In the final part of my discussion with Ex-ANZ Director John Dahlsen, ahead of the closing date for submissions into the Senate Inquiry into Banking Structural Separation, we discussed the core questions, and what barriers really need to be overcome.
I discuss the new Senate Inquiry into Banking Separation with Robbie Barwick from the CEC.
With three weeks before the closing date for submissions, now is the time to make that submission – we have the opportunity to drive much needed reform into the banking system.
It promises to be a dog fight Royale. The four big banks can be expected to behave
like uncontrollable Pit Bulls, determined to savage Senator Hanson’s Banking
System Report (Separation of Banks) Bill 2019.
This Bill is about re-establishing confidence in the banking system by
separating ‘core banking’, called retail and commercial banking where deposits
are protected, from the risky wholesale and investment banking.
By Patricia Warren,Byron Echo Vol 33 #40 March 13, 2019 p21
By default the
recent Haynes Royal Commission has brought focus on how banks are currently
structured to do business. It’s their
power base and they will fight to defend it. Fur will fly because bankers do not want a firewall
between deposits and the flow of these into their trading activities. Bloodletting can be expected should this Bill
stand in the way of using your money to cover their gambling in high return
investments, including derivatives.
Learned from the GFC?
People are
reminded that it was the collapse of the derivatives market that brought about
the Global Financial Crisis 2007/08.
Nothing has been learned. In December
2018 “The notional value of the
derivatives cleared worldwide is 4.4 times world GDP, up from 2.8 times in
2008.” While not all derivatives
are evil, it is estimated that Australian banks are currently exposed to more
than $37Tr in derivatives and billions in short term debt. The global derivatives markets are vast,
unregulated, some deliberately untraceable in off-shore entities and commonly
off the books. Currently, there is
potentially US$540Tr of global derivatives set to ignite a global financial
crisis.
Divorce time
The idea of separating core banking activities from the higher
risk investment banking is not new.
Leading financial commentator, Alan Kohl wrote of his random sampling of
10,140 submissions to the Royal Commission, “ Without exception they called for the banks to be broken up and most
of them, surprisingly, used the term ‘Glass Steagall’ suggesting that the
now-repealed American law that used to forcibly separate banking from insurance
and investment banking be introduced into Australia”. Hanson’s Bill has been crafted after the Glass
Steagall and modified to suit the Australian conditions.
There is widespread support for the breaking up of the banks,
including that coming from former CEOs of major banks, academics and former
Prime Minister Paul Keating. In fact,
there are now more people supporting the breakup of the banks since the Royal
Commission than before it.
The banks are powerful and effective lobbyists exercising undue
influence not only in the market place where they work like an oligopoly but
with both major political parties to which they reportedly have donated $2.6m.
Their relationship with Treasury and the regulator, Australian Prudential
Regulatory Authority (APRA) has been described as ‘incestuous’.
Currently there is approximately $2.8Tr held in deposits as
unsecured loans in Australian financial institutions of which over 80% is
concentrated in the four big banks. Banks are currently paying very little interest
on deposits whilst using a significant proportion of funds to trade in high
risk areas.
BAIL IN
Under Australia’s BAIL IN legislation, where there is no explicit
exclusion of deposits in the law, deposits are exposed to cover the gambling
risks of financial institutions in times of financial crisis in the global
system. So, if the derivatives market
collapses, as it did in the GFC, then cash will be used to BAIL IN and stablise
failing global institutions be it from peoples’ term deposits, business
operating and superannuation fund accounts. Politicians have refused to amend the
Financial Sector Legislation Amendment (Crisis Resolution Powers and Other
Measures) Act 2018 (FSLA) to exclude deposits from this and hence are
protecting the bankers and their risk taking behavior.
Deny Risk
CEO’s of the major banks and other leading financial institutions
deny that deposits are at risk. They argue they are controlled by APRA’s
prudential standards and that ‘currently’
and ‘as the legislation sits’, only
‘capital instruments’ can be called upon to stablise a failing
institution. But APRA can change this
under the secrecy provisions of the FSLA to capture deposits as part of BAIL
IN. There is a loop hole which allows
APRA to change its standards to include ‘instruments’ ‘that are not currently considered capital under prudential standards.”
Failed
Gatekeeper
No CEO responded to concerns raised directly with them months ago
about that provision. Nor did APRA! APRA has failed as the gatekeeper on our financial system.
APRA takes recommendations directly from the International Bank of
Settlement (IBS). This means our
financial institutions are influenced by the motivation of the central bankers
to protect the global financial system above depositors.
