Transcript of Question & Answer Session Big Banks and Financial Stability

Thank you very much for those excellent presentations. We have about 20 minutes for a question and answer session. So, I’d ask you just to put up your hand and pose short, succinct questions and we’ll take them as they come, so. There should be a microphone somewhere. It’s being delivered. Yes. You can speak up.

Ben Potter, Australian Financial Review. Yesterday, the Prime Minister mentioned on a couple of occasions, so it must have been in his points, that property investors needed to note that property, what can go down can go up and that households are carrying high levels of debt and there are risks associated with potential movements in interest rates. And Kevin Davis mentioned today that overseas investors look at Australian banks and see them stocked to the gills with housing mortgages and think, how can that be unquestionably strong, or safe and resilient?

So, this is really a question for Michele Bullock, primarily. Are they wrong? Are they missing something? I mean, are our banks really unquestionably strong when they are so heavily exposed to a housing market that by many assessments, if not all, is over-valued and over-leveraged. Thanks.

Okay. So, let me make a couple of points with respect to housing, generally. We’ve highlighted housing as a risk in our Financial Stability Review. The issue really is not house prices per se. It’s, as you’ve identified, the issue of vulnerabilities of the household sector in particular. If housing prices turn down, what that might mean. And the issue of investors is of particular interest because investors might be more inclined to pro-cyclical. Buying on the way up and selling on the way down. So, they might exacerbate cycles.

But I would highlight one other point, I think, which is that the housing market issue really at the moment is what I’d say, a tale of two cities. It’s about Melbourne and Sydney. If you look at other major cities, you don’t tend to have these large price rises. And there are other reasons for house price rises in these cities, which go back to the very basics of supply and demand. So, in Sydney, we know that we were coming from a position where perhaps supply hadn’t run as quickly as demand over previous years and there’s some extent that we need to catch up. And in Melbourne in Victoria, you’re seeing very substantial population growth. So, demand is growing there as well.

So, I think that as I’ve said, we have highlighted that there are risks associated with high debt levels and income isn’t rising very quickly so debt to income ratios are rising. But, I’d also say that I think, in Melbourne and Sydney there are also some fundamental issues going on. That doesn’t necessarily mean that we’re headed for a housing crash in these cities. So, I think we need to just think a little bit about what else is going on that might be driving some of these moves in these cities.

If I could follow up, as someone who’s been saying that house prices are too high for ten years, I know I’ll be right eventually. I think there are a couple of points that need to be made. One is, APRA and the Reserve Bank I guess, joined in stress tests of the banking sector and they were referred to in the recent APRA paper on it, unquestionably strong. And those stress tests from memory, include a fall in house prices of 40 per cent I think. An unemployment rate going up to 10 was it, or some number like that? I mean, a range of things. I mean, catastrophe. Not just stress test. And under the APRA’s determination of capital requirements that big banks should have, if that stress situation occurred overnight, we know that it’s not going to happen overnight it’s going to be over a period of time and banks can adjust, that the banks would still have enough capital to be well in excess of the trigger point for the bail-in of the hybrid securities.

So, I think, when you look at all of that you have to say, they look unquestionably strong, under the new regime. I think there’s two other things that are worth saying. One is, that the points about household debt are very important, and the allocation of that across households is very important. But I often wonder whether or not actually we’re sort of, looking at the wrong issue. Because if you look at household financial assets, they’ve actually grown as much as household debt.

Now of course, I might be wrong on my interpretation of the statistics. But, I think that’s actually superannuation balances included in there. So the issue that arises is that you’ve actually got households, yes, their net debt hasn’t gone up because they’ve got this increase in the actual net financial assets. The trouble is, all those financial assets are locked away in superannuation and therefore, if you have a situation where people get into problems, they can’t access that to pay off the debts they’ve got. So, I think we have to be careful about just looking at the aggregate gross household debt figures and ignoring the other complications of what’s the structure of household balance sheets both in aggregate but also across the individuals.

I think the other point that’s worth making in all of this, and this comes back to the issue of competition that was mentioned. My understanding is that interest only mortgages are now 40 per cent or something, of the total mortgages. I just can’t understand how banks could … and this comes back to the issue of competition can lead to situations where you end up with financial instability or financial risks. The notion our banks would have just been pushing interest only mortgage loans out the door only 10 years after the Global Financial Crisis. That worries me. Very much.

