RBA Minutes Highlight Improved Bank Margins

A number of interesting comments were contained in the RBA minutes for July, released today.  Bank margins are increasing, and the next move in the cash rate is more likely up, not down (though complicated by exchange rates).

There was a decline in dwelling investment, a rise in household spending in April, after a fall in the first quarter, and a rotation from investment lending to owner occupied lending.  The underemployment rate, which measures the number of part-time workers wanting to work more hours, had remained elevated.

“Auction clearance rates in Sydney and Melbourne had softened recently, suggesting that conditions in these markets had eased somewhat. Housing prices in Perth and apartment prices in Brisbane had fallen further. Members noted that there had been several periods in the preceding decade in which housing prices had fallen, or growth had slowed significantly, in different parts of the country”.

“Members discussed trends in the composition and cost of Australian banks’ funding. Deposits, which are generally a relatively low-cost form of funding, had increased as a share of funding over recent years, to around 60 per cent, while the share of debt funding, particularly at short maturities, had declined. The cost of both types of funding had declined further since late 2016. Members noted that, over the same period, banks’ lending rates had increased slightly, driven by increases in housing lending rates for investors and on interest-only loans. As a result, the implied spread between the estimated average outstanding lending and funding rates for banks was estimated to have increased slightly”.

“Members discussed the Bank’s work estimating the neutral real interest rate for Australia. The various estimates suggested that the rate had been broadly stable until around 2007, but had since fallen by around 150 basis points to around 1 per cent. This equated to a neutral nominal cash rate of around 3½ per cent, given that medium-term inflation expectations were well anchored around 2½ per cent, although there is significant uncertainty around this estimate. Members noted that some of this decline could be attributed to lower potential output growth, but the increase in risk aversion around the time of the global financial crisis was likely to have been a more important factor, given that the bulk of the decline in the estimated neutral real interest rate had occurred around that time. Estimates of neutral real interest rates for other economies had shown a similar decline. All estimates of the neutral real interest rate for Australia suggested that monetary policy had been clearly expansionary for the preceding five years or so. It was also noted that a reduction in risk aversion and/or an increase in the potential growth rate could see the neutral real interest rate rise again”.

“The pipeline of residential construction was expected to support dwelling investment over the forecast period. The economic outlook continued to be supported by the low level of interest rates. The depreciation of the exchange rate since 2013 had also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment“.

Given the recent strength of the dollar, this could put the cat among the pigeons!

The Household Debt Quagmire

We know that household debt has never been higher in Australia, but I do not think the true impact of this, especially in a rising interest, low income growth environment is truly understood.  We have to look beyond mortgage debt.

The latest RBA E2 – Households Finances – Selected Ratios shows that the ratio of household debt to annualised household disposable income , rose to 190.4, the ratio of housing debt to annualised household disposable income rose to 135, and worryingly the ratio of interest payments on housing debt to quarterly household disposable income has risen to 7.0, thanks to the out of cycle rate hikes and flat or falling incomes.  Of course failing cash rates helped households out, but the lending standards were not adjusted until too late.

But, here is the really scary picture of total debt value held mapped by debt to gross income ratio (DTI), aka Loan-to-Income (LTI). DTI or LTI is a good measure of potential risk in the system.

This first chart shows the distribution of debt value – of all types, including mortgagee, (owner occupied and investment), personal loans, credit cards, SACC borrowing, and all other loans – relative to gross income in debt-to-income bands.  We are using date from our household surveys.  It also shows the distribution of households, with more than half having low, or no debt, but with a long tail of highly indebted households.

Across Australia, more than 45% of all household debt (not just households with mortgages, but those mortgage free or renting) sit with households who have an LTI of more than 4.5 times annual income. I used 4.5 times because this is the ratio the Bank of England uses, and they say that higher LTI’s are more risky.

The second chart shows the relative distribution across the states and territories.

The third chart shows the proportion of households in each state and territory with a DTI of more than 4.5 times.  NSW holds the record, with more than half of all households above this, compared with 26% in ACT and 9% in NT.

This is a big deal, especially in a rising interest rate environment.  It means households have little wriggle room, and granted many will be holding paper profits in property which has risen significantly in recent years, this does not help with servicing ongoing debt repayments.

The effect of the debt burden is to reduce the ability of households to spend, and in effect it is a drag anchor on future economic growth.

