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Wednesday, 12 October 2011
Page: 11572


Mr ROBB (Goldstein) (11:33): I rise to speak today on the Banking Amendment (Covered Bonds) Bill 2011. This bill amends the Banking Act 1959 to enable authorised deposit-taking institutions, including banks, credit unions and building societies, to issue covered bonds.

This proposal allows complying ADIs to raise a relatively small portion of their total funds by the issuing of covered bonds up to a limit—as the previous speaker has said—of eight per cent of the total value of the institution's assets. It will provide greater flexibility by increasing financing options for domestic Australian deposit-taking institutions. This will go some way to reducing their exposure to volatile overseas markets.

The proposed use of covered bonds is supported by the coalition, in part because the member for North Sydney first raised it back in October 2010. We have had a long interest in the role that covered bonds may take, certainly in the uncertain international financial climate that we face and given our dependence as a financial sector on wholesale funds from credit markets overseas. The government has lifted this idea, if you like, from the coalition's competitive and sustainable banking system plan. Covered bonds will increase the scope of ADIs to source funds domestically and will reduce their reliance on offshore markets for funding.

There will be an increase in domestic sourcing of funds because the wholesale price will in all likelihood be cheaper using the covered bonds than trying to access funds on international markets. Covered bonds are likely to be mainly used by the big four banks, although the bill does provide for ADIs to enter into an aggregating entity to issue covered bonds. This gives some scope to the smaller institutions to be involved in this market. Nevertheless, it is unlikely that the smallest ADIs will use this funding facility. Any increase in domestic sources of funding for the financial system as a whole, though, is certainly worth while. In the specific case of conventional bonds issued by a bank, Australian law has always required that the bank's depositors have the first claim on the remaining assets of the institution in the event that it fails and that they rank ahead of bond holders. Compared with the traditional claim by depositors on all assets with conventional bonds, the key feature of the covered bonds is that they entail the issuing bank setting aside a pool of assets specifically to back the bond, with this asset pool required to be topped up periodically as needed if the value of the assets in it falls. The value of assets in a covered bond pool must be at least 103 per cent of the value of the covered bonds. In the event of insolvency, the holder has recourse to the pool of assets underpinning the bonds and covered bond holders have first claim on these assets over other depositors. That is the key difference that has been introduced.

Despite that preference now being given to covered bond holders, having first claim on the assets of any institution that might fail, the rights of other holders of debts are protected in this bill. Firstly, the proportion of Australian assets which can be committed to the covered bonds pool is limited to eight per cent. That is a very important component, as we are seeing at the present time in Europe, given that there is a capacity and has been for a long time, as I understand it, to issue covered bonds. What is happening at the moment is that many of the financial institutions, given the parlous financial state of the credit markets in Europe, are issuing covered bonds which are simply being bought by other banks. It is becoming a very circular activity and, in many respects, further undermines confidence and the prospect of the European financial system finding an answer to the crisis that currently confronts it. So it is quite important to put a cap on the proportion of funds that banks can hold which are made up of covered bonds.

Secondly, the Financial Claims Scheme provides a government guarantee for small depositors, currently up to a limit of $1 million and reducing to $250,000 from February 2012. As a last resort, there is a measure where the government could levy the financial sector to protect the depositors in any failed institution. So, on a number of accounts, the longstanding preference given to your normal depositor is protected, I feel, in this bill. Unfortunately, during the global financial crisis this government botched the handling of the government guarantees—that is, the $1 million government guarantee on depositors, which is in the near future to be reduced to $250,000. By providing that guarantee initially to the four big banks we saw a rush of depositors' money flood out of smaller ADIs, regional banks and building societies. We saw some very longstanding and reliable trust funds find that they had a rush on the deposits that they held.

As a consequence, the position in the market, quite contrary to what the previous member has claimed—that there is an increase in competition—is that the opposite in fact happened. The botched use of the guarantees led to the big four banks having a massive increase in their deposits, all at the expense of other financial institutions, and it added further pressure for the amalgamation of the St George Bank that would never have happened outside of the global financial crisis. It has further diminished the competition and further enhanced the position of the big four banks. The government loves to belt the big four banks, but I think it was hoodwinked on this occasion. There was a sense of panic running through the government and on a number of measures, including of course the extraordinary and massive spending that went on as a consequence. In this instance it has materially improved the market power of the big four banks by the way in which it botched the handling of the guarantees.