I just have a question about the bail-in provisions that you say have been implemented in some European countries so this is particularly for …

Could you just speak in the mic …

Sorry. So, with those hybrid securities being triggered in say, Italy, to bail-in some of those banks, have they been successful in doing that? And how successful do you think we’d be here in Australia using bail-in provisions to, I guess, resolve crisis situations. Do you think we’d end up resulting to just taxpayers again fronting most of the burden?

Who are you asking …

Michele.

Me. I’m sure you’ll …

Are you allowed to answer it?

You’re right. In Europe, there has been some examples. In some cases they have been bailed-in. In other cases, and you might be thinking in particular, you mentioned Italy specifically, people were bailed-in but to the extent that they were retail investors the government has tried to shield them somewhat. So, even though there’s these two LAC-like instruments, most countries are still to try and finalise their arrangements. And I think those are the sorts of issues that are going to be important in settling to understand how effective such a regime might be. Can you in the heat of the moment actually bail those securities in and use them for what you need to use them for. Kevin might be able to … Yeah, I don’t know what …

I can go to town on this if you’d like. I think there are real problems in this area. Yes, it’s true, in Europe, in Spain Banco Popular was the, hybrid securities were bailed-in together with the shareholders and the bank was sold to Santander, I think it was or …

Santander.

Yeah, for one Euro. But when you look at what was actually happening, it’s not clear that the bank had a capital problem, but rather there was a run on it. And so, one of the issues there is these things are meant to be triggered if the bank’s likely to become capital deficient. It’s not clear that they were and that might be because the reported capital ratios were just completely crazy. And we all know that the accounting in this, is a critical issue, in this whole area is determine what is the capital ratio. You might have a loan on your books for a $100, it’s actually worth nothing. Your true capital ratio is actually a lot less, because you’re overstating the value of the assets.

So, I think the Spanish one also indicates one of the problems that you’ve got with these instruments. They basically just said, "We’re just going to sell the thing over to Santander. Get rid of it." That wasn’t the original purpose. The original purpose of these things was to facilitate an orderly resolution of the entity. My concern is that if one of the big banks in Australia, any bank in Australia, if APRA said, "We’re going to bail-in the hybrid securities," what’s going to happen? Everybody’s going to run. No one’s going to stay with that bank as a depositor. Even if you’re insured, you’ll probably move. And you’ve got to run and for an orderly resolution, you’re going to have to have the government come in and put a blanket guarantee over the bank to prevent a run. An immediate failure of the thing. On the surface these things look like a really good idea. I think in practice, they’re going to be absolute nightmare.

Two points I’d make. The Global Financial Crisis 10 years ago, one of the problems was too many complex instruments being sold to investors, or complex loans they didn’t understand. What do we got now? We got really complex financial instruments that people can’t value, being sold to retail investors. There’s been 40 billion of these sorts of securities issued and listed on the ASX bought mainly by retail investors. So, we’ve got regulations that are actually inducing banks to issue very complex, impossible to value securities, I would say. And they’re being sold to retail investors. That doesn’t seem to me to be a sensible thing.

The last point I’d make would be that there are two sorts of these hybrid securities. One is what I refer to as an Additional Tier 1 Capital, which are the ones being sold to retail investors. There’s also Tier 2 hybrid instruments, that have been sold primarily to overseas investors or wholesale markets. The pecking order is such that if a bank gets into trouble or looks like getting into trouble and APRA says, "We’re going to bail-in these things," it should be Additional Tier 1 securities that get bailed-in first, before the Tier 2.

Now, just imagine what’s going to happen if we have a situation where APRA and the government say, "We’re going to bail-in all the retail investors who are the self-managed super funds and other retail investors," and the value of their securities are going to go to hell. Probably going to leave the international investors free. It ain’t going to happen. Well, it might. You might be in that position. You might have to authorise it at some stage …

I hope not.

It just seems to me that this is one of those innovations that look good on paper but once you start to really get into it, no. I just think it’s not good.

And I couldn’t possibly say any of that.

So, I had a question from gentleman in the middle of the room and another lady down here at the front. So perhaps we’ll take both of those and allow the panel to respond to them collectively.

I just actually just wanted to give the Shadow Minister an opportunity to respond to Kevin Davis, his assertion that a Royal Commission wasn’t warranted.