The traditional argument that “most debt is held by those who can afford it” is partly true, but bigger debts require bigger incomes to service them, and the leveraged effect in a rising interest rate environment is profound.



BOE Warns Popular 35-Year Mortgages Shackle Consumers With “Lifetime Of Debt”

From Zero Hedge.

Consumers in the UK have been on a credit binge since the Bank of England cut its benchmark interest rate to an all-time low as investors braced for the widely anticipated economic shock of Brexit – a shock that, unsurprisingly, has yet to arrive, despite warnings from the academic establishment that a “leave” vote would trigger an imminent economic catastrophe. And now, with total credit growth rising at 10% a year, the BOE is warning that the increase in unsecured lending is becoming increasingly unsustainable.

While the central bank is less concerned with mortgage debt than credit-card debt and other types of consumer credit, some at the bank are beginning to worry that the growing demand for long-term mortgages will shackle borrowers with a lifetime of debt, according to the Telegraph.

 “British families are signing up for a lifetime of debt with almost one in seven borrowers now taking out mortgages of 35 years or more, official figures show.

Rapid house price growth has ­encouraged borrowers to sign longer mortgage deals as a way of reducing monthly payments and easing affordability pressures.

Bank of England data shows 15.75pc of all new mortgages taken out in the first quarter of 2017 were for terms of 35 years or more. While this is slightly down from the record high of 16.36pc at the end of 2016, it has climbed from just 2.7pc when records began in 2005.”

The steady rise has triggered alarm bells at the BOE, prompting regulators to warn that the trend risks storing up “problem[s] for the future” if lenders ignore the growing share of households prepared to borrow into retirement. Indeed, bank figures show one in five mortgages today are between 30 and 35 years, up from below 8% in 2005, as the traditional 25-year mortgage becomes less popular.

There’s also the unaffordability question. That borrowers are opting for longer mortgage terms means they’re finding rent and mortgages are growing increasingly unaffordable, a worrying sign as credit expands.

David Hollingworth, a director at mortgage broker London & Country, said the trend showed that an increasing share of borrowers were “struggling with affordability pressures, and deciding that lengthening the term will offer leeway” as house price growth continues to outpace pay rises.

Sam Woods, the chief executive of the Prudential Regulation Authority, has said policymakers are watching developments closely.

“If lenders become too narrowly preoccupied with the profile of the loan in the first five years” and not look at the entire profile of the loan when assessing affordability “this could store up a problem for the future,” he said in a speech.

While interest rates are expected to stay low, the pound’s 15% drop against the dollar since the last year is driving up the price of consumer goods, adding to the pressure on borrowers. Prices of consumer staples are growing at an annualized rate of 3%, far more than interest rates on savings accounts.

ASIC consults on proposed financial benchmark regulatory regime

ASIC is seeking feedback on proposed rules for the administration of licensed financial benchmarks.

Initially and consistent with the Council of Financial Regulators (which includes ASIC (?))  advice, the following five benchmarks are likely to meet the criteria for significant benchmarks set out in the proposed legislation:

(a) the BBSW;
(b) Standard & Poor’s (S&P)/ASX 200 index;
(c) the ASX bond futures settlement price;
(d) the cash rate (including the total return index derived from the cash rate); and
(e) the consumer price index.

The proposed legislation requires administrators of significant benchmarks to hold a financial benchmark administrator licence, unless they are exempt from the requirement to hold a licence. Exemptions from the requirement to hold a licence would be rare.

Financial benchmarks are indices or indicators used to:

(a) determine the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments;
(b) determine the price at which a financial instrument may be dealt, or the value of a financial instrument; or
(c) measure the performance of a financial instrument.

As benchmarks affect the pricing of key financial products, a number of benchmarks have become critical to a wide range of users in financial markets and throughout the broader economy. This means there is a risk of financial contagion or instability, or of undermining investor confidence, if the availability or integrity of key benchmarks is disrupted.

Concerns about the integrity and reliability of financial benchmarks have prompted a number of regulatory reform initiatives. The International Organization of Securities Commissions (IOSCO) issued the Principles for financial benchmarks (IOSCO benchmarks principles) in July 2013. The Financial Stability Board (FSB) has also undertaken work on globally significant interest rate and foreign exchange benchmarks.

