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Economics References Committee
Effects of the global financial crisis on the Australian banking sector

NAYLOR, Mr Phil, Chief Executive Officer, Mortgage and Finance Association of Australia

CHAIR: I welcome representatives of Mortgage and Finance Association of Australia. Mr Naylor, would you like to make an opening statement?

Mr Naylor : I will refer to three slices of history in the finance industry to demonstrate the point that our submission makes. In 1992 the average standard variable mortgage rate in Australia was 10 per cent, the RBA cash rate was 5.75 per cent and the margin between the two was 4.25 percentage points. There were no non-bank lenders in the market at that stage. The bank market share was 89.8 per cent and the mutuals—that is, the building societies and credit unions—had the remainder of the market, which was 10.2 per cent.

In the next slice of history, in 2005 the average standard variable mortgage rate was 7.3 per cent, the RBA cash rate was 5.5 per cent and the margin between the two had reduced—sensationally, one might say—to 1.8 percentage point. At the same time the mortgage market share captured in a few years by the non-bank lenders had gone from nil to 13.6 per cent. The share held by the banks was 79.5 per cent, with the big four holding 60.3 per cent of that, and the mutuals held a reduced amount of 6.9 per cent.

In 2009, in the depths of the GFC, the average standard variable mortgage rates was 5.5 per cent, the RBA cash rate was 3.25 per cent and the margin between the two had moved out again to 2.3 percentage points. By that time the non-bank lenders' mortgage market share had crashed to three per cent because of the collapse of the securitisation market. The non-bank lending sector is the canary in the coalmine. As it slowly suffocates so does competition. The bank share was 91.4 per cent and the big-four bank share was 81.5 per cent, which had also surged because of the first homeowners boost. The mutuals' share was 5.6 per cent.

By March 2012 the average standard variable rate was 7.54 per cent, the RBA cash rate was 3.75 per cent and the margin between the two was 3.29 percentage points—the highest it had been since non-bank lenders entered the market in the early nineties. The non-bank share was a barely discernible 1.1 per cent. The canary is gasping for breath but no-one seems to have noticed. No-one seems to have noticed that its fate shows the coalmine of the finance banking industry is full of anticompetitive gas. The bank market share at that stage had grown to 92.4 per cent and the big four share was 75.6 per cent, or 79.4 per cent if Bankwest is included as part of the CBA group as it was by then. The mutuals' share was 6.5 per cent.

While I acknowledge that during that period there was discounting by the banks of their standard variable rates, which reduced the actual margin that they earn, the fact remains that while soever the non-bank lender presence in the market is strong the difference between the cash rate and average standard variable rate is lower, and when the non-bank lender presence is weak, as it is now and was prior to 1995, the difference is higher. The relevance of all this is to establish—if it needs to be established—that non-bank lenders are critical, strong competition in the mortgage market.

This is the third occasion since 2008 in which I, on behalf of the Mortgage and Finance Association of Australia, have appeared before a parliamentary inquiry into the banking or lending sector to argue the cruciality of ensuring a more competitive lending sector and the key role of a healthy non-bank sector in achieving that. As the committee will be aware, our detailed submission argues that previous inquiries and government reforms have dealt only with peripheral issues in attempting to facilitate commission in the mortgage lending sector. They have ignored the elephant in the room, as we call it in our submission, that is access to competitive price funding, though I note that Senator Bushby referred to it in proceedings earlier today.

We argue that such access will take pressure off the cost of wholesale funding for larger lenders and provide a source of funding to non-bank and smaller lenders which they currently do not have—that is, a viable and healthy securitised funding market. We argue, as we have done twice before, that such a system operates successfully in Canada, and its key features should be closely examined with a view to adapting them to Australian circumstances. We strongly believe that the implementation of such a program will enhance a more competitive market in Australia to the ultimate benefit of Australian borrowers.

CHAIR: Thank you, Mr Naylor. I note from your submission—and you referred to it in your opening statement—that you have appeared before committees on a number of occasions and have made recommendations in this regard. I do note that this committee did, in its majority report, acknowledge that competitive access to funds was the key issue, and the many recommendations contained in its competition banking report aimed to achieve that. Obviously not all of those have been picked up by government. Nonetheless, I just wanted to put that on the record.