Under the
Banking System Reform (Separation of Banks) Bill 2019 it is intended to break
that direct connection. Instead, APRA must
not only come before an Australian parliamentary committee for “prior express written approval and consent” to
act before implementing any recommendations or decisions of any foreign bank,
or foreign authority but have Parliamentary approval to change its prudential
standards for the purpose of regulating our financial institutions.
Public Inquiry
Parliament’s
Senate Standing Committee on Economics is currently holding a public inquiry on
the Bill and calling for submissions.
It is a numbers game and broad based support of the Bill is needed to
counter what can be expected from the banks, Treasury and APRA.
Submissions
need only read: I support the Banking System Reform
(Separation of Banks) Bill 2019 and I support the separation of retail commercial banking
activities involving the holding of deposits from wholesale and investment
banking as proposed in the Bill. Submissions
need to be sent to economics.sen@aph.gov.au or mailed to the Senate Standing Committee
on Economics PO Box 6100 Canberra ACT 2600 by 12 April 2019. If you want your cash made more secure then
you’re encouraged to make a submission.
Alternatively, there is always under the
mattress.
I discuss the latest on the Senate Inquiry into Banking Separation (Glass-Steagall) with Robbie Barwick from the CEC. We have a significant opportunity to drive the change to benefit Australians and Australia.
The Senate has initiated an inquiry into the structural separation of the banks, following the Hayne report, and the bill represented to the chamber.
I discuss the critical issues surrounding this with businessman John Dahlsen, who was a director at ANZ for many years. John and I were both mentioned in the Hansard on this topic!
There are so many compelling reasons to support structural separation, yet there are powerful forces which will resist the concept.
The bottom line is structural separation would be good for customers, good for shareholders, and good for businesses seeking finance; and reduce the structural risks in the banking system thanks to derivatives and too big to fail. So why is structure a dirty word?
This will help you to prepare a submission to the inquiry when its formally sought!
The Senate will review the regulatory environment surrounding payday lenders and consumer leasing businesses and also buy now, pay later schemes such as Afterpay. The scope will likely also include debt negotiation firms and credit repair agencies, who offer “services” which are unregulated and often costly.
Given the high and rising levels of household debt and mortgage stress, and the fact that this area is not caught within the current Royal Commission, it makes sense for it to be examined, assuming appropriate regulatory intervention follows.
This is the latest in a string of reviews which seem to go nowhere. After the previous inquiry, the Small Amount Credit Contract and Consumer Lease Reforms bill from 2015 would have introduced a cap on leases equal to the base price of the good plus 4 per cent a month and only allow leases and short-term loans to account for 10 per cent of a customer’s net income. The recommendations were broadly accepted in 2016. But five ministers and more than 1000 days later, nothing has changed. People are getting more into debt, and the growth in the alternative lending sector continues.
Since the Government released the report of the Independent Panel’s Review of the Small Amount Credit Contract Laws in April 2016, three million additional loans have been written, worth an estimated $1.85 billion and taken by some 1.6 million households.
In that time, around one fifth of borrowers or around 332,000 households, were new payday borrowers.
When I last addressed this Committee, I outlined some of the many ways APRA is accountable to both the Parliament and the Australian people. These measures are crucial for APRA to maintain the trust of industry and the public as we aim to fulfil our mandate as a prudential regulator, promoting financial safety and thereby protecting the interests of bank depositors, insurance policyholders and superannuation members.
The core of APRA’s mission is safety and soundness. Clearly, some of the revelations emerging from the Royal Commission have been disturbing and go to the heart of whether financial institutions treat their customers fairly. However, while institutions have a great deal of work to do to restore trust, I want to emphasise that Australians can be reassured that the industry is financially sound, and that the financial system is stable. That reflects considerable policy reform and hands-on supervision, over a long period of time, designed to build strength and resilience. We don’t know when the next period of adversity will arrive or what will trigger it, but when it does arrive we need to have done what we could to strengthen the financial system so that it can continue to provide its essential services to the Australian community when they are needed most.
The importance of accountability has been one of our key themes this year, and was front and centre with the release in April of our review of executive remuneration practices in large financial institutions. Incentives and accountability can play an important role in driving positive outcomes such as growth, innovation and productivity, and also in deterring behaviours or decisions that produce poor risk-taking and damaging results. Our review found that while policies and processes existed within institutions to align remuneration with sound risk outcomes, their practical application was often weak. We have indicated that we are minded to strengthen the prudential framework to give better effect to the principles we want to see followed – less rewards based on narrow and mechanical shareholder metrics, and greater exercise of Board discretion to judge senior executive performance more holistically. But we have also urged institutions to push ahead with their own improvements, notwithstanding some investor opposition, in light of the long-term commercial benefits that can flow from better remuneration practices.
