August 2016 – Digital Finance Analytics (DFA) Blog

BIS, FSB and IMF publish elements of effective macroprudential policies

The International Monetary Fund (IMF), Financial Stability Board (FSB) and Bank for International Settlements (BIS) released today a new publication on Elements of effective macroprudential policies. The document, which responds to a G20 request, takes stock of the international experience since the financial crisis in developing and implementing macroprudential policies and will be presented to the G20 Leaders’ Summit in Hangzhou.

Following the global financial crisis, many countries have introduced frameworks and tools aimed at limiting systemic risks that could otherwise disrupt the provision of financial services and damage the real economy. Such risks may build-up over time or arise from close linkages and the distribution of risk within the financial system.

Experience with macroprudential policy is growing, complemented by an increasing body of empirical research on the effectiveness of macroprudential tools. However, since the experience does not yet span a full financial cycle, the evidence remains tentative. “The wide range of institutional arrangements and policies being adopted across countries suggest that there is no ‘one-size-fits-all’. Nonetheless, accumulated experience highlights – and this paper documents – a number of elements that have been found useful for macroprudential policy making,” the publication says. These include:

A clear mandate that forms the basis for assigning responsibility for taking macroprudential policy decisions.

Adequate institutional foundations for macroprudential policy frameworks. Many of the observed designs give the main mandate to an influential body with a broad view of the entire financial system.

Well-defined objectives and powers that can foster the ability and willingness to act.

Transparency and accountability mechanisms to establish legitimacy and create commitment to take action.

Measures to promote cooperation and information-sharing between domestic authorities.

A comprehensive framework for analysing and monitoring systemic risk as well as efforts to close information gaps.

A broad range of policy tools to address systemic risk over time and from across the financial system.

The ability to calibrate policy responses to risks, including by considering the costs and benefits, addressing any leakages, and evaluating responses. In financially integrated economies, this includes assessing potential cross-border effects.

The document includes some data on the use of macroprudential tools; illustrative examples of institutional models for macroprudential policymaking; and a brief summary of some of the empirical literature on the effectiveness of macroprudential tools.

“Usage” counts the number of countries using the various instruments that comprise each group. Assuming that once a country introduces an instrument, it continues using it, the charts show usage of the various groups of instruments.

Institutional arrangements adopted by a country are shaped by country-specific circumstances, such as political and legal traditions, as well as prior choices on the regulatory architecture. While there can therefore be no “one size fits all” approach, in practice, there has been an increasing prevalence of models that assign the main macroprudential mandate to a well-identified authority, committee, or interagency body, generally with an important role of the central bank. While each of these models has pros and cons, any one model can be buttressed with additional safeguards and mechanisms.

Model 1: The main macroprudential mandate is assigned to the central bank, with its Board or Governor making macroprudential decisions (as in the Czech Republic, Ireland, New Zealand and Singapore). This model is the prevalent choice where the central bank already concentrates the relevant regulatory and supervisory powers. Where regulatory and supervisory authorities are established outside the central bank, the assignment of the mandate to the central bank can be complemented by coordination mechanisms, such as a committee chaired by the central bank (as in Estonia and Portugal), information sharing agreements, or explicit powers assigned to the central bank to make recommendations to other bodies (as in Norway and Switzerland).

Model 2: The main macroprudential mandate is assigned to a dedicated committee within the central bank structure (as in Malaysia and the UK). This setup creates dedicated objectives and decision-making structures for monetary and macroprudential policy where both policy functions are under the roof of the central bank, and can help counter the potential risks of dual mandates for the central bank (see further IMF 2013a). It also allows for separate regulatory and supervisory authorities and external experts to participate in the decision-making committee. This can foster an open discussion of trade-offs that brings to bear a range of perspectives and helps discipline the powers assigned to the central bank.

Model 3: The main macroprudential mandate is assigned to an interagency committee outside the central bank, in order to coordinate policy action and facilitate information sharing and discussion of system-wide risk, with the central bank participating on the committee (as in France, Germany, Mexico, and the US). This model can accommodate a stronger role of the Ministry of Finance (MoF). Participation of the MoF can be useful to create political legitimacy and enable decision makers to consider policy choices in other fields, e.g. when cooperation of the fiscal authority is needed to mitigate systemic risk.

Home Lending Reaches New High, But Slowing

The RBA’s credit aggregates for July 2016 shows that whilst lending grew to a new all time high, the momentum is slackening. Housing lending reached $1.58 trillion, seasonally adjusted, up $7.5 billion, of which owner occupied housing rose by $6.3 billion (0.6%) and investment housing rose by $1.2 billion (0.22%). Investment lending comprises 35.1% of all home loan stock, close to last months figure. Lending to business was up $3.7 billion (0.44%). Lending to business was 33.3% of all lending to the private sector and remains flat.

