1. What my comments address.
1.1 The thrust of the 4 published questions (Business Day 24/11/10-David Llewellyn-Smith) raises basically 2 issues against a GFC backdrop.
1.2 First Issue -The risks and benefits of Australian 4 pillar banks (“4PB”) and their present wholesale debt fund raising strategies including the use/future use of Federal Government guarantee.
1.3 Second Issue- Increased competition in the financial services sector with the measure of success being progressing the ability of the non 4 PB competitors: smaller banks and others being able to compete on a more equal footing by reducing their cost of funds in those market sectors in which there is a capacity against the 4 PB. The role of securitization in this process.
1.4 Both issues must have regard to the continued stability of the financial sector.
2. Some General Observations
2.1 This article takes into account the Federal treasure’s policy paper published 12/12/10
2. 2 The test of commercial reality should be applied to any changes to be introduced in legislative form or by widening of powers in ACCC & APRA.
2.3 Any quarantining by the Federal Government of an area of fund raising or lending by application of law may cause an aberration in market forces with unknown unquantified outcomes.
2.4 It is interesting to note how various Governments reacted to the GFC for their major banks-UK took equity, USA loan funds and equity and Australia by guarantee.
2.5 What are the substantive issue(s) in this debate and hue & cry surrounding it?
In my view, having read most of the headlines and articles in the media and other public forums it comes down to the Government attempting to unravel what is perceived to be a monopolistic market place in which the 4 PB operate, created, in part, by successive Governments for the stability of the financial sector as a whole. This is to be achieved by legislative changes which are yet to presented and debated but now subject of announced policy. This is in response to a perception that the heirachery of the 4 PB are acting indifferently and hence arrogantly, to requests from the Government over some time to loosen up competition. One of the platforms of attack from the Government and others is that the 4 PB should accept as a yardstick for cost of fund increases/decreases by adopting the RBA determined amount of + or – cash deposit rate changes. A mechanism in place to arrest inflation and relevant only in part to cost of fund calculations. It is reported that over the last 12 months nearly all lenders have increased their lending margin over the RBA yardstick. It is interesting to note that the RBA, in its recent submission to the Senate Banking enquiry, put forward a view concerning the most recent rise of 25 basis points that all that was justified in real cost of fund increases by the 4 PB was no more than the increase in the RBA’s increase in deposit rate. This could mean that the RBA considers that the 4 PB are a little over the odds in pleading justification this time around.
A sobering thought is if the 4 PB through their boards and senior management had been a little more street-wise then this entire ruckus perhaps could have been avoided and their respective shareholders and rating agencies could have concluded business as usual.
3. Issue one
3.1The balance sheet of a Bank and any other competitor is all important for commercial well being; credit rating; stock market value; interbank limits; credit risk standing for depositor of funds; and regulatory supervision. Prior to, during and since the GFC, the 4 PB measured up well under all of the above criteria. A commentator recently said that 45% of the funding book should be funded offshore with the 4 PB doubling their size and diversifying offshore to remain a competitive force in world standings and provide for a better mix of income streams.
3.2 Large wholesale debt can be offshore and onshore. The form of borrowing is diversified, with staggered maturities and an expectation of rollovers on maturity. Therefore, the cost of funds can be just as diversified in measurement. Matched book borrowing and lending defines with certainty the earn margin.
3.3 The RBA cash deposit rate is only one factor in funding costs and this appears to be common ground by those aware of the commercial issues.
3.4 The principle risks of 4 PB wholesale debts are:
-borrowing to fund onshore transactions-currency exchange rate-risk management contracts and systems can be engaged to minimize risk
-lack of liquidity on rollovers (GFC experience) and as a consequence substantial increased funding costs (these were largely avoided though use of Fed Government guarantee). What would have been the outcome if no guarantee had been made available? The 4 PB say that new replacement wholesale debt, without the Fed Guarantee is at a higher cost due to market place forces and no doubt this is the case. A free market place determines the cost of supply.
-the need to have an ever increasing deposit base is diminished in real terms
3.5 The principle benefits of 4 PB wholesale debts are:
-Should be cheaper in reasonable times as a source of funds. Offshore business makes it necessary to have foreign wholesale debt.
-Can structure hybrid instruments as a tool in capital adequacy.
-Can have a range of staggered maturities which is good for liquidity pressures and also relevant to profile of lending/investment book.
There are pros and cons; however as in common with most large corporates they have to access foreign debt as a source of funding their book.
It will be business as usual for the large 4 PB without the Fed guarantee. However it may be some comfort that the same may be available if anything approaching a GFC (tantamount to a threat to systemic failure) was to present itself in the future. The mechanism is now proven.
4. Issue Two
4.1 This is the more interesting side of the debate.
4.2 All things being equal on marketing, efficiency, and service from all competitors to a notional borrower for a house / business loan what is the broad thrust of requested main changes to be made to boost competition?
From submissions made by various parties from the non 4 PB competitors and others appearing before the current Senate Banking enquiry-raise these points:-
-capital adequacy rules should be revisited in home mortgage sector. In short APRA should loosen up to get more leverage on increased debt and therefore the recycling of funds for new loans. If this change was made only for the small end then it would be a structural intervention.
-Revitalizing the securitization market (the selling of securities in mortgage backed securities with AAA rating) by 2 measures. First to increase funding from the Federal Government over and above the $16B recently made available and secondly to “encourage” the participation of new investors such as super funds in addition to the traditional institutional investors. This would help in accessing liquidity at reasonable pricing. This process has been interrupted by the GFC and regeneration needs to be continued. This is a non structural intervention.