Treasury earlier today told us that the characteristics of the banking market that existed prior to the GFC are unlikely to return as we go through a transition. I asked him whether that meant that the concentration levels we are currently seeing are likely to be retained. He was not absolutely emphatic, but basically he indicated that that is likely, or possible. Treasury also went on to say they believe that, even with those concentration levels, the market is currently competitive, with high levels of competition between the big four and also amongst other players. Your comments in your opening statement and your submission do not seem to suggest that you agree with that. Is that correct?

Mr Naylor : That is correct. I think it can be demonstrated clearly by the fact that the banks in toto—but the major banks in particular—have increased their market share. One would have thought that if competition was working, and working better than it was a few years ago, then the smaller banks, the nonbanks, the credit unions and the building societies would have started to take market share from those major four. It is clear from our submission, which has been based on research, that the interest rates that are being offered by the smaller lenders, the credit unions and the non-bank lenders are noticeably lower than those of the major four, but they just do not have access to sufficient funding to be able to have a critical mass in the market—as they did, certainly in the non-bank sector, pre-GFC. They needed to have only about a 13 to 15 per cent share of the market to have the big four looking over their shoulders to see what they were doing. Now the big four do not need to worry about what the smaller lenders are doing, because they have 80 per cent of the market.

CHAIR: Are you saying that the smaller players are not able to meet the demand they have because they do not have the funds to actually provide? They have a high demand, given that they are out there, as you say, with lower rates. They just cannot fill all the interest they have in terms of people taking out loans through them, because they cannot source the funds. Is that what you are saying?

Mr Naylor : I cannot speak for every individual lender, but I think generally you can say that if interest rates are important to consumers—and we keep hearing that they are—then they would have been knocked over in the rush by consumers to go to them because of their lower rates. But the fact is that whilst they have advertised rates at sometimes a per cent lower than the majors they do not have sufficient funds to be able to make any critical impact in the market.

CHAIR: I am in furious agreement with you that the main issue in terms of competition is providing competitively priced funds to participants so that they can compete. What is the answer? Securitisation markets have dried up. The Australian government has done some good work through the AOFM, with its buying up of RMBS to try to kick-start the market. To some extent that has worked, but not to a great extent. Where is the answer? How can we actually improve access to funds?

Mr Naylor : You are right. The Australian government, in introducing the AOFM initiatives, did the right thing. But these initiatives were always only intended as a temporary measure to try to kick-start the securitisation market. Quite clearly that has not happened. I know I am sounding a bit like a broken record, but we have been pushing the government and the Treasury to look at the Canadian system, because the Canadian system has worked for 30 years, gone right through the GFC and produced something like $100 billion of funds every year, which goes to the major lenders and the smaller lenders equally, such that they have a strong non-bank lending sector, and that provides competition to the majors. All we are saying is, please have a look at the Canadian system; do not just discount it. I am not suggesting that this committee or previous committees have discounted it, because the previous committee did make some recommendations about it. But I have not seen any evidence that that recommendation was taken up and that some detailed analysis of the Canadian system was done in order to see how its key features could apply in the Australian situation. We have looked around the world for examples, and that seems to us to be a shining light that works. But no-one seems to want to grasp it and see how it could apply to Australia.

CHAIR: For the benefit of the committee, what are the key features of the Canadian system that could be applied in Australia?

Mr Naylor : The key feature is that the government guarantees it. The funds that go into the securitised system in Canada have a AAA rating. They produce funds that are lower than any other source of funding except for the price of deposits in Canada. So they are lower than what we have heard many times from the banks in the global wholesale lending market. The margins are much lower. They produce a benefit to investors, because they are pretty close to guaranteed—they are very low-risk investments—and they produce a surplus for the government.

Senator WILLIAMS: Just to add to that, at what cost to government would that come at—to do what you just suggested in terms of the Canadian model?

Mr Naylor : The government makes a profit out of it.

CHAIR: They charge a premium for the guarantee, as we did with the wholesale funding guarantee.

Senator WILLIAMS: Yes. So there is a windfall for the taxpayer if the government makes a profit. The small players in the field get cheaper money to lend out in major amounts, and that provides much better competition in the banking system in Canada. That is what you are saying here.

Mr Naylor : And the investors also get very low-risk funds. A lot of pension funds invest in Canadian mortgage bonds as part of their mandate for investments.

CHAIR: But the risk is to the taxpayer, ultimately.