Looking at monthly trends, growth rates for these series have been adjusted to remove the effect of loan purpose changes so housing lending overall grew at 0.5%, with weakening momentum in owner occupied loans, and a small rise in investor lending after a deep dip earlier.

The 12 month ended growth shows owner occupied housing grew the strongest, whilst weaker investor lending pulled overall housing growth lower to 6.6% (7.3% a year ago) and business lending growth slipped but at 6.2% is higher than the 4.9% from a year ago. Personal credit contracted again, down 0.8%.

The RBA says:

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $43 billion over the period of July 2015 to July 2016, of which $1.0 billion occurred in July. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

Home Lending Higher In July 2016, But Slowing

The latest monthly banking stats from APRA shows that total lending for home loans by the ADI’s (banks, building societies, credit unions etc.) rose 0.5% in July, down slightly from the previous month. Within that loans for owner occupied loans rose 0.64% to reach $952.5 billion, and investment lending rose 0.3% to $527 billion. Loans for investment property now comprise 35.6% of outstanding loans. So the rate of loan growth is slowing, but the overall level of household debt continues to rise and investment loans are back in favour. Remember too that these numbers are still messed up with ongoing loan reclassification with $43 billion over the period of July 2015 to July 2016, of which $1.0 billion occurred in July.

Looking at individual lender movements, CBA lent more on both the owner occupied and investment side of the ledger.

As a result we see CBA lifting its market share, though Westpac still has a greater share of investment loans.

If we examine the relative growth of loan portfolios against the APRA 10% speed limit, most major players remain within the 10% target.

We will look at the RBA financial aggregates next, which gives us the view of all loans across the market, including the non-bank sector.

The Top 10 Mortgage Stress Post Codes In The Hobart Region

We finish our series on mortgage stress by looking at TAS, and the region around Hobart. Using data from our surveys, 24.3% of households are currently in mortgage stress. This is above the national average of 21.3%. You can read about our methodology here. We assess individual household income and expenditure, and do not rely on a simplistic “35% of income rule of thumb” used by many others.

Here is the mapping around Hobart, showing the relative count of households in stress.

Looking at the top 10 in TAS, Riverside 7250 contains the largest number in stress.

Riverside is a suburb of Tasmania, about 164 kms from Hobart to the north west. The average age of the people in Riverside is 40 years of age and the average income $1,110. The average mortgage is below $100,000.

Next is Kingston, (7050), a suburb of Tasmania about 11 kms from Hobart. The average age of the people in Kingston is 36 years of age and the average income is $1,110 whilst the average mortgage is $130,000.

The third highest is Dynnyrne, just 2 kms from central Hobart. The population is younger and more wealthy than the other post codes, with an average income of $1,380. The average mortgage is $409,000.

So, once again we see a wide range of households in stress.

That completes our series on mortgage stress in Australia in 2016. Our next piece of work will be to update our probability of mortgage default. Whilst this is connected to mortgage stress, the default modelling takes account of a range of broader economic indicators.

A Hybrid Is Not A Higher Yielding Deposit Alternative

Within the APRA speech we discussed earlier, there was an important little paragraph, which warrants separate coverage. It concerns the emergence of “hybrid” instruments, which banks have been offering, with a fixed return higher than deposit interest rates – returns which in the current low interest rate environment many will find attractive. However APRA makes the point, they should not be considered as higher yield alternatives to deposits as they are intrinsically less safe. Should a bank find they fall below certain capital ratios, the hybrid becomes the first line of defence, and will not pay out. These risks need to be understood.

Searching for new capital when a business is distressed, and time is of the essence, is ideally to be avoided. And we want to minimise the risk that the taxpayer has to come to the rescue. With that in mind, the post-crisis regulatory framework has built mechanisms that trigger automatic corrective action to help restore a firm’s capital when it has been diminished. There is a lot of discussion and debate on the merits of so-called bail-inable instruments and bail-in powers, including in response to the FSI’s third recommendation that APRA implement a framework for recapitalisation capacity sufficient to facilitate the orderly resolution of an Australian ADI and minimise taxpayer support. But the idea of bail-in is not something completely new: certain recapitalisation mechanisms already exist in the Australian framework. Examples include:

the use of the capital conservation buffer, which imposes increasing limitations on a ADI’s ability to make discretionary distributions to capital providers and employees as the ADI approaches its minimum regulatory requirements;

the trigger that exists in Additional Tier 1 instruments (often referred to as ‘hybrids’) that provide for the instrument to be written off, or converted to equity,
in the event that an ADI’s capital ratio falls below 5.125 per cent; and

the point of non-viability trigger in both Additional Tier 1 and Tier 2 instruments, which provides for the instruments to be written off or converted to equity in the event that APRA considers that the ADI would become non-viable without such action (or some other form of support).

