IMF: Growth Weaker; Australia 2.1%

The latest World Economic Outlook warns of slower growth though sees a possible acceleration later in the year (thanks to the Fed’s recent change in tune!).

Australian growth is forecast to fall to 2.1% in 2019, with CPI at 2% and unemployment at 4.8%. In 2020, GDP is forecast at 2.8%, CPI 2.3% and unemployment at 4.8%.

One year ago economic activity was accelerating in almost all regions of the world and the global economy was projected to grow at 3.9 percent in 2018 and 2019.

One year later, much has changed: the escalation of US–China trade tensions, macroeconomic stress in Argentina and Turkey, disruptions to the auto sector in Germany, tighter credit policies in China, and financial tightening alongside the normalization of monetary policy in the larger advanced economies have all contributed to a significantly weakened global expansion, especially in the second half of 2018. With this weakness expected to persist into the first half of 2019, the World Economic Outlook (WEO) projects a decline in growth in 2019 for 70 percent of the global economy. Global growth, which peaked at close to 4 percent in 2017, softened to 3.6 percent in 2018, and is projected to decline further to 3.3 percent in 2019. Although a 3.3 percent global expansion is still reasonable, the outlook for many countries is very challenging, with considerable uncertainties in the short term, especially as advanced economy growth rates converge toward their modest long-term potential.

While 2019 started out on a weak footing, a pickup is expected in the second half of the year. This pickup is supported by significant policy accommodation by major economies, made possible by the absence of inflationary pressures despite closing output gaps. The US Federal Reserve, in response to rising global risks, paused interest rate increases and signaled no increases for the rest of the year. The European Central Bank, the Bank of Japan, and the Bank of England have all shifted to a more accommodative stance. China has ramped up its fiscal and monetary stimulus to counter the negative effect of trade tariffs. Furthermore, the
outlook for US–China trade tensions has improved as the prospects of a trade agreement take shape. These policy responses have helped reverse the tightening of financial conditions to varying degrees across countries.

Emerging markets have experienced a resumption in portfolio flows, a decline in sovereign borrowing costs, and a strengthening of their currencies relative to the dollar. While the improvement in financial markets has been rapid, those in the real economy have yet to materialize. Measures of industrial production and investment remain weak for most advanced and emerging economies, and global trade has yet to recover. With improvements expected in the second half of 2019, global economic growth in 2020 is projected to return to 3.6 percent. This return is predicated on a rebound in Argentina and Turkey and some improvement in a set of other stressed emerging market and developing economies, and therefore subject to considerable uncertainty. Beyond 2020 growth will stabilize at around 3½ percent, bolstered mainly by growth in China and India and their increasing weights in world income. Growth in advanced economies will continue to slow gradually as the impact of US fiscal stimulus fades and growth tends toward the modest potential for the group, given ageing trends and low productivity growth. Growth in emerging market and developing economies will stabilize at around 5 percent, though with considerable variance between countries as subdued commodity prices and civil strife weaken prospects for some.

While the overall outlook remains benign, there are many downside risks. There is an uneasy truce on trade policy, as tensions could flare up again and play out in other areas (such as the auto industry) with large disruptions to global supply chains. Growth in China may surprise on the downside, and the risks surrounding Brexit remain heightened. In the face of significant financial vulnerabilities associated with large private and public sector debt in several countries, including sovereign-bank doom loop risks (for example, in Italy), there could be a rapid change in financial conditions owing to, for example, a risk-off episode or a no-deal Brexit.

With weak expansion projected for important parts of the world, a realization of these downside risks could dramatically worsen the outlook. This would take place at a time when conventional monetary and fiscal space is limited as a policy response. It is therefore imperative that costly policy mistakes are avoided. Policymakers need to work cooperatively to help ensure that policy uncertainty doesn’t weaken investment. Fiscal policy will need to manage trade-offs between supporting demand and ensuring that public debt remains on a sustainable path, and the optimal mix will depend on country-specific circumstances. Financial sector policies must address vulnerabilities proactively by deploying macroprudential tools. Low-income commodity exporters should diversify away from commodities given the subdued outlook for commodity prices. Monetary policy should remain data dependent, be well communicated, and ensure that inflation expectations remain anchored.