Mr Naylor : Ultimately it is, but it has been in existence for 30 years and went right through the GFC without missing a beat. One would have thought that if ever it was going to come under attack or into some sort of failure mode, that is when that would have occurred. And only a couple of miles across the border, the US system fell apart, because it did not have the rigour and the robustness about it that the Canadian system has.

CHAIR: Regarding securitisation as a feature of the Canadian banking system, are you aware of how much is actually issued through this?

Mr Naylor : Between 25 and 30 per cent of the Canadian lending market comes from securitised funds. So it is an important part of—

CHAIR: And that is all guaranteed?

Mr Naylor : Yes. The Canadian system is similar to Australia's. They have five pillars instead of four, but all the big banks use securitisation in some large amounts, because it is cheaper than any other source of funds. So they do not have the problem with global wholesale costs that our lenders keep talking about.

CHAIR: Do you have any information on the state of competition in the Canadian banking market?

Mr Naylor : Yes. The banking sector in Canada has about 73 per cent of the market in Canada, compared with 92 per cent in Australia, but it is still a big chunk. The non-bank lenders have about 10 or 11 per cent, and the credit unions have the balance. If you add the credit unions and the non-bank lenders together you have about 27 per cent of the market outside the banking sector, whereas in Australia it is about seven or eight per cent.

CHAIR: And that is probably about the right percentage. You would not want it to be too much, because you want that stability—the larger ones as well as people who can keep them honest.

Mr Naylor : Exactly. I agree with previous speakers; you have to have balance. But I think pre-GFC the government made all the right decisions about fighting the war against the GFC, but not enough preparation for living the peace after the war. We are now in a relatively peaceful period, but no-one seems to have thought about what is going to be the by-product of giving savings guarantees and wholesale funding guarantees to the majors.

Senator CAMERON: Thank you, Mr Naylor, for your submission. It is a very good submission. Perhaps I could take you to page 6 in your submission. Table 1 shows the market share of housing finance approvals. Back in 1992, building societies and credit unions were at their peak—10.2 per cent. Was that because of securitisation?

Mr Naylor : No.

Senator CAMERON: Could you just explain that to me? I was just wondering why it was so high back then.

Mr Naylor : In that period, if you were a borrower the only opportunity for getting a loan was to go to a bank or to go to a building society or credit union. In most of those cases the funding came from deposits. Securitisation did not really come into the market until the non-bank lenders discovered it and used that as a tool for competing with the major banks. Also, they took market share from the building societies and credit unions.

Senator CAMERON: I am just trying to see, in this table, when securitisation kicked in.

Mr Naylor : It was in about 1995, when the non-bank lenders started and made their mark in the market fairly quickly.

Senator CAMERON: But the percentage dropped a bit, to 9.8, as securitisation was implemented. Are you saying that, if securitisation had been there, the percentage of finance approvals from non-bank lenders would have dramatically fallen?

Mr Naylor : Non-bank lenders could not have survived without securitisation, because that was their only method of funding. They would not have existed without securitisation.

Senator CAMERON: I suppose it fluctuated and then started declining again. If you look at that period from 2007 through to 2011, we have a kick up from 6.9 in 2005 and a drop to 5.6 in 2009. Do you have any explanations for those variabilities there?

Mr Naylor : No, not for the building societies and credit unions. I am not sure why that would have been. All the way through they have pretty well totally relied on their deposits as their funding source. I know some of them were into securitisation, but not to the extent that the non-bank lenders, or even the banks, were.

Senator CAMERON: In Table 2 on page 7, is there evidence there that the nonbanks actually helped reduce interest rates?

Mr Naylor : I think there is evidence to show that the rates overall were less than they would have otherwise been. You just have to look at the trend. The graph down the bottom shows that more pictorially. When the non-bank lending share was at its highest, the interest margin between the variable rate and the cash rate was at its lowest. As they lost their potency in the market, that margin started to push out again.

Senator CAMERON: And you say the Canadian mortgage bond approach is the approach that would kick in some more competition?

Mr Naylor : We believe so. As Senator Bushby knows, I have raised that a number of times before. I have never heard anyone in government or Treasury explain why it should not be considered as a possible solution in Australia. I would be happy if Treasury were able to examine it and say, 'Look, it won't work in Australia, for this reason or that reason.' But from all the examination we have done—and we have been to Canada a lot of times and spoken to the banks, small and large, and to the nonbanks and the brokers and the government—everyone seems to think it is a great system. That of itself seems to sell, at the very minimum, the idea that we should give it close attention.