ASIC will establish a new licensing regime requiring administrators of significant benchmarks to obtain a new benchmark administrator licence from ASIC. Licensees would be required to comply with any conditions on the licence as well as a range of obligations imposed in the legislation.

The Government is currently consulting on draft legislation to implement financial benchmark regulatory reform. ASIC’s consultation is about the licensing regime for administrators of significant benchmarks and ASIC’s rule-making powers in the event the amendments to the Corporations Act are passed by Parliament. This early consultation and preparation will help Australia’s financial benchmark regulatory regime to be implemented more expediently.

Together, the draft legislation and ASIC’s proposals will help to ensure the robustness and reliability of financial benchmarks in the Australian economy in line with the IOSCO Principles for Financial Benchmarks. The proposals are also designed to facilitate equivalence assessments under overseas regimes including the European Benchmarks Regulation.


When Is a Bank, Not a Bank?

The Treasury has also released draft legislation to enable more entities to be able to use the term “bank”.  The Government announced in the 2017-18 Budget that it will act to reduce regulatory barriers to entry for new and innovative entrants to the banking system, by lifting the prohibition on the use of the word ‘bank’ by authorised deposit-taking institutions (ADIs) with less than $50 million in capital.

In practice this means a wider range of entities can now claim to be a bank, provided they are an ADI. Given the term is widely recognised in the community, it may help to level the playing field a little (though it is probably less important than differential capital rules and other barriers, such as implicit Government guarantees!)

Currently APRA  only permit ADIs with Tier 1 capital exceeding $50 million to use the terms ‘bank’, ‘banker’ and ‘banking’. However, there are a number of smaller ADIs which are prudentially regulated by APRA who would benefit from the use of these terms. The proposed amendment will allow all ADIs to use the terms will create a more level playing field in the banking sector.

The current restriction on the use of the words ‘bank’, ‘banker’ and ‘banking’ under section 66 of the Banking Act will be removed to the effect that where an entity is an ADI, that entity will be able to use those terms in its business. This will allow a range of ADIs to use the term ‘bank’.

APRA will retain its ability to restrict the use of the term ‘bank’ in certain circumstances; for example, where a purchase payment facility is an ADI but does not conduct traditional ‘banking’ business.

It is important that APRA retains the ability to determine that some ADIs may not use the restricted terms. Therefore, APRA will continue to be able to restrict the use of the terms ‘bank’, ‘banker’ and ‘banking’ through providing an affected ADI with a written determination restricting that ADI from use of the terms. [Item 5, subsection 66AA(3) of the Banking Act]

Determinations made by APRA to restrict the use of these terms may apply to a single ADI or to a class or classes of ADI. It is expected that APRA would use the power to prohibit certain ADIs which do not have the ordinary characteristics of banks from utilising the term ‘bank’ (for example, purchase payment facilities). This power may also be used to deny the use of the term where serious or unusual circumstances warrant APRA making this determination.

APRA may still receive applications from non-ADI financial businesses for permission to use the term ‘bank’, or from ADIs who wish to apply for the use of other restricted terms, such as ‘credit union’ (non-mutual ADIs are separately prohibited from inaccurately describing themselves as ‘credit unions’ or like terms). The latter approval is not automatically granted in the same way as ‘bank’ given that these terms convey the concept of mutuality, which is not relevant to all ADIs.

However, given APRA will no longer receive applications from many ADIs, it is no longer desirable that the remainder of the decisions to be made under section 66 be reviewable. This more appropriately reflects the Government’s intent to limit the use of the term ‘bank’ by financial businesses other than ADIs to very rare and unusual circumstances. This approach is consistent with Recommendation 35 of the Financial System
Inquiry to clearly differentiate the investment products financial companies and similar entities offer retail consumers from ADI deposits.

The Customer Owned Banking Association welcomed the move:

COBA congratulates the Government on moving quickly to allow all credit unions and building societies to use the term ‘bank’.

Credit unions and building societies are Authorised Deposit-taking Institutions (ADIs), like banks, and are subject to the same prudential regulatory framework as banks and the Government’s deposit guarantee under the Financial Claims Scheme.

“It makes sense that all ADIs should be able to choose to use the term ‘bank’ to explain what they do – which is banking,” said COBA CEO Mark Degotardi.

