieve their other financial goals, in the year ahead. We will do this while continuing to invest in building stronger communities and making a positive impact on important social issues,” Mr Goudswaard said.

CUA’s banking operations (ADI)

CUA’s banking business (or ADI) achieved a full-year NPAT of $49.65 million, down 6.4 per cent from the FY16 result of $53.03 million.

CUA issued $2.81 billion in new loans for FY17. Lending volumes improved in the second half of the financial year, with $1.64 billion in new lending in the six months to 30 June 2017. This was up on the $1.17 billion in lending for the first half, when CUA was impacted by extremely competitive market conditions. The result also reflected an active refinancing market. While owner occupier and investor home loans accounted for $2.53 billion of the new lending, CUA’s personal loan performance was a standout with a record $256.58 million in personal loans issued over the period – a 37.9 per cent increase on FY16 personal lending of $186.1 million.

Mr Goudswaard said the ADI’s net interest income of $239.22 million was up 2.9 per cent on last year’s result, reflecting interest revenue flowing from the growing CUA loan book. Capital adequacy increased slightly from 14.24 per cent to 14.28 per cent over the year, reflecting CUA’s strong capital position.

CUA Health

CUA has continued to invest in the growth of its wholly-owned private health insurance subsidiary, with CUA one of the few organisations in Australia to offer integrated financial, health and insurance solutions. CUA Health improved NPAT for the year to $7.51 million. CUA Health recorded premium revenue of $143.59 million, up 5.8 per cent. The insurer returned $122.41 million in benefits for its policy holders, equivalent to 85 cents in the dollar.

The strong result reflected lower claims activity across the industry, a new CUA Health strategy for its investments which delivered higher returns, and the success of the new suite of hospital and extras cover launched in November.

The strong performance will support CUA Health’s continued rollout of new initiatives to benefit members including proactive health, wellness and disease management programs, as well as improved information and search tools to help members choose their medical specialist. The fund is exploring options to introduce loyalty discounts and enhanced product features for 2018, to return even more value to members.

Credicorp Insurance

Credicorp Insurance posted a half-year NPAT of $1.13 million, down 1.0 per cent for the year. This subsidiary now provides general insurance to more than 13,700 members. The result reflected the lower levels of new lending in the banking business, with Credicorp policies typically taken out by borrowers applying for a new home loan or personal loan.

 

PC Inquiry can address banking competition problems – COBA

The customer owned banking sector today identified significant problems with banking competition in Australia and made three key recommendations to the Productivity Commission (PC) Inquiry to address the issue.

In their submission they highlighted the better rates on offer from Customer-owned banks, reflecting lower returns to stakeholders, but of benefit to customers.  They also show better rates for depositors.

COBA’s Submission to the Productivity Commission Inquiry into Competition in the Australian Financial System recommends:

1. Policymakers and regulators give greater consideration to the impact on competition of the regulatory compliance burden and ensure that regulation is targeted, proportionate, risk-based and, where possible, graduated.

2. The Government introduce an explicit ‘secondary competition objective’ (SCO) into APRA’s legislative mandate, including with an accountability mechanism.

3. Interventions are needed to empower consumers to switch between banking products but interventions to promote switching should be cost-effective and based on rigorous market studies of banking product markets and consumer behaviour.

COBA’s Director – Policy, Luke Lawler, said:

“The enduring solution to concerns about the banking market is action to promote sustainable competition.

“We don’t have sustainable banking competition at the moment. A lack of competition can contribute to inappropriate conduct by firms, and insufficient choice, limited access and poor quality products for consumers.

“The regulatory framework over time has entrenched the dominant position of the largest banks.

“Promoting a more competitive banking market does not require any dilution of financial safety or financial system stability.

“A ‘secondary competition objective’ (SCO) for APRA would raise the relative ‘priority’ of competition compared to APRA’s ‘other considerations’. It would remain secondary to APRA’s primary responsibilities of financial stability and safety. The SCO would include reporting obligations to ensure accountability against the objective.

“The SCO would formalise the relative ‘prioritisation’ of competition and ensure that it becomes ingrained into APRA’s day-to-day regulatory processes.

“APRA’s peer regulator in the UK, the PRA, was given an SCO in 2014 and the outcome is a ‘material change of gear’ where ‘competition is gaining airtime and traction at all levels’ and ‘there are numerous instances where competition considerations have influenced policy outcomes.’

“We do not doubt that APRA already gives some consideration to competition but we judge this to be inadequate and inconsistent.

“Examples of APRA’s failure to give due consideration to competition concerns include: lack of urgency in addressing the market distortions caused by the unfair funding cost advantage enjoyed by the major banks due to the implicit guarantee continuing wide gap in mortgage risk weight settings between the major banks and smaller banking institutions, and implementation of macro-prudential measures affecting investor lending that rewarded major banks which had expanded their investor lending portfolios most aggressively before the cap was applied.