These latter two recapitalisation mechanisms, in particular, are designed to provide some ‘breathing space’ to allow for orderly resolution. They are not designed to deliver resurrection, but more modestly to provide scope for an ADI’s services to customers to continue while new owners and managers are being put in place. Strengthening this by increasing loss absorption and recapitalisation capacity further, as recommended by the FSI, remains a work in progress and likely to take some time to complete. We are, as I have said elsewhere, hastening slowly in response to that recommendation given the importance of getting the policy settings right.

However, the new mechanisms that have already been instituted within existing capital instruments are a very important part of the new regulatory framework. Viewing these capital instruments as simply higher-yielding substitutes for vanilla fixed-interest investments, let alone deposits, is something to be counselled against, since from APRA’s perspective holders of these instruments are providing the important first lines of defence that we can call into action, in some instances even ahead of shareholders, to aid an orderly resolution.

Capital Is Not Enough – APRA

In a speech by APRA Chairman Wayne Byres, “Finding success in failure” delivered in Sydney today at the Actuaries Institute conference, ‘Banking on Capital’, he discusses capital standards for authorised deposit-taking institutions (ADI’s) and why a sole reliance on capital to deliver financial stability is an unwise strategy:

‘When we judge a bank’s capital to be high or low, or something in the middle, we are making a judgement that takes into account a range of issues that impact on bank risk profiles: funding and liquidity, asset quality, governance, risk management and risk culture, to name a few, all come into the equation in some way or another.’

‘To attempt to provide the community with an iron clad guarantee that nothing can go awry would require severe limitation on the risk-taking ability of the banking system, and prevent it from fulfilling the vital and productive roles that it plays in intermediating between borrowers and lenders and facilitating the smooth functioning of payments throughout the economy. Put simply, a zero failure regime is not desirable.’

‘If we accept that failures, while hopefully still reasonably rare, are nevertheless inevitable, then preparation to minimise their impact is an essential investment.’

‘Planning and investing to facilitate their own demise is something that financial firms inevitably struggle to do, so APRA will be reinforcing its expectations in relation to ADI’s [Financial Claims Scheme (FCS)] testing programs in the near future, with a view to ensuring there is genuine readiness to activate the FCS if it is ever needed.’

APRA, along with our colleagues amongst the Council of Financial Regulators, has spent a great deal of time in recent years looking in a fairly hard-nosed way at how well Australia stacks up against these preconditions. The conclusion was somewhat mixed: there are no glaring deficiencies, but a number of areas for improvement.

The importance of active supervision, and a willingness to intervene where appropriate, were some of the hard lessons that APRA took to heart following the HIH episode. Justice Owen found APRA under-resourced to identify problems, and slow to respond to them once found. These were fair conclusions, and APRA worked hard under my predecessor to build both its capacity and conviction. Fifteen years on from HIH, efforts to further improve our supervision – to identify risks early and respond promptly – remain at the forefront of our latest strategic plan, and I expect they will always feature prominently in APRA’s priorities.

When it comes to powers to intervene, the FSI’s Final Report noted there are some gaps and deficiencies in the Australian statutory framework for crisis management and resolution when compared with international standards.⁶ This includes the need for such things as broader investigation powers; strengthened directions powers; improved group resolution powers; enhanced powers to deal with branches of foreign banks; and more robust immunities to statutory and judicial managers. In his speech last week, the Treasurer noted the Government’s intention to make improvements in this area, which we see as a very valuable (and low cost) investment in the stability in the financial system.

Crisis planning is critical. Last year at this event I spoke about our plans for recovery and resolution planning. During the past year, I’m pleased to say larger ADIs have submitted new plans based on updated guidance issued by APRA, and we are now reviewing and benchmarking the plans in order to highlight areas of better practice that will further increase the credibility of plans in subsequent iterations.⁷ On resolution planning, more detailed work is also underway with specific firms to consider the planning required to ensure that APRA is able to use our resolution powers when needed. Our focus here is on the assessment of critical functions, intra-group dependencies such as critical shared services, and the identification of potential barriers to resolvability.