“The historic restriction on use of the term bank by ADIs with more than $50 million in capital is out of date and no longer relevant.

“We welcome the Government’s move to level the playing field.

“There are already 18 customer owned banks providing competition and choice in the retail banking market. These former credit unions and building societies are likely to be joined by many of the 60 other customer owned banking institutions currently trading as credit unions and building societies.

“Some credit unions and building societies may prefer not to rebrand but at least now they will have a choice.

“This draft legislation is the latest installment of the Government’s agenda to promote competition in banking. COBA congratulates the Government on its commitment to this agenda and its delivery of positive reform.

“We look forward to engaging with the Government on the draft legislation.”


APRA Reach Extended To Non-ADI Lenders

The Treasury has released draft legislation for consultation which extends some of APRA’s powers to some non-ADI lenders.  This is an important move, not least because we are seeing signs of non ADI lenders expanding their market footprint as regulators bear down on the larger mainstream players. Smaller non-ADI’s with assets of below $50m appear to be exempt.

The consultation on the draft Bill will close on Monday, 14 August 2017.

It covers the “conduct of a non-ADI lender relating to lending finance including the lending of money, with or without security or any other activities which either directly or indirectly result in the funding or originating of loans or other financing, which has the ability to cause or promote instability in the financial system”.

APRA will be able to apply different regulations to non-banks, a sub-section of these lenders, or to specific lenders. This does not include responsible lending responsibility which fall under ASIC. APRA will need to consult with ASIC when planning intervention (which highlights again the problem of role definition between APRA and ASIC).

Corporations with a stock of debt on their books, and a flow of debt through their books, which does not exceed $50,000,000, will not be registrable corporations for the purposes of the Financial Sector (Collection of Data) Act 2001 (FSCODA).

A new power will be provided to APRA to make rules with respect to lending finance by non-ADI lenders, for the purpose of addressing financial stability risks. APRA will also be provided a power to issue directions to a non-ADI lender, in the case that it has, or is likely to, contravene a rule. Appropriate directions powers and penalties will also be introduced for a non-ADI lender that does, or fails to do, an act that results in the contravention of a direction from APRA.

As a result of these amendments, corporations whose business activities in Australia include the provision of finance, or have been identified as a class of corporations specified in a determination made by APRA, will become registrable corporations for the purposes of FSCODA.

This will widen the class of registrable corporations under the FSCODA and will ensure that all non-ADI lenders, within specified parameters, are captured by these amendments.
Corporations which are not considered to be registrable corporations for the purposes of the FSCODA will include those corporations: whose sum of assets in Australia, consisting of debts due to the corporation resulting from transactions entered into in the course of the provision of finance by the corporation, does not exceed $50,000,000 (or any greater or lesser amount as prescribed by regulations); and whose sum of the values of the principal amounts outstanding on loans or other financing, as entered into in a financial year, does not exceed $50,000,000 (or any other amount as prescribed by regulations).

It is important to note that these powers do not equate to ongoing regulation by APRA of non-ADI lenders. APRA will not prudentially regulate and supervise non-ADI lenders as it does ADIs.

Under the Banking Act 1959 (Banking Act), a body corporate that wishes to carry on ‘banking business’ in Australia may only do so if APRA has granted an authority to the body corporate for the purpose of carrying on that business. Once authorised by APRA, the body corporate is an authorised deposit-taking institution (ADI) and is subject to APRA’s prudential requirements and ongoing supervision.

There are other entities who, like ADIs, provide finance for various purposes within Australia, but are not considered to be conducting ‘banking business’ as they do not take deposits. Given there are no depositors to protect, these entities are not required to be licensed as ADIs and prudentially regulated by APRA. These non-ADI lenders currently only have to report data to APRA in certain circumstances.

Under current law, APRA has significant powers with which to address the financial stability risks posed by the lending activities of ADIs. For example, concerns in recent years about residential mortgage lending have led APRA to take specific prudential actions to reinforce sound residential mortgage lending practices by ADIs.

APRA currently has no such ability with respect to non-ADI lenders. This gap potentially undermines APRA’s ability to promote financial stability, as lending practices that APRA has curtailed or prohibited for ADIs may continue to be pursued by non-ADI lenders.

