The Financial Systems Inquiry was spawned in an environment of fear and risk aversion pervading markets in the wake of the global financial crisis. That genesis has consequences.
While the two key themes of the FSI are competition and funding the Australian economy, there can be little doubt policy makers enacting change based on the report, will be influenced by the events that flowed from the US sub-prime mortgage crisis of 2007, and how it spread to become a global financial crisis.
The risk aversion can be observed in the current debate on bank liquidity, and measures being discussed to “derisk” the major banks’ reliance on home mortgage lending, to open up mortgage lending up to more competition.
Of course, the reason the major banks control over 80% of the mortgage loan market is an effect of the GFC. In August 2007 the big four had a combined market share of 56.8% of the $1.3 trillion mortgage market.
Just two years later, as the GFC hits its peak, market share had grown to 73.8%, and it is now over 80%.
It was the reawakening of fear from the GFC that led debt holders to flee to the balance sheet strength and perceived invulnerability of the big banks.
And that still holds true today, as global markets have yet to fully shake off the fear that the GFC may return, bigger and nastier than before.
A consequence is property mortgages now account for over 60% of the loan books of the big banks, compared to under 50% a decade earlier.
And with home prices continuing to rise, and investors still keen on property as an investment, it’s not a situation about to change.
But just because house prices are rising does not mean buyers are throwing caution to the wind. With the exception of mortgages, household debt has declined since mid-2007, and the buffer against further economic shock bolstered.
According to ABS statistics the trend since the GFC to repay mortgages more quickly than required has continued, with the average mortgage holder able to withstand 24 months of scheduled repayments in the event of reduced income or unemployment.
And alternative sources for a diversification of bank funding is not readily apparent. Corporate Australia is not crying out for debt. Merger and acquisitions activity has been subdued since the GFC, and corporates have concentrated on reducing debt to bolster balance sheets.
At the SME level there has been strong demand for credit but banks across the OECD have been cautious lenders, primarily due to the risk inherent in that end of the market if a downturn eventuates.
While mortgages would certainly be impacted by a large increase in unemployment, Australians are among the safest bet in the world when it comes to mortgage default.
At the peak of the GFC, housing defaults in the US approached 6% while in the UK it reached 2.5%. Australia remained below 1%.
And yet the prime topic on the lips of every regulator on the face of the planet is the same– capital ratios.
FSI chairman David Murray wants to ensure that wherever the global consensus falls on safe levels of capital buffers, Australian banks are deemed to be among the best.
His reason is that Australian banks are still highly reliant on foreign funding, and that the safer our banks, the less likelihood funding will run dry in the event of a global crisis.
How that transfers to policy is yet to be determined. Final submissions on the FSI were due on March 31, and the Treasurer Joe Hockey has yet to bring down a final verdict.
But it is a comprehensive report and will impact the financial system from banking to payments, superannuation to housing. And given the next such report is likely 15-20 years away, it’s a blueprint the Treasurer will need to give thoughtful consideration.
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