No matter how good the plan, however, stabilising and restructuring a financial firm that is no longer viable in its current form is rarely going to be a quick and easy exercise. So it is important that, while a resolution plan is being implemented, the firm’s critical functions can be maintained so as to reduce potential losses and minimise the disruption to the broader financial system. Key to doing this is that the firm has the financial resources to allow it to continue to operate while its business is reorganised.

Apple hits back against banks

From ComputerWorld.

Even if the Australian Competition and Consumer Commission (ACCC) authorises collective negotiations between a group of banks and Apple over the use of the Apple Pay platform, the iPhone maker says that it “will not and cannot” agree to the conditions likely to be sought by the banks.

Bendigo and Adelaide Bank, the Commonwealth Bank of Australia, National Australia Bank and Westpac last month applied to the ACCC for authorisation to collectively negotiate with mobile wallet providers, with the application naming Apple’s service as well as Google Pay and Samsung Pay.

The banks argue that Apple, Google and Samsung are potentially in a position to negotiate terms for use of their mobile wallets that “likely to result in reduced competition and innovation, and increased risk in the security and transparency of mobile payments.”

Currently in Australia only American Express and ANZ customers offer Apple Pay support for their customers, but worldwide more than 3000 issuers support the platform, according to Apple.

Apple says that based on the banks’ application to the ACCC, the applicants will not agree to support Apple Pay unless it allows them to charge consumers for the use of the platform, it provides access to the iPhones Near Field Communications (NFC) antenna, and it agrees to security guidelines drafted by the applicants that will only apply to third party mobile wallets (not the banks’ own offerings).

These terms will “undermine the availability, security and privacy our customers expect when using Apple devices to make payments,” Apple argues in a submission to the ACCC. The submission follows on from an interim submission that “strongly urged” the ACCC to reject the banks’ application.

Apple says that it has attempted to negotiate agreements with each of the applicant banks bar one (which was not willing to sign a confidentiality agreement). The inability of the banks to reach agreement with Apple “demonstrates that each individual applicant bank possesses a significant amount of bargaining power against Apple,” the iPhone maker argues.

“As each of the banks has individually resisted serious engagement with Apple for the past two years, collectively negotiating will further entrench the applicant banks’ position by ensuring that all of them can only advance in lockstep with the slowest, least willing member,” the submission argues.

“The applicant banks would know that they can continue to hold out without the threat that one of their competitors will introduce Apple Pay for their customers, which could result in the loss of some customers who will switch banks in order to access Apple Pay.”

Apple in its submission takes particular umbrage to banks seeking access to the iPhone’s NFC capabilities.

“This is not open to negotiation with any bank,” the company argues. “Apple designs its products to provide very secure experiences, especially where payments are concerned. Apple has been able to provide the required level of security with tight integration of hardware, software, and services such as Apple Pay. Apple does not provide banks access to the NFC radio because doing so would undermine the security our customers expect when using Apple devices to make payments.”

As justification, the submission cites examples of security vulnerabilities in Android.

Apple adds that just because it will not support use of NFC by third parties, there are alternative technologies that can be used for contactless payments, for example QR codes.

“Apple’s desire to protect the integrity of its own proprietary hardware installed within its own devices is not anticompetitive,” the submission argues. “It is not ‘exclusive dealing’ conduct to which Australian competition law applies.

“What the applicant banks are seeking is the right to impose a collective boycott for the purpose of putting pressure onto Apple to grant them access to proprietary hardware and software. Apple has invested significant financial and other resources developing a simple and convenient mobile wallet service with the highest security and privacy protections available. This is also the basis on which Apple seeks to differentiate its mobile wallet from those offered by other mobile wallet providers.”

The full submission is available online.

Investment Loans On The Rise

The latest ADI Property Exposures data from APRA to Jun 2016 highlights that interest only loans, and investment property loans are on the rise, along with continued growth in the overall loan book and growth in broker originated loans. However, there are some interesting moving parts as we look across the various ADI’s.

Overall housing loans were up 8.1% compared with June 2015, to $1.44 trillion. The number of housing loans grew 3.7% to 5.62 million loans and the average loan balance rose 4.6% to $252,000. New loans approved in the quarter were $98.4 billion, up 2.1%.

Looking first at loan stock, overall, the mix of investment loans is at around 35% of the total, down from 39% a year ago, reflecting loan reclassification and business mix. We see a slight rise in interest-only mortgages, and a stronger rise in loans with offset facilities.

Looking at the flow of new mortgages, we see a rise in the proportion of new loans for investment purposes, and a rise also in overall loan flows by value.