To address this gap, APRA will be given new rule making powers which apply to non-ADI lenders. These new powers will allow APRA to make rules relating to the lending activities of non-ADI lenders, where APRA has identified material risks of instability in the Australian financial system.

These powers are narrow when compared to APRA’s powers over ADIs. This is an appropriate outcome, given there are no depositors to protect in non-ADI lenders. When exercising these powers, APRA will have to consider efficiency, competition, contestability and competitive neutrality consistent with section 8 of the Australian Prudential Regulation Authority Act 1998 (APRA Act).

A separate but related issue is APRA’s ability to collect data from registrable corporations under Financial Sector (Collection of Data) Act 2001 (FSCODA). The current definition of registrable corporation in section 7 of the FSCODA has limited APRA’s ability to collect data, as corporations which engage in material lending activity are occasionally technically not required to register. This has inhibited the ability of APRA and the Council of Financial Regulators (CFR) to properly monitor the financial stability implications of the non-ADI lender sector.

APRA’s ability to collect data from non-ADI lenders will be improved by an alteration of the definition of registrable corporations in FSCODA. The new definition will seek to capture entities who engage in material lending activity, irrespective of whether it is their primary business.




ING Direct Battles Turnaround Delays

Further evidence of a shift in mortgage applications from majors to other smaller lenders is provided by the fact that ING Direct has acknowledged lengthier processing times for incoming home loan applications and has promised to work through the issue.

According to Australian Broker, “As has been the case in the past, it is important we are transparent and keep you informed on how we are addressing these challenges,” Mark Woolnough, head of third party distribution & direct mortgages, wrote in a note to brokers on Thursday (13 July).

“We have all available resources working towards getting our turnaround times back to much shorter levels.”

The primary cause for the delays has been elevated application flows, Woolnaugh told Australian Broker.

“A combination of other factors have also exacerbated the extended delays, namely the introduction of requirements regarding Common Reporting Standards and re-work on incomplete applications; in many cases multiple re-works on the same files.

“It is vital that our competitive positioning remain strong; this won’t be compromised by our processing challenges.”

The bank has created separate assessment queues for purchase and refinancing, he said, which would assess purchase applications in a faster manner and address extended queues for refinancing.

Credit assessment staff have also been brought in both over the weekends and on weeknights, while a recruitment effort for additional assessment and processing staff is underway.

At the time the broker note was sent out, ING was assessing purchasing applications received on 6 July and refinance applications received on 23 June.

“We are doing everything we can to get back to acceptable turnaround times. We thank you for your continued support and patience.”

ING was making real progress in solving these issues, Woolnaugh said, with purchase applications now at a four day turnaround time. He promised that this figure will continue to be brought down whilst ING also worked on refinances in parallel.

“We expect to be back within turnaround times of below four days within the next few weeks. We will also do everything we can do ensure we hold and further improve these and avoid any return to the turnaround times we’ve experienced over the past few weeks.”

Turbulent Times – The Property Imperative Weekly 15 July 2017

At the heart of the property market there is a paradox – prices are still rising in most centres and auction clearance rates remain elevated, yet mortgage lending momentum is easing. How can this be?

In our latest weekly review we look at lending momentum, property prices and mortgage industry innovation. We are living in turbulent times! Welcome to the Property Imperative Weekly to 15th July 2017.

First, don’t believe all the noise about home prices collapsing. Latest data shows continued growth. For example, in Victoria, according to RIEV, the metropolitan Melbourne median house price rose 2.9 per cent in the three months to June 30, to $822,000. The top growth suburbs were spread right across Melbourne, and at both the low and high ends of the market, from Broadmeadows and Roxburgh Park in the north, to Malvern East and Toorak in the south-east. Croydon in the outer east experienced the city’s largest quarterly increase, up more than 20 per cent to a median of $810,000. Toorak was the most expensive suburb though half of the top-growth suburbs are priced below the Melbourne’s median, suggesting buyers continue to seek value further from the city.

Melbourne’s apartment sector performed similarly well in the June quarter, with the metropolitan Melbourne median apartment price increasing 4.3 per cent to $606,500.  House prices in regional Victoria rose strongly for the second consecutive quarter, up two per cent in June to a record high $385,000.