Across all economies, the imperative is to take actions that boost potential output, improve inclusiveness, and strengthen resilience. A social dialogue across all stakeholders to address inequality and political discontent will benefit economies. There is a need for greater multilateral cooperation to resolve trade conflicts, to address climate change and risks from cybersecurity, and to improve the effectiveness of international taxation.

What Should New Home Buyers Expect?

Consumers have more protection when buying a new fridge, than when buying a new property – according to an article in the The Conversation.

Regulation of the Australian building industry is broken, according to the Shergold-Weir report to the Building Ministers’ Forum (BMF).

[…] we have concluded that [the] nature and extent [of problems] are significant and concerning. The problems have led to diminishing public confidence that the building and construction industry can deliver compliant, safe buildings which will perform to the expected standards over the long term.

You can say that again.

Just one of the issues identified in the report, combustible cladding, could affect over 1,000 buildings across Australia. An unknown proportion of these are tall (four storey and above) residential strata buildings. Fears of rectification costs are starting to have severe impacts on the apartment market.

The cost of replacing combustible panels at the Lacrosse Apartments in Melbourne, which caught fire in 2014, will be at least A$5.7 million, plus A$6 million or so in consequential damages. The total cost of replacing combustible panels across Australia is unknown at this point, but is likely to run to billions of dollars.

The Shergold-Weir report identifies a catalogue of other problems, including water leaks, structurally unsound roof construction and poorly constructed fire-resisting elements. Faults appear to be widespread.

A 2012 study by UNSW City Futures surveyed 1,020 strata owners across New South Wales and found 72% of respondents (85% in buildings built since 2000) knew of at least one significant defect in their complex. Fixing these problems will cost billions more.

Regulatory failures are not only “diminishing public confidence”, they have a direct impact on the hip pockets of many Australians who own a residential apartment. In short, building defects resulting from lax regulation are a multi-billion dollar disaster.

How could authorities let this happen?

A web of regulations and standards enacted by governments cover construction in Australia, but this regulation is centred on the National Construction Code (NCC). The Australian Building Codes Board (ABCB), a body controlled by the Building Ministers’ Forum, manages the NCC. The ABCB board comprises appointed representatives from the Commonwealth plus all the states and territories and a few industry groups.

It is such a complicated system that it is hard to identify any government, organisation or person that is directly responsible for its performance.

The NCC is supposed to create “benefits to society that outweigh costs” but it appears the ABCB may have been more focused on the need to “consider the competitive effects of regulation” and “not be unnecessarily restrictive”. (Introduction to the NCC Volume 1; ABCB)

The BMF’s February 8 communique, issued after the fire in the Neo200 building in Melbourne, is straight out of the Yes Minister playbook:

Ministers agreed in principle to a national ban on the unsafe use of combustible ACPs (aluminium composite panels) in new construction, subject to a cost/benefit analysis being undertaken on the proposed ban, including impacts on the supply chain, potential impacts on the building industry, any unintended consequences, and a proposed timeline for implementation. Ministers will further consider this at their next meeting [in May this year].

This suggests the ministers are more concerned about possible impacts on the panel suppliers and the building industry than the consumer. The earliest a ban can take effect is in May. In the meantime, anecdotal evidence suggests buildings are still being clad in combustible ACP.

Thanks to the journalist Michael Bleby, we know governments and the ABCB failed to act in 2010 when presented with evidence that combustible ACP was not only a danger, but was also being widely used on tall residential buildings.

Bleby quoted ABCB general manager Neil Savery as saying neither his organisation, nor any of the states, was aware that builders were using the product incorrectly.

We also know that panel manufacturers, including the Australian supplier of Alucobond, actively lobbied building ministers. At the July 2011 BMF meeting, the ACT representative effectively vetoed an ABCB proposal to issue an advisory note on the use of combustible ACP.

We are entitled to ask why the ABCB and its staff, or the downstream regulators and their staff, did not know about serious fire problems with ACP that the technical press identified as long ago as 2000. The answer will be of particular interest to residents of tall apartment buildings clad in these panels, all of whom are now living with an active threat to their safety.

Consumers are owed better protection

While both Labor and Coalition governments have worked to improve consumer protection for people buying consumer goods, their record on housing, particularly apartments, is awful. While a consumer can be reasonably sure of getting restitution if they buy a faulty fridge, no such certainty exists if they buy a faulty house or apartment.