By value, a greater proportion of loans are being originated by third party (broker) channels, and again we see the rise in interest only loans. There remains a small proportion approved outside normal criteria, but low documentation loans are almost non-existent among ADI’s.

The LVR mix also tells an important story. More loans are being written at lower LVR levels, with the number above 90% falling considerably. More than half are in the range 60-80%, reflecting the refinancing of existing loans as lenders battle for relative share.

If we delve into the differences by lender type, we see that building societies are writing the largest proportion of below 60% LVR loans.

As a result, their loans in higher groups remain below the other lenders.

In the 80-90% LVR range, foreign banks are lending a larger proportion, relative to the other lenders.

Over 90% LVR, and these would generally be the more risky loans, we see the volume falling, with foreign banks lending the least.

Turning to investment loans by lender type, the major banks are lending more than other types of ADI, in percentage terms, well ahead of other domestic banks as well as credit unions and building societies. In the last quarter, major banks grew their books more than in the previous quarter.

Loans approved outside serviceability are down, but major banks are still lending more loans outside normal terms – reflecting competition in the sector and a need to write business. Credit unions have fallen back into line from their peak last year.

Foreign banks have more of their loans originated by brokers, followed by the other non-major domestic banks. Credit unions are the least likely to use brokers.

Finally, we see that the major banks are writing a larger share of interest only loans. Non-major banks appear to have ratcheted down their interest only lending, though foreign banks are on the up.

So, overall what can we conclude? First, loans are still being written, and there is strong competition across the sector. Major banks are growing their books the strongest. The volume of investment loans is rising, and more loans are being originated by brokers and third party channel. We are seeing the regulator in action, as the number of high-LVR loans are down. However, we think more intervention is still required to tame the home lending beast.

Also, bear in mind that some of the high LVR and non-conforming “slack” are being taken up by the non-bank sector. These loans do not form part of the APRA report, or supervision.

Building Approvals Up In July

The number of dwellings approved rose 0.2 per cent in July 2016, in trend terms, and has now risen for eight months, according to data released by the Australian Bureau of Statistics (ABS) today. The number of units rose, whilst the number of houses fell.

Dwelling approvals increased in July in New South Wales (2.4 per cent) and Victoria (0.5 per cent) but decreased in Tasmania (3.7 per cent), Northern Territory (3.2 per cent), Australian Capital Territory (2.6 per cent), Queensland (1.8 per cent), South Australia (1.8 per cent) and Western Australia (1.8 per cent) in trend terms.

In trend terms, approvals for private sector houses fell 0.5 per cent in July. Private sector house approvals fell in South Australia (1.6 per cent), Western Australia (1.5 per cent) and Victoria (1.1 per cent). Private sector house approvals rose in Queensland (0.8 per cent) and were flat in New South Wales.

In seasonally adjusted terms, total dwelling approvals increased 11.3 per cent, driven by a rise in total other residential dwelling approvals (23.4 per cent). Total house approvals fell 0.6 per cent.

The value of total building approved rose 1.9 per cent in July, in trend terms, and has risen for seven months. The value of residential building rose 0.9 per cent, while non-residential building rose 3.9 per cent.

The Top 10 Mortgage Stress Post Codes In The Perth Region

We continue our series on mortgage stress by looking at WA, and with a focus on the Perth region. Using data from our surveys, 22.5% of households are currently in mortgage stress. This is above the national average of 21.3%. You can read about our methodology here. We assess individual household income and expenditure, and do not rely on a simplistic “35% of income rule of thumb” used by many others.

Here is the mapping around Perth, showing the relative count of households in stress.

Here is the top 10 list from WA.

6430, is in the mining belt of WA and includes Binduli, Broadwood, Hannans, Kalgoorlie, Karlkurla, Lamington, Mullingar, Piccadilly, Somerville, South Kalgoorlie, West Kalgoorlie, West Lamington, Williamstown, and Yilkari. It is in the federal electorate of O’Connor. The average age is just over 30 years. Average mortgage is $279,400.

Next on the list is Tapping (6065), a northern suburb of Perth about 27 kms from the CBD. The average age is 31. The area includes many recent migrants and the average mortgage is $170,610. A large proportion of purchasers are first time buyers.

Third is Wembley Downs (6019). Wembley Downs (6019) is a suburb of Perth on the coastal strip, about 9 kms from Perth. Average age is 40, and average weekly household income is $1,850. Here the average mortgage is $502,000.

Finally, Samson (6163) is a suburb about 14 kms south of Perth in the federal electorate of Fremantle. Average age is 45 years, average weekly household income $1,410 and average mortgage is $301,100.

Once again we see a diverse spread of households in mortgage stress.