Data from CoreLogic also showed that to 9th July, prices in Sydney rose 3.4% in the past month, in Brisbane they rose 0.5% but fell in Adelaide by 1% and Perth 0.8%. In addition, the preliminary auction clearance rates increased to 70.7 per cent this past week, up from 67.3 per cent the previous last week, even though auction volumes fell week-on-week, there were 1,751 properties taken to auction this week, down from 2,001 last week, still higher than this time last year. All but two of the capital cities saw the clearance rate increase week-on-week while Melbourne recorded the highest preliminary clearance rate at 73.9 per cent.

There are a number of clouds on the horizon though. This week the Government released draft legalisation stemming from the 2017-18 Budget when the Treasurer said travel expense deductions relating to residential investment properties would be disallowed and depreciation deductions for plant and equipment used in relation to residential investment properties would be limited.

We released our Household Finance Confidence index to June 2017, and the news was not good. Overall the index dropped below the neutral setting and appears to be trending lower. The current reading is 99.8% compared with 100.6 in May. The fall is being driven by a confluence of issues, none new, but now writ large. Households are seeing the costs of living rising (especially power costs, child care costs and council rates), whilst household income remains depressed and is falling in real terms. Returns on deposits actually fell as well, so mortgage repricing is not being matched by better saving rates. The costs of mortgage repayments rose. The most significant fall in confidence was in the property investor segment, where loan repricing has been more pronounced, whilst rental incomes are hardly growing. They are also concerned about slowing capital appreciation. However, it is still true that property owners have their confidence buttressed relative to property inactive households who are more likely to be renting, and see no rise in their net worth.

The ripple of mortgage rates rises continued with Advantedge an important wholesale funder and distributor of white-label home loans, and part of the National Australia Bank Group, announcing it will increase the interest rate on all new and existing variable rate interest only home loans by 0.35% p.a., effective Tuesday 8 August.

Westpac said it ditching mortgage and equity-release products in a high-level review of its product range and underwriting standards. The latest products to be dumped include equity access low documentation loans, which is a revolving line of credit secured against property; and a range of fixed rate low documentation home loan. Review recommendations are expected to flow onto Bank of Melbourne, St George Bank and BankSA.

Data from the ABS showed that overall lending finance sagged in May. Owner Occupied housing grew, by 0.4%, with a rise in first time buyers, but all other lending flows were lower, whether you look at the trend or seasonally adjusted figures.

Personal credit continues to fall, the flows fell 3.2% of $193 million, with similar rates of decline across both fixed and revolving loans.

Total commercial lending fell 0.8% of $314 million. Within that lending for investment housing fell 1.5% or $194 million, whilst other fixed commercial lending fell 0.5% or $96 million. Revolving commercial credit fell 0.3% or $24 million.  If business confidence is really so strong, why no growth in borrowing – something does not add up!

As a result, the total proportion of business lending to total lending stood at 29.9% down from a peak of 30.9% in December 2016. The proportion of investment property lending flows slipped to 18.1% of all lending, and 37.4% of all housing lending.

So whilst the regulatory tightening is crimping demand for investor finance, it is not being replaced with a rise in productive business lending, so commercial finance has fallen. This will put downward pressure on growth, at a time when mortgage interest rates are rising. We cannot see how the future growth expectations from the RBA are going to be met on these figures.

It is clear however, that secured lending for owner occupation rose, as first time buyers pick up the slack, and investor lending remains strongest in the two overheated markets of Sydney and Melbourne. Much of the fall in investment sector lending resides in the other states, who are already experience economic pressure. Data from AFG showed that more new loans are being written by non-major banks, who are helping fill the void left by some of the majors and consumers are benefiting from the fact that a mortgage broker can offer products from those lenders without a branch network.

All this explains why we have home prices moving up, whilst lending is slowing – you need to get granular to understand what’s happening, as discussed in an interesting IMF working paper.

Elsewhere, mortgage brokers commissions were in the spotlight following the ASIC review which found that consumers were not getting great outcomes and that the standard model of upfront and trail commissions creates conflicts of interest.  The industry is being given a chance to self-regulate.

A combined industry forum, which involves the ABA, MFAA, FBAA and COBA, first met in June and is scheduled to meet later this month, with the broad objective of responding to ASIC’s review. Participants though hold a range of different views.