At the moment, the NCC does not have any focus on providing protection for buyers of houses or apartments. There are few requirements for the durability of components and astonishingly weak requirements for waterproofing. Under the NCC and its attached Australian Standards, particularly AS 4654.1 and 2-2012, a waterproof membrane could last, in practice, five minutes or 50 years.

Given the magnitude of the economic loss, it would be appropriate for the BMF and ABCB board to publicly admit they have failed. Since their appointments in November 2017 and January 2013 respectively, neither ABCB chair John Fahey nor Savery as general manager has remedied the situation. The Shergold-Weir report has not been implemented and the combustible cladding issues remain unresolved. It would be reasonable for Fahey to step down and for Savery to consider his future.

The next federal government should consider what further action should be taken, particularly in relation to individuals on the BMF and within the ABCB involved in the 2010-2011 decision not to issue the proposed advisory note on the use of ACP. Since the ABCB does not publish minutes and none of its deliberations are in the public domain no one knows what actually happened or who did what.

The new board should consider moving residential apartment buildings (Class 2 buildings in the NCC classification) from Volume 2 of the NCC to Volume 1, which controls detached and semi-detached housing. Volume 1 should then have as its overriding objective the protection of consumers.

The downstream regulators should focus on requiring builders to deliver residential buildings with no serious faults and providing simple mechanisms for redress if they don’t.

Surely this is not too much to ask.

Author: Geoff Hanmer, Adjunct Lecturer in Architecture, UNSW

Houses to be hit harder than units in 2019 downturn

Across the eight capital cities, house values are set to decline 7.7% in 2019, a sharper correction than apartments which are forecast to see a 4.3% hit, says Moody’s. Via Property Observer.

House prices have declined over 9% since their peak in late 2017, while apartment values are down around 6% from the peak, according to CoreLogic.

House values in Sydney declined 5.5% in 2018 and are forecast to fall a further 9.3% in 2019. Apartment values are set to decline 5.9% in 2019.

Melbourne’s house price decline has been more accelerated than Sydney’s, and its sharp downturn is reflected in the forecast for its house values in 2019.

Moody’s suggest values will decline 11.4% across Great Melbourne, with apartments to fall 5%.

The worst is over for Brisbane, according to Moody’s, with house values to see a correction in 2019.

There will be strength in East Brisbane, offset by declines elsewhere.

There’s also good news for the Brisbane apartment market, Moody’s forecast. Values are tipped to recover 0.9% in 2019.

It’s not such good news for Perth, where house values are like to decline 7.6% in 2019.

Adelaide’s housing market will continue its stable run, with house values forecast to rise 1% in 2019 after a 1.9% gain in 2018.

Australia has a new National Construction Code, but it’s still not good enough

From The Conversation.

After a three-year cycle of industry comment, review and revision, May 1 marks the adoption of a new National Construction Code (NCC). Overseen by the Australian Building Codes Board (ABCB), the code is the nation’s defining operational document of building regulatory provisions, standards and performance levels. Its mission statement is to provide the minimum necessary requirements for safety and health, amenity, accessibility and sustainability in the design, construction, performance and liveability of new buildings.

Some say the building industry is in deep crisis and broken, that even our entire building regulatory system is not fit for purpose. Consider what has happened, particularly in residential construction. We have had buildings burning, cracking, windows exploding, rooms with intolerable heat stress, rendered unfit for occupation without costly remedial action, class actions against developers, and multi-million-dollar court judgments against consultants and builders.

What have reforms to the old Building Code of Australia (BCA), now the NCC, delivered? Is the new code good enough?

Well, how do you measure performance? We should think in terms of lives saved, heat stroke minimised, costly remedial works avoided, less sleep deprivation and climate-induced respiratory issues, disability access, less bill shock for the vulnerable, and housing that is built to allow ageing in place.

Safety and amenity

Widespread use of non-compliant building materials, and specifically combustible cladding, has been foremost in the minds of regulators. Three years ago, after the Lacrosse fire in Melbourne Docklands, the ABCB amended the existing code. This crucial revision has been carried forward into the new code.

Individually, states have acted on the findings of a Senate inquiry into this area. Last October, for example, Queensland enacted the Building and other Legislation (Cladding) Amendment Regulation 2018.

Investigations into the highly publicised, structurally unsound Opal tower in Sydney found the design – namely the connections between the beams and the columns on level 10 and level 4, the two floors with significant damage — indicated “factors of safety lower than required by standards”.