Well unsurprisingly, after my presentation I respectfully disagree with Kevin on that point. And I think again, I tried to pose the question in my presentation. Politicians are elected to respond to community issues, community concern and there’s no doubt there’s a substantial issue here that’s been raised across the country. And in coming to this position I think Labor did consider and it was prior of my time in taking this portfolio, Labor had engaged consistently with financial institutions, raising concerns and I think the response at the end of the day by the time we came to this position, was, not enough action had occurred. And that if we were in government at the time was to have a very close look at what was going on. I accept that the regulators are there and they intervene, they have a very full program. I think we can have the discussion around resources as well. But, I think in looking, a Royal Commission would also look at those issues. Are the regulators resourced appropriately? Do they have the right powers? Are they intervening at the right point? It’s not just to solely look at one aspect of the financial system it would look more broadly.

But again, I think if you had to deal with my daily inbox. I mean, at some point you have to accept that there is a genuine issue here and it’s not something that can be just laid back at 2008. It’s a situation of people walking in the door pretty consistently. When I first took the job, I sort of inquired with the banks why they were so opposed to it, because it seemed to me they were saying, "Look, we’re on top of everything. There’s nothing to see here. Where there’s been shortcomings, we’re addressing them. We’re changing our culture. We’re really putting the effort in." And my question to them was, "Well, if that’s the case, what is your major concern?" And really, the only concern they could raise with me was a perception, how it would be seen particularly from overseas, if the government of the day called a Royal Commission into them. And I guess, Labor’s response to that is that, the reputational damage and issues like trust and confidence, that train has left the station.

And that’s actually exactly what we would want to see a Royal Commission do was return that trust, return that confidence and provide the opportunity for all of the issues including how the regulatory system works and whether it works in the best interests of the consumers to be looked at in the most thorough way. But, I accept there’s different opinion on that. I do. I hear that pretty consistently, too.

I was curious. Last night the Treasurer said something about a policy to encourage lenders with low capitalisation. What impact would that have on this situation? He was talking about banks of some sort with very low capitalisation.

I was there and maybe I went to sleep then. I shouldn’t say that, should I. Could it be peer-to-peer lenders?

I wasn’t there, I don’t know. Certainly there’s a lot of debate about, and you mentioned the customer-owned banking associations. I don’t know whether he was sort of, looking to push more from those sort of lenders?

I think I was awake, actually. I think what it was, was as in the UK they’ve allowed small start-up banks and in Australia the government has reduced the minimum capitalisation to call yourself a bank. One of the things on the financial system inquiry we talked about whether we should get rid of the crazy term, Authorised Deposit-taking Institutions, ADIs. Which no one knows what it means outside of Australia. Not even inside Australia. Let them all call themselves banks. And up until a few years ago, a mutual organisation couldn’t call itself a bank. They changed the legislation or regulation to allow those who had $50 million in equity capital to call themselves a bank and now they’ve removed that entirely. So anyone who’s got a licence can call themselves a bank.

I actually thought when you started, I thought maybe you’ve been talking about an alternative form of financing, which is the peer-to-peer lending. Which to me is one of the areas where they don’t need any capital, because they’re just operating a platform connecting you as a person with some money to lend across to a whole lot of potential borrowers. And I see that as actually one of the major potential threats to the banking sector. These new platforms, where sophisticated investors or even unsophisticated investors, can invest directly in a portfolio of loans from the people in this room or wherever and be diversified in that way. Because the platform isn’t taking on any of the credit risk, they don’t need the capital adequacy like a bank does. They have to be strong enough for the platform to survive. It’s a very different type of financing.

Would there be any regulation?

Sorry?

Would there be any regulation?

There would be regulation as per ASIC in the sense of …

ASIC. That’s the sort of thing that ASIC would regulate. And ASIC, in fact, has its regulatory sandbox and that’s the sort of thing that you might anticipate would be in that space.

ASIC’s been struggling, well was struggling for quite a while with how they should regulate these entities because they just didn’t fit into any of these. And they’ve been regulating them effectively as a managed investment scheme. Which I think is not a bad way of doing it. But, I think there’s probably better ways, actually. But that’s for another day.

So, I think we’re about time. I offer the panel if you each wanted to say something quickly each to sum up, about 30 seconds. I’ll offer you that you don’t have to take it.

No. Look, I don’t think I have anything left to add.

Now we know Kevin would want to …

Can I just move closer to Katy in the sense of saying I think ASIC has all of the same, if not more powers than a Royal Commission because it can actually take action itself rather than just recommending action. The benefit of a Royal Commission is that it wouldn’t be the regulators doing the investigating and some part of the whole debate might be about, do the regulators have the power? Did they have the right activities and so on. So there is some merit in an external body as opposed to ASIC. I think if you want to name and shame, ASIC’s got all the powers it needs there.

Okay, well it’s left to me just to ask you to join me in thanking the panel for an excellent discussion.