-Immediately reduce the cost of the Fed Guarantee where currently employed. It permits more competitive pricing and the lender makes presumably the same margin. The only party losing out is the tax payer through a lower return.
-Guarantee the mortgage insurance on loans subject of securitization thereby reducing costs. This is a structural intervention.
-The facilitation of changing a lender relationship on a cost effective and timely basis. “A separate survey from Essential research found 37 per cent of bank customers had considered leaving a major bank after this month’s interest rate rises in excess of Reserve Bank movements”. This can be a structural intervention.
-A new borrowing vehicle, initially supported by 25 credit unions, which has been in the making for 12 months and is targeting $1B of new funds for mortgage lending with funding targeted from Super funds and global markets the offered security being a rated financial instrument. APRA, it is reported is comfortable. The form of requested Government support is to be a cornerstone investor. It is hoped that familiarity and market acceptance will be taken up by the other players in this grouping which “there are 126 credit unions and mutual building societies in Australia representing $73 B worth of assets, 4.6 million members and more than 7% of the new home loan market”. This will assist in reducing the cost of funds. This is not a structural intervention.
-An extension of the Fed guarantee to wholesale debt instruments, presumably on / offshore, to provide a AAA rating for the non 4 PB competitors. To support the establishment of a 5th pillar to be competitive against the 4 PB. This is a structural intervention.
-Remove ban on sale of covered bonds.
4.3 Financial Stability
There seems to be some common ground on caution of structural intervention;
-UBS said the “5th pillar idea is potentially risky and would require massive increase in activity from small lenders. To be a credible 5th force with a 10% share of all mortgages and deposits, credit unions would have to raise their lending from $50B today to $144B in 4 years. Achieving this growth while keeping leverage ratios intact would require ‘them’ to find an extra $8B of capital to go more than double the $5.9B the sector holds”.
-Abacus spokesperson (represents credit unions and building societies) “As well as highlighting the funding task, the 5th pillar idea also posed potential risk to financial stability. Competition and financial stability had an inverse relationship as demonstrated in recent years”.
-The 4 PB in their respective submissions to the Senate Banking enquiry amongst other things stated in response to the 5th pillar idea
-unintended consequences could result in the taking of bigger and possibly dangerous risks in chasing market share.
5. The Fed Treasurer’s policy statement released 12/12/10 (format partially adopted from SMH 13/12/10)
As to lowering cost of funds-Deposit guarantee extended indefinitely, although threshold of $1m could change
-Government protected deposit logo to be available
-Government to increase its investment pool for securitization from $16B to $20B
-All banks are able to sell covered bonds
As to increasing competition
-Inquiry into account number portability
-Mutual’s fast tracked to become banks
-Increased power to ASIC & ACCC to better monitor & prosecute signaling
-Standard fact sheet to be supplied by all banks for mortgage offers
-No guarantee for wholesale debt
-Outright ban on mortgage exit fees (to change existing contracts without compensation unconstitutional)
-“tracker mortgages” with fixed margins
-Limits on how much banks can charge
-Australia Post competing as a bank
-New financial system enquiry
-Bank super profits tax
-The creation of a 5 th PB (perhaps just to complicated)
5. Some conclusions
5.1The jury is still out as to whether or not there is a lack of competitive forces under the present regime. Most recent statistics indicate that the non 4 PB competitors are writing more new home mortgage loans than the 4 PB
5.2 No structural changes should occur unless they have been thought through.
The Fed guarantee for the non 4 PB competitors is available on deposits (not available for wholesale debt) and is proposed to be issued in perpetuity. Its role into the future would be interventionist in a market place which seems to be regenerating from the GFC.
5.3 The Fed Guarantee will cause a 2 tier credit standing which is completely unjustified commercially and from a stability viewpoint. What happens if the Government looses its AAA to a lower rating? Does this automatically transfer to rating the cost of funds of the non 4 PB.This can be a by-product of being on the Government teat.
5.4 The creation of a 5th PB seems to have been shelved. Bank of Queensland chief executive was quoted today stating that the concept had been put back 15 years by the policy statement.
5.5 It will lead to more defacto controls at operational level, due to the conditions that will attach to the Fed Guarantee and which maybe come more onerous over time.
5.6 If I was a non 4 PB competitor and was given the option of using a Fed Guarantee I would have 2 loan books-one with and the other without same. Regulatory supervision is necessary but keeps the bureaucrats out of the operational side of the business. All things being equal there must be a point in time when the cost of the Fed Guarantee equates to a rating differential cost and its continued use is not necessary. This is more than likely will be the outcome as the strong regulatory regime continues at all relevant times.
5.7 In any event the 4 PB ratings enable them to borrow cheaper-it comes with the turf.
5.8 Variable rate interest is an option that a borrower takes and with it the ups and downs that accompany this financial risk.
5.9 The substantive point is the Government is using the tax payer’s money to be a partner in the banking system. This is against the fundamental recommendation of the Wallis commission. Isolating the GFC, what has changed to support on a perpetuity basis Government intervention?
5.10 If the Government can intervene in this industry, then what is next?
5.11 The debate and hue and cry, except for some non structural fixes which should be selected and implemented, seems to me to be one big furphy.Change should not be by way of structural intervention.
5.11 Surely it is not a plot to nationalize by stealth Are they that clever?
The quotes have all been extracted from various editions of SMH/ Business Day.