Just two months ago when the new code was released in preview form, we learnt that a significant number of approved CodeMarks used to certify compliance for a range of building materials are under recall. The Australian Institute of Building Surveyors posted urgent advice: “We are in the process of making enquiries with the ABCB and Building Ministers to find out when they were made aware that these certificates were withdrawn and what the implications for members will be […] and owners of properties that have been constructed using these products.”

Fire safety concerns are driving changes in the code. The new NCC has extended the provision of fire sprinklers to lower-rise residential buildings, generally 4-8 storeys. However, non-sprinkler protection is still permitted where other fire safety measures meet the deemed minimum acceptable standard.

Comfort and health

The code includes new heating and cooling load limits. However, requirements for overall residential energy efficiency have not been increased. The 6-star minimum introduced in the 2010 NCC remains.

The code has just begun to respond to the problem of dwellings that are being constructed to comply but which perform very poorly in the peaks of summer and winter and against international minimum standards. The change in the code deals with only the very worst houses – no more than 5% of designs with the highest heating loads and 5% with the highest cooling loads.

It’s a concern that the climate files used to assess housing thermal performance use 40-year-old BOM data. Off the back of record hot and dry summers, readers in such places as Adelaide and Perth might be surprised to learn the ABCB designates their climate as “the mildest region”.

For well over a decade my colleagues and I have researched thermal performance, comfort and health and improvements by regulation. Our recent paper, based on a small sample of South Australian houses built between 2013 and 2016, demonstrated what has been discussed anecdotally in hushed voices across the industry, that a building can fail minimum standards using one particular compliance option yet pass as compliant using a different pathway.

A building that is not six stars can be built under the new code. In fact, it may have no stars!

Lamentably, there has been no national evidenced-based evaluation (let alone international comparison) of the measured effectiveness of the 6-star standard. CSIRO did carry out a limited evaluation of the older 5-star standard (dating back to 2005). An evaluation for commercial buildings is available from the ABCB website.

Accessibility and liveability

Volume 2 of the NCC covers housing and here it is business as usual, although the ABCB has released an options paper on proposals that might be part of future codes. Accessible housing is treated as a discrete project. Advocates for code changes in this area, such as the Australian Network for Universal Housing Design (ANUHD), have written to the ABCB expressing disappointment.

A Regulation Impact Assessment on the costs and benefits of applying a minimum accessibility standard to all new housing has yet to see the light of day.

These proposals or “options” talk of silver and gold levels of design (there is no third-prize bronze option for liveable housing). Codes of good practice in accessible design have for decades recommended such measures.

It’s all about performance

Some argue that deep-seated problems have developed from a code that favours innovation and cost reduction over consumer protection. There is a cloud over the industry and over some provisions – or should we say safeguards and compliance?

Safety should not be a matter of good luck or depend on an accidental selection of a particular building material or system. New buildings born of this new code are hardly likely to differ measurably from their troublesome older siblings. The anxiety for insurers, regulators and building owners continues.

The National Construction Code adopts a performance-based approach to building regulation, but don’t expect the sales consultant to know the U-value of the windows, whether the doors are hung to allow for disabled access, or if the cleat on your tie beam is to Australian standards.

Anyone can propose changes to the NCC. The form is on the website. Consultants will be hired to model costs and benefits.

Regulatory reforms introduced through the ABCB over the past 20 years have produced an estimated annual national economic benefit of A$1.1 billion. That’s a lot of money! The owners of failing residential buildings could do with some of that cash to cover losses and legal fees.

Author: Dr Timothy O’Leary, Lecturer in Construction and Property, University of Melbourne

A Chance To Hear Harry Dent In Australia/NZ

A couple of weeks back I ran a live discussion with Harry Dent, which was well received. Its still available on replay.

Harry, the world renowned economist, has an interesting perspective on what’s ahead. I always find his views stimulating (even if sometimes I disagree).

I promised to advise the arrangements for Harry’s visit. Today I can release the schedule.

Auckland: Wednesday, April 24th

Perth: Friday, April 26th

Adelaide: Sunday, April 28th

Melbourne: Tuesday, April 30th

Sydney: Wednesday, May 1st 

Brisbane: Thursday, May 2nd 

Normally tickets to these events are on sale for $97, but I am able to offer up to two complimentary tickets each to DFA followers as a thank you for supporting us.