“Customer owned banking institutions offer the full range of consumer retail banking products and services, including highly competitive home loans, credit cards, personal loans and deposit products. Many of these products are market leading and award winning.

“As the providers of these products, customer owned banking institutions strongly support cost-effective measures to empower consumers to switch.

“COBA recommends rigorous market studies of retail banking product markets, taking into account consumer behaviour and behavioural biases, to identify the barriers to switching and to design interventions to reduce these barriers in the most cost-effective way.

“We welcome the Government’s decision to provide resources to the ACCC to establish a dedicated Financial Services Unit to undertake regular in-depth inquiries into competition issues in the financial system. We also support the Government’s decision to include competition in ASIC’s mandate. We recommend clarity of responsibility between these two regulators for carrying out market studies and designing interventions to promote switching.”

Property Price Rises; It Depends

The latest ABS data on Residential Property Prices to Jun 2017 are out. They show considerable variations across the states, with Melbourne leading the charge, and Perth and Darwin languishing.

The price index for residential properties for the weighted average of the eight capital cities rose 1.9% in the June quarter 2017. The index rose 10.2% through the year to the June quarter 2017.

The capital city residential property price indexes rose in Sydney (+2.3%), Melbourne (+3.0%), Brisbane (+0.6%), Adelaide (+0.8%), Canberra (+1.3%) and Hobart (+1.8%) and fell in Perth (-0.8%) and Darwin (-1.4%).

Annually, residential property prices rose in Sydney (+13.8%), Melbourne (+13.8%), Hobart (+12.4%), Canberra (+7.9%), Adelaide (+5.0%) and Brisbane (+3.0%) and fell in Darwin (-4.9%) and Perth (-3.1%).

The total value of residential dwellings in Australia was $6,726,783.5m at the end of the June quarter 2017, rising $145,868.5m over the quarter.

The mean price of residential dwellings rose $12,100 to $679,100 and the number of residential dwellings rose by 40,000 to 9,906,100 in the June quarter 2017.

 

Mortgage Arrears at Five Year High

From Australian Broker.

The number of Australian residential mortgages that are more than 30 days in arrears has shot up to a five year high, according to Moody’s Investors Service.

The ratings agency recorded a 30+ delinquency rate of 1.62% in May this year with record high rates in Western Australia, the Northern Territory and South Australia. Arrears were also up in Queensland and the Australian Capital Territory while levels decreased in New South Wales, Victoria and Tasmania.

“Weaker conditions in states reliant on the mining industry, high underemployment, and less favourable housing market and income dynamics will continue to drive delinquencies higher. Regions with exposure to the resource and mining sectors dominated the list of areas with the highest delinquencies in May 2017,” analysts said.

Eight of the 10 regions with the highest 30+ day delinquency rates were found in either Western Australia or Queensland and are locales indirectly or directly related to mining and resources.

“The ten regions with the lowest mortgage delinquencies in Australia in May 2017 were all in Sydney and Melbourne, where housing market and economic conditions were the most supportive for mortgage borrowers.”

Ratings agency Standard & Poor’s (S&P) Global Ratings also recorded an increase in the higher number of delinquent housing loans underlying Australian prime residential mortgage-backed securities (RMBS).

This rate rose from 1.15% in June to 1.17% in July according to the agency’s monthly report RMBS Arrears Statistics: Australia. This latest percentage was lower than the July average for the past decade, S&P analysts said.

Delinquent loans underlying the prime RMBS at the major banks made up almost half of all outstanding loans and increased from 1.08% to 1.11% from June to July. For the regional banks, this level rose from 2.30% to 2.35%.

Arrears for prime RMBS at non-bank financial institutions actually dropped from 0.49% to 0.47% over the month while non-bank originator RMBS arrears declined from 0.88% to 0.85%.

“The pronounced improvement in nonbank originator prime RMBS arrears since their peak of 2.99% in January 2009 reflects a general improvement in the overall collateral quality of this sector. This is evidenced by a fall in low documentation loans from 22% in December 2009 to 15% in June 2017 across their prime portfolios. Higher loan-to-value (LTV) ratio loans – ie, those exceeding 75% – in this sector have declined to 28% as of July 2017 from around 50% in 2009.”

NAB Goes LTI

From The Adviser.

The NAB Group, including Advantedge, has changed its credit policy so that applications for interest-only and principal and interest loans will only be approved if they pass a loan-to-income ratio test.

NAB and its subsidiary companies (including wholesale funder and white-label provider Advantedge), have changed their home lending credit policies in reaction to the regulators’ concerns about Australia’s household debt-to-income ratio.

The lender has announced that is has changed its home lending credit policy so that only borrowers with a certain loan-to-income (LTI) ratio will be approved for loans.