A lack of accountability for poor outcomes was a theme that also emerged in the Final Report of the Prudential Inquiry into the Commonwealth Bank of Australia, which was released earlier this month. The Report is clear and comprehensive, and provides a strong message – not just to CBA but to the entire financial services industry – about the importance of cultivating a robust risk culture, especially when it comes to non-financial risks. We are keen that the Report will be seen not just a road map for CBA, but a useful guide for all institutions in relation to strengthening governance, culture and accountability.
Residential mortgage lending is another area where APRA has been lifting industry standards. Although there remains more to do before we are ready to significantly dial back our supervisory intensity, there has been a lift in industry lending practices. As a result, last month we announced we would remove the 10 per cent investor growth benchmark for those lenders who could provide a range of assurances as to the quality of their lending standards and practices now and into the future.
Superannuation is an area where APRA consistently emphasises the need for trustees, regardless of size or ownership structure, to go beyond compliance with minimum regulatory requirements and aim to deliver the best possible outcomes for members. In this vein, we have just released the results of two thematic reviews of superannuation licensees; on board governance and the management of related parties. Both reviews noted improvements in industry practices in recent years, but also found more work was needed to address some longstanding weaknesses, including finding ways to bring fresh ideas, perspectives and skills onto trustee boards. Our post-implementation review of 2013’s Stronger Super reforms, launched last week, should also provide us additional insights on how the prudential framework is performing, and whether any adjustments would help to better achieve our objectives. Many of the findings in the Productivity Commission report into superannuation released this week are consistent with APRA’s approach to supervising RSE licensees. In particular, they align with APRA’s focus on enhancing the delivery of member outcomes through our engagement with trustees with “outlier” underperforming funds and products.
Technology is rapidly changing the way financial institutions operate. In all likelihood, the financial system will look very different in five years’ time relative to the way it looks today. Much of that change will bring benefits to the community, in the form of new competitors, products and ways of access. But it will also bring risks, and the accelerating threat of cyber-attacks to regulated entities has prompted APRA to recently propose its first prudential standard on information security. Industry consultation is ongoing, but we hope to implement the new cross-industry standard from 1 July next year. This is an issue which is only going to grow in importance.
Continuing to look ahead, APRA’s preparations are well advanced for the commencement of the Banking Executive Accountability Regime (BEAR), which will begin in just over a month. The BEAR largely strengthens APRA’s existing powers to identify and address the prudential risks arising from poor governance, weak culture, or ineffective risk management. However, I have made the point previously that while important, the BEAR alone will not remedy perceived weakness in financial sector accountability, and we have encouraged all regulated entities – not just ADIs – to use the new regime as a trigger to genuinely improve systems of governance, responsibility and accountability.
Finally, APRA is continuing to provide relevant information to the Royal Commission to help it in its inquiries. In addition, APRA and the Australian financial system more broadly, will be subject to intensive scrutiny from the International Monetary Fund in the weeks ahead as part of its 2018 Financial Sector Assessment Program (FSAP). The FSAP will examine in quite some detail financial sector vulnerabilities and the quality of regulatory oversight arrangements in Australia. As ever, APRA will fully cooperate with our international reviewers, and look forward to their report card, including any recommendations on how we could perform our role more effectively in the future.
With those opening remarks, we would now be happy to answer the Committee’s questions.
During the session he said that the 10% cap on banks lending to housing investors imposed in December 2014 was “probably reaching the end of its useful life” as lending standards have improved. Essentially it had become redundant.
But the other policy which is a limit of more than 30% of lending interest only will stay in place. This more recent additional intervention, dating from March 2017, will stay for now, despite it being a temporary measure. The 30% cap is based on the flow of new lending in a particular quarter, relative to the total flow of new lending in that quarter.
This all points to tighter mortgage lending standards ahead, but still does not address the risks in the back book.
But the tougher lending standards which are now in place will be part of the furniture, plus the new capital risk weightings recently announced. Its all now focussing on loan serviceability, something which should have been on the agenda 5 years ago!
The evidence before the Senate on mortgage fraud is worth watching.
He also included some interesting and relevant charts.
Around 10% of new loans are still Loan to income is still tracking above 6 times loan to income.