But be warned, I’ve only been given a total of 50 complimentary tickets to give away and once they’re gone, they’re gone.

Simply click here to secure your complimentary tickets:

https://nz561.isrefer.com/go/gh2019/ormn/

Want to know more about Harry’s sunspot theory – now’s your chance?

NOTE: DFA is not endorsing the events, or receiving any commercial benefit from mentioning Harry’s visit. Its simply a gift to those who may be interested – act quickly!!

I may see you there!

IMF Finally Gets With The OZ Household Debt Problem

Until now the IMF has been warning in general terms of the risks from our housing sector, but in a recent working paper – Household Debt, Consumption, and Monetary Policy in Australia, they take the issue significantly further.

Within its 39 pages, the paper discusses the evolution of the household debt in Australia and finds that while higher-income and higher-wealth households tend to have higher debt, lower-income households may become more vulnerable to rising debt service over time.

Then, the paper analyzes the impact of a monetary policy shock on households’ current consumption and durable expenditures depending on the level of household debt. The results corroborate other work that households’ response to monetary policy shocks depends on their debt and income levels. In particular, households with higher debt tend to reduce their current consumption and durable expenditures more than other households in response to a contractionary monetary policy shocks. However, households with low debt may not respond to monetary policy shocks, as they hold more interest-earning assets.

And we should say at this point that IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Household debt in Australia has increased to comparatively high levels over the last three decades, a period during which housing prices also have risen rapidly. By end-September 2018, the ratio of household debt to household gross disposable income reached 189 percent, among the highest in advanced economies. High levels of household debt are widely considered to be risky, as they can amplify the impact of external and domestic shocks and, thereby, increase a country’s economic and financial vulnerabilities and pose risks to financial stability. In addition to amplifying financial and economic vulnerabilities, high household debt can also intensify the ongoing corrections in the housing market in Australia.

The macroeconomic impact of and the risks from household debt depend not only on the average debt level but also its distribution across households. Higher-income households might be at lower risk of debt default than lower-income households, for example. The latter might also be more likely to be finance-constrained in times of debt distress. From a monetary policy perspective, a key consideration is the extent to which household debt levels and distribution affect monetary policy transmission.

Household debt in Australia has been rising faster than household disposable income for the past three decades. As a result, the household debt ratio has risen to one of the highest levels among advanced economies.

The housing boom has also played a significant role in the rapid accumulation of household debt. High housing demand due to income and population growth in conjunction with relatively inelastic supply have pushed up house prices, and expectations of future capital gains has encouraged investment demand for housing.

The interaction between the long-term upswing in housing prices and relatively easy mortgage financing has therefore led to the buildup of a high level of residential mortgage debt.

High household debt also reflects the preference for home ownership and housing investment in Australia. Housing debt at 140 percent of household disposable income accounted for about three-quarters of household debt outstanding as of September 2018, with owner-occupied housing debt accounting for a relatively stable share of about one half.

The rise in the share of investor housing debt since 2000 has also contributed to the fast increase in household debt, while other personal debt has remained broadly stable (one quarter of household debt outstanding) at about 46 percent of household disposable income since 2000.

For financial stability, as well as monetary and macroprudential policies, it is not only the level of household debt that matters but also the speed of debt accumulation or leverage increases, the extent of leverage, and, more importantly, the distribution of debt.

The IMF uses old data, from the HILDA survey, which has been running with annual frequency from 2001 to 2016 to make their assessment – clearly the debt position has deteriorated since then, yet they show that debt has grow across the cohorts and segments. The RBA analysis has the same fundamental flaw.

The paper finds that high debt exposure is more prevalent among higher-income and higher-wealth households. Nevertheless, the debt exposure of lower-income and more vulnerable households has also increased over time, and thereby more exposed to risks from rising debt service. The presence of over-indebted households at both low- and higher-income quintiles suggests that macro-financial risks have increased, suggesting a need for close monitoring.

Despite the high debt level, households’ debt service burden has remained manageable due to historical low mortgage interest rates and given that financial institutions assess mortgage serviceability for new mortgage lending with interest rate buffers above the effective variable rate applied for the term of the loans. However, downside risks on debt service capacity and consumption remain with regards to a sharp tightening of global financial conditions which could spill over to higher domestic interest rates.