The government was not satisfied with just giving a preference to the big four in the first instance. We have now seen so many small institutions, particularly some of the trust funds which had been specialising in small and medium business financing for 50 years—they had been around forever, had been very reliable and had very deep experience in the way in which they serviced particular parts of the market—disappear; they have gone forever. In some cases, people are still waiting and still have their deposits frozen. Here we are, some years after the global financial crisis but, because of the way in which the government panicked, gave preference to the big four banks and saw a rush on all of our smaller financial institutions, we still have people who cannot access their own savings. Their funds are still frozen in a number of institutions. So we now see continued tinkering with the guarantees and, again, I think it is going to disadvantage the smaller players in reducing it, as is in prospect, from $1 million down to $250,000.

The big banks have an implicit guarantee already because they are too big to fail. In fact, the government really inferred that by the preference given to the big four banks during the global financial crisis. The government inferred that these banks are too big to fail. Most people would deposit money in all of our big four with that assumption. Those with investments which exceed $250,000 will see no advantage in keeping their accounts with the regional institutions, and I refer particularly to, say, local government. So many local governments have placed money in local regional banks in order to support their local industry and, in this case, their local banks. They might have $600, $700, $800, $900 or $1 million deposited in regional banks. Now, with the reduction of the depositor guarantee to $250,000 and with the big four banks being too big too fail, we are going to see the credit unions, regional banks and smaller players again materially disadvantaged. Their customers and others will walk from them, which is understandable because they will seek to take advantage of the extra layer of implicit guarantee afforded to the big banks.

The other issue, of course, is that when the government provided that million-dollar guarantee it imposed a fee, which was not unreasonable. But the fee for the big banks was 70 basis points cheaper than it was for the smaller institutions. So on several counts during the global financial crisis the position of the big four banks was materially advantaged by the government's actions. There is no case if you are providing a positive guarantee. We were talking about a risk factor, but with the deposit guarantee there is no case for discriminating between the different financial institutions as they have done. It is still unclear what the government will do with the cost in the case of the $250,000 deposit guarantee, but I urge the government to consider not disadvantaging the smaller institutions, because they have already been put under enormous pressure in trying to access funds to keep their activities and their ability to compete with the big banks going.

In relation to covered bonds there is an expectation that investors in this class of asset will be satisfied by a lower interest rate than they would demand for a conventional bond given the greater security they are provided. For this reason covered bonds are often argued to be a way in which banks would be able to raise funds more cheaply and therefore, it is suggested in turn, lend at lower rates. The use of covered bonds as outlined by this bill will positively increase the product range offered by ADIs. It will also cater to a class of investors who would not otherwise consider putting their money into Australian bonds but who might do so if covered bonds with their more secure characteristics were available. In theory the allowance of covered bonds will increase the total supply of funds in the market and certainly the total supply of funds sourced locally, thereby reducing borrowing costs and in turn reducing Australia's exposure to needing to borrow wholesale funds on international credit markets.

There is no doubt that international credit markets will come under increasing pressure. In my view, funds will be dearer over the next few years as Europe seeks to grapple with their massive sovereign debt problem. In particular, the idea that the use of covered bonds by banks would allow them to hold their standard variable home rates lower than otherwise has been put forward in the media as one of the key benefits such bonds would bring were they to be permitted in Australia. While this may be right, I think it should not be overstated. As the RBA has noted, to the extent banks have to commit high-quality assets to back any covered bonds they issue, the average credit quality of their remaining assets will be commensurately lower. Hence the rate lenders will presumably demand for the ordinary bonds that banks issue to obtain the rest of their funding will likely be higher than otherwise, offsetting the lower rates the banks can expect to have to pay on their covered bonds.

Covered bonds are not a panacea, but properly managed they contribute a useful addition to the suite of financial products available to be offered. As such, the coalition supports the bill. (Time expired)