This despite a fall in high LVR new loans.
The volume of new interest only loans is down, 20% of loans from the major banks are interest only, higher than other ADI’s
Overall investor loan growth is lower, in fact small ADI’s have slightly higher growth rates than the majors.
As a result of the changes the share of new interest only loans has dropped below the target 30%, to about 20%.
And investor loans are growing at less than 5% overall, significantly lower than previously.
So you could say the APRA caps have worked, but more permanent and calibrated measures are the future.
More broadly, here are his remarks:
I’d like to start this morning by highlighting the importance of the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017 which – with the welcome endorsement of this Committee – was recently passed into law by the Parliament.
The Bill delivers a long-awaited and much needed strengthening of APRA’s crisis management powers, better equipping us to deal with a financial crisis and thereby to protect the financial well-being of the Australian community. Put simply, these powers give us enhanced tools to fulfil our key purpose in relation to banking and insurance: to protect bank depositors and insurance policyholders. That purpose is at the heart of all that we do, and the legislation is designed with that protection very much in mind.
With the Bill now passed, the task ahead for APRA is to invest in the necessary preparation and planning to make sure the tools within the new legislation can be effectively used when needed. We hope that is neither an imminent nor common occurrence, but we have much work to do in the period ahead to make sure we, along with the other agencies within the Council of Financial Regulators that will be part of any crisis response, have done the necessary homework to use these new powers effectively when the time comes.
So that is one key piece of work for us in the foreseeable future. But it is far from the only issue on our plate. With the goal of giving industry participants and other stakeholders more visibility and a better understanding of our work program, we released a new publication in January this year outlining our policy priorities for the year ahead across each of the industries we supervise.1 Initial feedback has welcomed this improved transparency of the future pipeline of regulatory initiatives, and the broad timeline for them.
That publication is one example of our ongoing effort to improve our processes of engagement and consultation with the financial sector and other stakeholders. Another prominent example is that we’ve just embarked on our most substantial program of industry engagement to date as we seek input into the design and implementation of our next generation data collection tool.2 Through this process, which we launched on Monday this week, all of our stakeholders will have an opportunity to tell us – at an early stage of its design – what they would like to see the new system deliver, as well as influence how we roll it out.
More generally, and recognising the increased expectations of all public institutions, I thought it would also be timely to briefly recap the ways APRA is accountable for the work we do supervising financial institutions for the benefit of the Australian community. At a time when Parliament has moved to strengthen APRA’s regulatory powers, we fully accept that these accountability measures take on added importance. They play a crucial role in reassuring all of our stakeholders that APRA is acting at all times according to our statutory mandate.
APRA’s accountability measures are many and varied. They start with the obvious measures such as our Annual Report, our Corporate Plan and Annual Performance Statement, and our assessment against the Government’s Regulator Performance Framework. We obviously also make regular appearances before Parliamentary committees such as this to answer questions about our activities, and now meet with the Financial Sector Advisory Council in their role reporting on the performance of regulators. Our annual budget, and the industry levies that fund us, are set by the Government, which also issues us a Statement of Expectations as to how we should approach our role. We comply with the requirements of the Office of Best Practice Regulation in our making of regulation, and our prudential standards for banking and insurance may be disallowed by Parliament, should it so wish.
To give greater visibility to these mechanisms, we have recently set out an overview of our accountability requirements – including some that we impose on ourselves – on our website so that they can be better understood by our stakeholders.3
I’d like to also note that we will be subject to additional scrutiny this year through two other means:
We expect that aspects of APRA’s activities will be of interest to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. We have already provided, at their request, documents and information to the Commission, and will continue to cooperate fully as it undertakes its important work.
We will be subject to extensive international scrutiny from the IMF over the year ahead as part of its 2018 Financial Sector Assessment Program (FSAP).4 The FSAP will look at financial sector vulnerabilities and regulatory oversight arrangements in Australia, providing a report card on Australia (and APRA in particular) against internationally-accepted principles of sound prudential regulation. As was the case previously, we expect the IMF to find things we could do better. APRA is ready, along with other members of the regulatory community, to give the IMF our full cooperation and look forward to their feedback.
Finally, time does not permit me to discuss our on-going work in relation to housing lending but, anticipating some questions on this issue, I have circulated some charts which might be helpful for any discussion (see attached).
With those opening remarks, we would now be happy to answer the Committee’s questions.