The empirical analysis investigates the transmission of monetary policy shocks to the current consumption and durable expenditures of households with different debt-to-wealth ratios. With reasonable assumptions and using the large sample of households available in the HILDA survey for 2001-16, the results corroborate that households’ response to monetary policy shocks will vary, depending on both their debt and income levels.

In particular, the results suggest that households with high debt tend to reduce their current consumption and durable expenditures relatively more than other households in response to a contractionary monetary policy shocks. At the same time, households with low debt may not respond to monetary policy shocks, as they hold more interest-earning assets and thereby can smooth their consumption using the higher interest income, suggesting that for these households, the income effect dominates the intertemporal substitution effect.

The results of the analysis suggest that, with a larger share of high-debt households and given their high responsiveness to a monetary policy shock, it may take a smaller increase in the cash rate for the RBA to achieve its policy objectives, compared to past episodes of policy rate adjustments. It corroborates recent RBA research, which suggests that the level and the distribution of the household debt will likely alter monetary policy transmission, in other words, more bang for the buck. By responding gradually, the RBA can still meet its mandates.

The implications of higher household debt for monetary policy have also required that the RBA addresses this challenges in its communication. The results of the textual analysis show that the RBA’s communication has increasingly focused on the impact of household debt on monetary conditions and financial stability over the past decade, consistent with the rise in debt-to-income ratios. Markets have also started to take into account household debt in their assessment of monetary policy and market expectation analysis. Therefore, continuing with a transparent and strengthened communication strategy on issues related to the household debt and household consumption will further improve predictability and efficiency of monetary policy in Australia.

My take is the household debt burden is larger, and more exposed to potential risks than many accept. Nothing new perhaps, but the IMF highlighting the issues is one more piece of the too-high debt narrative!

And according to the AFR, in an exclusive interview, the International Monetary Fund’s lead economist for Australia, Thomas Helbling said Australia’s housing market contraction is worse than first thought, leaving the economy in what he called a “delicate situation” that boosts the need for faster infrastructure spending and even potential interest rate cuts.

Australia’s housing market contraction is worse than first thought!

Mutuals Can Now Join The Capital Raising Dance – But What Of The Risks?

The latest amendments passed into law last week extends the capital raising capabilities of mutuls in Australia, via mutual capital instruments (MCIs), which Moody’s rates as “credit positive”.

However, we are concerned by the extension of “financialisation” into the mutual sector, the potential higher risks it introduces as players compete for returns to investors, and the complexity of the financial markets they have to engage in. This could be a disaster.

Frankly, this just continues the journey away from meat and potato banking and is a further illustration of the myopic views of the regulators, especially APRA.

Rather than extending these additional capital channels, we need banking structural reform to contain the over-risky sector. This is the wrong strategy at the wrong time (especially as the housing sector tanks).

Anyhow, this is what Moody said:

On 4 April, Australia’s parliament passed the Treasury Laws Amendment (Mutual Reforms) Bill 2019, which amends the Corporations Act 2001 to allow mutually owned institutions to issue capital instruments. The development is credit positive for mutuals because it will enhance their ability to support growth, invest in technology innovation and, over time, will also strengthen their competitiveness.

In particular, the amended Act introduces a definition of a “mutual entity;” clarifies that demutualisation rules can only be triggered by an intended demutualisation and not by other acts such as capital raising; and creates mutual capital instruments (MCIs) that are specific to the mutual industry to raise equity capital.

MCIs will provide mutuals with an additional capital channel to respond to growth opportunities, supplementing the retained earnings they have relied on to date. This additional capital channel is particularly important for mutual authorised deposit-taking institutions (mutual ADIs, which include mutual banks, building societies and credit unions) at a time when their profitability is under pressure. Pressure on profitability stems from competition for lower-risk owner-occupier mortgages with principal and interest repayments, the mutuals’ core products. This elevated competition stems from a number of factors including reduced overall loan growth; a reduced demand for investor mortgage loans in the face of potential changes to negative gearing and capital gains taxes; and tightened underwriting criteria at the major commercial banks as a result of public scrutiny during Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

Additional capital options will also help mutual ADIs build the scale and efficiency they need for technology investment, which is particularly important at a time when banking services are rapidly becoming technology-based. Compared with mutual ADIs, the large commercial banks have more resources to develop or acquire innovative products, digitise processes and integrate new technologies into their business models. Technology-driven financial firms (fintechs) are seeking entry to banking, while the Australian Prudential Regulation Authority (APRA) has established a framework that allows new entrants to begin operating at an earlier stage in their licensing process than previously. These new entrants are currently small and subject to regulatory constraints in taking deposits
and making loans. In most cases they have not yet built up a retail customer base of meaningful size. However, they could grow to challenge incumbents, particularly small-scale ones like the mutual ADIs, over time.