CHOICE, said it was “simply not good enough” that ASIC “has left it up to the industry to find a solution”. They suggested that the way mortgage brokers are currently paid “means it’s very unlikely that a customer is going to get a loan that’s best for them” and that the industry therefore needed a “major change”.

In a joint submission to the Treasury, consumer advocacy group CHOICE, along with the Financial Rights Legal Centre, Consumer Action Law Centre and Financial Counselling Australia, called for the removal of upfront and trail commissions, the implementation of fixed fees (via lump sum payments or hourly rates), the removal of bonus commissions, bonus payments and soft dollar payments; and  a change in law so brokers have to act in the ‘best interest’ of clients; and a requirement that brokers disclose ownership relationships and the lender behind any white-label loan recommended to a consumer.

However, the peak broker bodies – the MFAA and FBAA have called this submission “ignorant” and “misinformed”, which perhaps is unsurprising, as these bodies are strongly aligned with the current mode of operation.  They slammed the recommendations as “detrimental” to consumer interests and claimed mortgage rates would rise if such reforms were implemented.

The Australian Bankers Association announced it wants commissions to be decoupled from loan size but is prepared to negotiate with brokers to find a new model. Their Sedgwick review called for commissions to be completely decoupled from loan size by 2020.

So there will be some changes to mortgage broker commissions, but is not yet clear what the shape of those reforms will be. Whilst consumers say they get good service from brokers, the implicit conflicts in the current model cannot be overlooked.

Finally, this week two interesting Fintechs launched, highlighting that innovation is set to disrupt the mortgage market.  Tic:Toc has emerged offering ‘instant home loans’ through a digital real-time loan processing system that connects customers directly to the lender, claiming a 22-minute home loan is available, which includes approval and document generation.  This is significantly faster than most traditional lenders.

Separately, peer-to-peer lender Zagga, held a launch party in Sydney recently. The firm is looking to differentiate itself from competitor peer-to-peer players by pitching itself as the ‘secured alternative’. All Zagga’s loans are secured against a property and investors are matched with a specific loan, i.e. it is not a ‘pooled’ structure. While an algorithm is used to match investors with borrowers, depending on each investor’s risk tolerance, each lender undergoes a credit assessment by Zagga’s staff.

So signs of digital disruption now hitting the mortgage industry, in this time of uncertainty.

And that’s the Property Imperative week to 15th July. If you found this useful, do subscribe to get the next edition, or sign up to the Digital Finance Analytics blog to receive all the latest news. Thanks for watching.

The interplay of accounting and regulation and its impact on bank behaviour

According to a new working paper – from BIS, accounting and regulatory standards are pulling in different directions, and as a result bank risks may be misinterpreted.

Accounting rules and disclosure standards are important determinants for banks’ incentives and behaviour, and the recent financial crisis, where criticism was voiced (eg regarding the role of fair value accounting of financial assets and incurred loss provisioning of loans), is just another example of the importance and relevance of banks’ financial reporting in a regulatory and supervisory context.

In March 2013, the Basel Committee’s Research Task Force initiated a work stream that deals with aspects of the interplay of accounting and regulation and its impact on bank behaviour from a research perspective. Specifically, the work stream was tasked to “identify ways in which the interaction between accounting and regulatory rules provides incentives that affect the risk taking of financial institutions”, and it commenced research on specific aspects of loan loss provisioning, disclosure rules, fair value accounting, and prudential filters.

In summary, the results described in this report as well as the conclusions from other studies reported in Basel Committee working paper 28 suggest that both in the context of loan loss provisioning and the valuation of banks’ assets, there is a tension between backward-looking and forward-looking measurement. This observation is also consistent with the mixed picture that is given by the analytical results regarding several research questions. One conclusion is that corner solutions in one or the other direction do not seem optimal, and that an adequate mix of the two concepts may be superior. The other conclusion is that further evidence on the research questions posed is clearly needed. For example, all projects of the work stream focus on quantities, but not on prices of financial instruments (eg loan rates or yields of securities). Therefore, researchers are encouraged to further address the interplay of accounting and regulation and its impact on bank behaviour from an academic perspective.

Note: The Working Papers of the Basel Committee on Banking Supervision contain analysis carried out by experts of the Basel Committee or its working groups. They may also reflect work carried out by one or more member institutions or by its Secretariat. The subjects of the Working Papers are of topical interest to supervisors and are technical in character. The views expressed in the Working Papers are those of their authors and do not represent the official views of the Basel Committee, its member institutions or the BIS.