The new ratio, which aims to determine the “customer’s indebtedness to the loan amount” takes the total limit of the loan and divides it by the customer’s total gross annual income (as disclosed in the application).

Ratios greater than eight will be declined, according to the new policy, for applications assess on or after 16 September 2017.

Applications with conditional approval prior to this change will reportedly be honoured for the 90-day validity period.

A spokesperson for NAB commented: “NAB is committed to lending responsibly, and ensuring our customers can meet their home loan repayments today and into the future.

“Regulatory bodies have raised concerns about Australia’s household debt-to-income ratio, which has risen significantly over the past decade.

“With this in mind, NAB, including Advantedge, made changes to our home lending credit policy for interest only lending in July this year, introducing a Loan-To-Income ratio calculation to better assess a customer’s ability to manage their home loan. We have now expanded this policy to apply to all new home loan applications.”

Connective Home Loans, which is affected by the new policy, has told brokers that they should complete a manual calculation on its Serviceability Calculator to determine whether the LTI is less than the relevant threshold.

It warned: “If the LTI is greater than eight, brokers are not to proceed with the application unless the customer’s financial position has changed.”

LTI ratios ‘most powerful and effective for controlling risk’

Some members of industry have been calling for LTI limits to be instated in Australia for some time.

Earlier this year, Digital Finance Analytics principal Martin North, said that LTIs could help address risk in the mortgage market.

Mr North told The Adviser in March: “My own view is that the Reserve Bank and APRA have been very slow to come to the realisation as to how much risk is actually in the housing market…

“I think they should be looking much more firmly at debt servicing ratios and loan-to-income ratios.

“Those are the measures from a macroprudential sense around the world that are being recognised as the most powerful and effective when it comes to controlling the risk in the market,” he said, recommending that Australia could learn from the UK, “where they have very significant rules around loan-to-income”.

Will Global Interest Rates Fall Further?

Mark Carney, Governor of the Bank of England gave a speech “[De]Globalisation and inflation“.  One passage in particular is highly significant. He discussed the impact of globalisation on inflation, and suggests that there are likely to be further downward pressure on real world interest rates, partly thanks to changing demographics and the relative pools of global investment and global savings. The net result is more investors looking for returns, compared with investment pools – which explains the bidding up of asset prices (including property and shares) while returns to investors continue to fall. The point is, this is structural – and wont change anytime soon. Indeed, he suggests real world interest rates could go lower, with the flow on to inflation.

For the past thirty years, a number of profound forces in the world economy has pushed down on the level of world real interest rates by as much as 450 basis points. These forces include the lower relative price of capital (in part as a consequence of the de-materialising of investment), higher costs of financial intermediation (due to financial reforms), lower public investment and greater private deleveraging. Two other factors – demographics and the distribution of income – merit particular attention.

Bank research estimates that the increased retirement savings as a result of global population ageing and longer life expectancy have lowered the global real interest rate by around 140 basis points since 1990 and they could lead to a further 35 basis point fall by 2025. The crucial point is that these effects should persist after the demographic trends have stabilised because the stock, not the flow, of savings is what matters.

 

By changing the distribution of income, the global integration of labour markets may also lower global R*. The changes in relative wages in advanced economies have shifted income towards skilled workers, who have a relatively higher propensity to save. Rising incomes in emerging market economies may be reinforcing that effect as saving rates are structurally higher in emerging market economies, reflecting a variety of factors including different social safety regimes.

The high mobility of capital across borders means that returns to capital will move closely together across countries, with any marked divergences arbitraged.

As a consequence, global factors are the main drivers of domestic long-run real rates at both high and low frequencies. For example, Bank of England analysis suggests that about 75% of the movement in UK long-run equilibrium rates is driven by global factors. Estimates by economists at the Federal Reserve deliver similar results.

 

Global factors also influence domestic financial conditions and therefore the effective stance relative to the shorter-term equilibrium rate of monetary policy, r*.

The presence of borrowers and lenders operating in multiple currencies and in multiple countries creates multiple channels through which developments in financial conditions can be transmitted across countries. For example, changes in sentiment and risk aversion can lead to international co-movement in term premia, affecting collateral valuations and so borrowing conditions.

Work by researchers at the Bank of England, building on analysis by the IMF, shows that a single global factor accounts for more than 40% of the variation in domestic financial conditions across advanced economies. For the UK, which hosts the world’s leading global financial centre, the relationship is much tighter, at 70%.

Highlighting the openness of the UK economy and financial system, a third of the business-cycle variation in the UK policy rate can be attributed to shocks that originate abroad.

One important channel of global spillovers is of course monetary policy. In coming years, it is reasonable to expect global term premia to rise as net asset purchases could shift significantly from the situation during the past four years when all net issuance within the G4 was effectively absorbed.