We do not expect mutual ADIs to swiftly ramp up their issuance of MCIs because their already-strong capitalisation and the current low loan growth environment are likely to reduce their need for additional capital. Mutual ADIs’ average Common Equity Tier 1 (CET1) capital ratio is well above that of the major commercial banks, which is itself strong by international standards. Moreover, APRA has set a 25% cap on the inclusion of MCIs in CET1 capital and has also capped the annual distribution of profit to holders of MCIs at 50% of a mutual institution’s net profit after tax for the year in question.

The prospect that the issuance of MCIs will remain limited will reduce the risk that mutual ADIs will significantly increase their risk profiles in an attempt to generate greater dividend returns for MCI holders. Mutuals will need time to amend their constitutions and build market recognition for MCIs. The experience of mutual banking peers in the UK also suggests that the process will be gradual. In the UK, mutuals have been allowed to issue core capital deferred shares, similar to MCIs, under the Building Societies (Core Capital Deferred Shares) Regulations 2013, but few have done so to date. We expect that Australian mutual ADIs that already have a strong investor base in the debt market to be in a better position to issue MCIs.

The sales culture at the heart of wealth management misconduct

Industry insiders have revealed why banks are distancing themselves from wealth management and how their actions will reshape the Australian financial services sector; via InvestorDaily.

There are a number of reasons why the big four have decided, to varying degrees, to put a ‘for sale’ sign on their wealth management businesses. 

Some major bank chief executives have run a ruler over their advice businesses and seen poorly performing divisions that just don’t provide enough margin for the group’s bottom line. 

Others, like Westpac CEO Brian Hartzer, have seen the “writing on the wall” and the mountain of increasing compliance that must be scaled to make advice operational, let alone turn a profit. 

But it may also have been a strategic play based on negative sentiment, bad press and the misguided belief that commissioner Hayne would propose an end to vertically integrated wealth models.

“What it looks like the banks have done in most cases, or in some cases, is they’ve picked up their vertically integrated business, which consist of advice and other products, and have looked to distance themselves from that by either demerging or selling the wealth business,” Lifespan Financial Planning CEO Eugene Ardino said. 

Speaking exclusively on the Investor Daily Live webcast on Wednesday (3 April), the dealer group boss said the banks aren’t actually dismantling their conflicted businesses – they’re selling them as bundled, vertically integrated models where product and distribution sit under the same roof. 

“That’s not dismantling vertical integration. That’s really them trying to distance themselves from wealth management. Whether that now goes ahead in some cases remains to be seen,” he said. 

“Perhaps what could have happened is some sort of recommendation around how to limit vertical integration or how to control it. 

“The issue you have is when you take a business that’s focused on sales and that business takes over as the dominant force in a company that also provides advice, then sales wins. I think that’s natural. Perhaps if they had started there, that could have led to some moderation of vertical integration.”

The royal commission hearings, more than anything, were a targeted attack on the sales culture of large financial institutions, many of which repeatedly defended their models as profit-making businesses, often beholden to shareholders. 

“In product businesses, their job is to sell. That’s fine. There’s nothing wrong with that. But if you’re putting an adviser hat on, there needs to be some separation. That’s an issue of culture,” Mr Ardino said. 

I haven’t seen some of the employment contracts of the advisers from some of the groups that got into trouble, but I would venture a guess that a lot of their KPIs talk about new business rather than retaining business and servicing clients.”

Fellow panellist and Thomson Reuters APAC bureau chief Nathan Lynch said that despite Hayne’s failure to propose banning vertical integration in wealth management, the model will ultimately be dismantled by market forces. 

“Hayne points out that a lot of the dismantling of the vertically integrated model comes down to the fact that it’s just not profitable. You have an environment where vertical integration will be dismantled to some extent by competitive forces and by technology,” he said. 

“Servicing the vast majority of client is going to become very difficult. Most businesses are starting to pivot to the high end. I think we need to view technology in advice as a positive, as an enabler.”