As I suggested in my article last week, the days when interest rates are dictated by the RBA appear to be over – at least for now.
During the week, a couple of financial earthquakes – which had been predicted previously by some in the media – occurred. Namely, Moody’s downgraded the long term debt of Aussie banks and the Federal Government passed legislation to impose the Bank Levy on banks last week and State Governments are also looking to line up to re-introduce Financial Institutions Duties (something they agreed to abolish as part of the deal to introduce GST almost two decades ago).
If that wasn’t enough, APRA is shortly due to announce further capital requirements for banks against their mortgage books.
In-case you’re wondering how this will affect you let me explain.
Two of the above will affect your home loans directly. The bank levy and the credit downgrade. These will increase the costs banks pay on their liabilities (what they borrow to lend to you).
The third will affect the amount of capital that banks raise.
Given that banks – like all other businesses – are judged by how efficiently they use capital to continue to attract it, they will have to ensure that their returns on that capital are consistent with how they’ve previously performed.
In other words, they’ll have to raise rates.
Now, you may be forgiven for thinking that the Government will not allow them to do any of that. You’d be mistaken.
One of the three horsemen of this financial apocalypse (ok, I’m exaggerating) is being slapped on the banks by the Federal Government (the bank levy). Another is being imposed by APRA (a regulator that reports into the Federal Treasury – in other words the Federal Government.
You may have read during the week some equity analysts were saying that the reason that Australian banks are so loaded with mortgages (the reason for the Moody’s downgrade) is that they only have two sectors to lend to – Mortgages and Resources.
That type of commentary is difficult to understand and should be ignored.
The reason Aussie banks have dropped the ball on diversifying their loan book is they have preferred to avoid any non-property risk and thus have put in place processes that are so heavily reliant on property as to exclude all other forms of security.
Let me give you a couple of scenarios that we showed one Aussie bank last week:
Scenario 1 is a single mother from SW Sydney who is reliant on Welfare to make ends meet. Her father is building a house for her and she requires a loan of $300k in total and she will be a home owner (which will be her sole asset). This loan was approved immediately by the bank.
Scenario 2 is a very prominent businessman with zero personal debt. With annual income in the many millions of dollars (from many sources) and a net worth in the tens of millions. He had just acquired a property for around $3M and wanted to borrow against the property – even though he could pay with cash.
The same bank that immediately approved Scenario 1, said they would struggle with Scenario 2 because it wasn’t straightforward. It didn’t fit within their process driven model. The borrower had too many sources of income.
We took the transaction to a different bank and are awaiting approval as this article is being written.
These two examples are not unique to this week. There is something very broken inside our financial system and it has nothing to do with mortgage lending. It has to do with why our banks have stopped lending to other sectors without property security (namely, small businesses that have a solid and consistent cash-flow).
This happened post GFC. So why is it different this time? That’s an easy one to answer and there are a few reasons for it.
- Firstly, banks didn’t run into a revenue hole post GFC (as they normally would in an economic downturn) – thanks to the Government guarantee favouring the big four.
- Secondly, the banking regulator, APRA, became more militant about over-enforcing rigid interpretations of Basel 3.
- Finally, over time banks realised that if they just kept lending against real estate security what was the need for all those talented and expensive bankers that understood sexy structures. They got rid of a lot of that talent. With that they lost the ability to evaluate risk. Compounding that problem is the fact that they’re not training any new bankers in that lost Jedi art of structuring transactions.
So where to from here?
Two things need to happen.
- If banks are to enjoy the explicit support of the Government, they need to fuel our economy and start expanding their loan book beyond real estate. This shouldn’t happen at the expense of real estate. Most senior bankers that we speak with understand this way of thinking but are handcuffed by current regulatory requirements.
- The bank levy should not be imposed on liabilities as it is regressive and will only serve to stunt growth of banks – and by extension – the economy. It should be imposed gradually on the mix of lending that banks have in their loan books. For example, after an adjustment period (say five years) banks should be taxed for having more than say 40% in any one sector and overlay it with a liability quantum (obviously percentage of exposure would vary from sector to sector and could be determined by APRA). The ABA would do well to propose such a plan if they want to avoid a disaster. The Government should re-think the bank levy as it is designed by bureaucrats and not by people who rely on capital/debt. If you impose a tax on banks’ liabilities, they will simply reduce their liabilities and by extension the amount that they lend out. If, as I propose, you only tax them if they favour a particular sector, it forces banks to diversify their loan book and thus benefits the wider economy and diversifies banks’ exposure away from a single sector. The increased taxes collected from businesses in the wider economy should offset (outweigh) any bank levy foregone. Just a thought.
This Week’s Top Policy Changes
Wetspac increased owner-occupied interest-only rates by 34 basis points to 5.83 per cent and investor interest-only rates by 34 basis points to 6.30 per cent.The group also announced an 8-basis-points reduction in variable interest rates for customers paying principal and interest on their owner-occupier home loans. This will take the standard variable rate for these owner occupiers to 5.24 per cent.These changes are all effective from 30 June 2017. Westpac joins many other banks in raising their rates to comply with APRA imposed regulatory rate rises.
Given we don’t deal with Westpac, there’s no danger of us placing a loan with them. We can do much better. Call us.