Superannuation Guarantee Compliance Reforms Ahead

Despite not being able to estimate the true amount of superannuation guarantee non-compliance, the Government is proposing a number of reforms to protect employees and strength compliance.  They say it is mostly small businesses who are non-compliant, and this is often caused by cash-flow issues. We have summarised their recommendations.

On 31 March 2017, the Superannuation Guarantee Cross-Agency Working Group provided its report on Superannuation Guarantee Non-Compliance to the Minister for Revenue and Financial Services. This Working Group, established in December 2016– comprised officials from the Australian Taxation Office (Chair), the Treasury, the Department of Employment, the Australian Securities & Investments Commission and the Australian Prudential Regulation Authority.

There are currently no robust estimates of superannuation guarantee non-compliance.

In December 2016, Industry Super Australia (ISA) estimated non-compliance in 2013-14 to be $2.8 billion (affecting an estimated 2.15 million employees). In March 2017 this estimate increased to $5.6 billion (affecting an estimated 3 million employees).

The Working Group believes this estimate should be considered in the context of the $89.6 billion in total employer contributions made in 2015-16. From the analysis of ISA’s methodology, the Working Group considers that the $5.6 billion estimate is likely to substantially overstate the actual size of the superannuation guarantee gap. The data is inconsistent with experiences and observations from the ATO’s
compliance program.

A review of ATO case data indicates that small businesses account for around 70 per cent of reported superannuation guarantee non-compliance. Cash flow problems are often the major reason small business employers provide as to why they did not pay their employees’ superannuation guarantee contributions.

The Working Group recognises that while there is, overall, a high level of voluntary compliance by the majority of employers there is scope to improve compliance to better safeguard employee entitlements.

The Working Group has identified two key barriers to maintaining or improving superannuation guarantee compliance.

The first barrier is that the ATO does not currently have any visibility over an employer’s superannuation guarantee obligations to their employees. The second barrier is that the ATO only receives information on superannuation guarantee payments received by superannuation funds on an annual basis so there can be a lag of up to 14 months in the reporting of contributions that employers have paid. This delay further reduces the effectiveness of the ATO’s compliance work.

The Working Group proposed changes that would improve substantially the ATO’s capacity to monitor superannuation guarantee compliance:

  • All employers should report superannuation guarantee obligation information to the ATO in a more timely manner. One way this will be achieved is to leverage the Government’s introduction of Single Touch Payroll legislation. Single Touch Payroll will commence for businesses with 20 or more employees from 1 July 2018. The Working Group considers that Single Touch Payroll should be extended to businesses with 19 or fewer employees as soon as practicable. Subject to more detailed design and consultation, it is believed that this change may be able to be implemented from 1 July 2018.
  • The regime should be more flexible so that penalties can be tailored to reflect different levels of employer behaviour and culpability. The current penalty regime within which the ATO operates is not consistent with the settings of other areas of taxation administration. The superannuation guarantee charge regime operates largely on a one-size-fits-all basis and does not distinguish between deliberate or repeated non-compliance and inadvertent mistakes.
  • Employers display to avoid superannuation guarantee obligations are closely related to characteristics that are seen in phoenix activity – the Phoenix Taskforce, which may recommend widening the manner in which the ATO is able to use Security Bonds and more readily securing outstanding superannuation guarantee charge debts through Director Penalty Notices.
  • The Government should clarify the law on how salary sacrifice agreements affect an employer’s superannuation guarantee obligations. In particular to, firstly, ensure that employers cannot use an amount an employee salary sacrifices to superannuation to satisfy the employer’s superannuation guarantee obligation; and secondly, to ensure that the ordinary time earnings base used to calculate an employer’s superannuation guarantee obligation includes those salary or wages sacrificed to superannuation. This will ensure that employees receive the full benefit of voluntary contributions.
  • At present, superannuation guarantee is required to be paid by employers within 28 days of the end of each quarter. The Working Group considers that improvements to data visibility are the main priority after which payment frequency could be reviewed.
  • There is merit in departments working more closely to promote conformance with, and performance of, the superannuation guarantee system drawing from the respective roles and expertise of each agency. So some information sharing arrangements will be changed.