There were several well publicised Government bail-out’s of banks which got into problems after the GFC. For example, the UK’s Royal Bank of Scotland was nationalised. This costs tax payers dear, so there were measures put in place to try to manage a more orderly transition when a bank gets into difficulty.
In October 2011, the Financial Stability Board (FSB) issued its Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes). These Key Attributes set out the ‘core elements that the FSB considers to be necessary for an effective resolution regime. There followed legislation in a number of jurisdictions.
But note the chilling words “the bank closes temporarily and some money is frozen. Bank re-opens under statutory manager. Customers can access non-frozen portion of their money, which is now Government protected. Frozen money can be used to help resolve the bank’s issues. Resolution of issues completed. Un-used portion of frozen money is returned to customers”.
Or in other words, customers money, held as savings in the bank are able to be grabbed to assist in the resolution. This is of course what happened to people with bank deposits in Cyprus a few years back.
The thinking behind it is simple. Banks need an exit strategy in case of a problem, and Government bail-outs should not be an option. So a manager can be appointed to manage through the crisis. They can use bank capital, other instruments, like hybrid bonds and deposits to create a bail-in. This approach to rescuing a financial institution on the brink of failure makes its creditors and depositors take a loss on their holdings. This is the opposite of a bail-out, which involves the rescue of a financial institution by external parties, typically governments using taxpayers money.
So, given the New Zealand position (and the tight relationship between banking regulators in Australia and New Zealand), we should look at the position in Australia. Are deposit funds in Australia likely to be “bailed-in”?
It all centered on the powers which were to be given to APRA to deal with a banking collapse. “The bill seeks to strengthen the powers of the Australian Prudential Regulation Authority (APRA) to facilitate the orderly resolution of an authorised deposit-taking institution (ADI) or insurer so as to protect the interests of depositors and policyholders, and to protect the stability of the financial system in case of crisis”. The Treasurer had argued that by “affording APRA the power to work with ADIs and insurers in order to plan for economic stress events, the cost to the taxpayer will be significantly
reduced in the event of a financial crisis”.
The Senate review and consultation elicited a significant number of submissions, and they made two main points in opposition to the bill: firstly, they believed that this bill gives APRA the power to ‘bail-in’ depositors’ savings to stabilise a failing financial institution; secondly, in place of the bill, the Australian Parliament should legislate a Glass-Steagall style separation of the banks.
Specifically, Dr Wilson Sy, a former analyst with APRA, considered that the bill was not clear enough on the topic of depositors’ savings. Dr Sy suggested that deposit protection is to be balanced against financial system stability, without the law clearly stating which has higher priority’. Dr Sy claimed that the bill is ‘designed to confiscate bank deposits to ‘bail-in’ insolvent banks to save the financial system.
It came down to the meaning of “any other instrument” in the draft bill. Treasury said, “the use of the word ‘instrument’ in paragraph (b) is intended to be wide enough to capture any type of security or debt instrument that could be included within the capital framework in the future. It is not the intention that a bank deposit would be an ‘instrument’ for these purposes”. Treasury confirmed that because deposits are not classified as capital instruments, and do not include terms that allow for their conversion or write-off, they cannot be ‘bailed-in’.
The committee concluded:
The committee believes that the protection of depositors’ interests is paramount and does not consider that the bill would allow the ‘bail-in’ of Australians’ savings and deposits. The stability of the financial system depends on its depositors having confidence in its financial institutions. By ensuring the security of depositors’ savings, the overall protection of the financial system can be ensured.
But there are a few questions to consider.
Why not expressly exclude deposits from the bill, the current vague wording appears to leave the door open for a deposit grab in case of financial instability? We may have some reassuring words from the regulators, but is it enough?
How does this fit with the NZ model, where deposits can be targeted, especially, as the regulators in the two countries are closely aligned, and in fact most banking in New Zealand is provided by Australian Bankers. In case of failure would customers of a bank operating in both countries be different?
And two wider questions.
The NZ model expressly says depositors should weight up the risks of placing money with specific lenders but can savers really do this?
The issue of hybrid bonds needs more careful consideration, in that in Australia (unlike some other countries) these bonds have been sold to retail investors, people looking to savings with good returns, and who probably do not understand the bail-in risks they may face. So even if deposits are excluded there is a risk that investors in hybrids will get a nasty shock.
Seems to me this is a messy area, and I for one cannot be 100% convinced savings will never be bailed-in. And that’s a worry!
I recall the Productivity Commission comment last week, that financial stability had taken prime place compared with competition (and so customer value) in financial services. The issue of bail-in of deposits appears to be shaping the same way.