Senator CAMERON: You say it has been there for 30 years.

Mr Naylor : Yes.

Senator CAMERON: Has that been supported by both conservative and Labor governments? I suppose the Liberals are the equivalent of the NDP.

Mr Naylor : Obviously, governments have changed over that 30-year period and the operations have never been pulled back, so I assume both political spectrums have supported it, because it works.

Senator CAMERON: Is there any Canadian Treasury analysis of the benefits of this?

Mr Naylor : I am not aware of any. I am aware of an analysis by KPMG that was taken out at the request, I think, of the Canadian government. That was done in 2008 and I referred to that in our submission. They gave quite a detailed report. Their indication was that it was a very good system and was working effectively. I know that under the charter of the corporation—the Canada Housing and Mortgage Corporation—they have to be externally reviewed every few years to ensure that they are delivering what they are supposed to deliver. I am not in a position to interrogate the Canadian Treasury; I suppose the Australian Treasury is in a better position to do that.

Senator CAMERON: If you get any better luck interrogating the Canadian Treasury than we have from time to time interrogating the Australian Treasury then you have done okay.

Mr Naylor : I share your frustration, Senator Cameron.

Senator CAMERON: Seriously, it is not a matter of interrogating the Canadian Treasury. I was wondering if there are any academic or technical analyses of the benefits of this. That was distinct. Do you reference the KPMG analysis?

Mr Naylor : Yes, I do. It is a very thick report. It was done in about 2008 so it is probably a little bit dated. Nevertheless, it gave the Canadian system a lot of big ticks.

Senator CAMERON: I suppose one of the weaknesses in all these systems is the link to the ratings agencies. You indicated that these bonds are AAA rated.

Mr Naylor : Yes.

Senator CAMERON: I suppose people are a bit jaundiced about the rating agencies and their role in the global financial crisis, and whether you can place any credibility on some of these ratings agencies. Is that an issue at all?

Mr Naylor : It may be at the margin but the AAA rating comes not so much from the bonds themselves but from the government guaranteeing them. The AAA rating is a Canadian sovereign rating. The power of the bonds is based on the power of the Canadian government's AAA rating.

Senator CAMERON: I notice on table 6, on page 18 of your submission, that in Canada deposits account for 58.9 per cent of housing. Is that right?

Mr Naylor : Yes. It is a bit higher than the Australian—

Senator CAMERON: It is a bit higher. It is about seven per cent higher—that is a fair bit higher.

Mr Naylor : Yes, but the important point of difference there is securitisation in the Australian market is one per cent whereas in the Canadian market it is 28 per cent. That is a significant difference.

Senator CAMERON: And that securitisation comes through the mortgage bond area?

Mr Naylor : There are two integrated programs: one is the mortgage-backed securities and the other is Canadian mortgage bonds. The way the system works is that if you have access to mortgage-backed securities you then can buy Canadian bonds. Those two are used to achieve that power of 28.3 per cent in a market.

Senator CAMERON: So this is seen as a socially beneficial program. It also provides a return to government.

Mr Naylor : It was initially designed by the Canadian government to ensure that as many people in the market who could afford it could have access to reasonably priced credit, so it had a social policy aspect to it as well. But it was also to make sure that there was competition in the market by ensuring that the market was not dominated by a large sector but a small number of players.

Senator CAMERON: And they have five major players as distinct from our four.

Mr Naylor : They have five major players. The total number of banks in Canada have 73 per cent of the market whereas ours have 92 per cent. From memory—I would have to check my submission—I think the market share of the big five is in the 50s somewhere. It is much lower than the Australian big four.

Senator CAMERON: It all just sounds a bit like a magic bullet. Is that too high? Obviously it is a bit high but it just sounds too good to be true.

Mr Naylor : I would like to think it is a magic bullet but we have pushed it for a number of years without any success. Maybe there is something in it that the Australian Treasury knows that we do not understand. All I can say is that from all the research we have done—and we have done a lot—it is a system that seems to work. At the very minimum Australia should give it a lot of analysis to see whether there are parts of it, or the whole of it, that will work in Australia.

Senator CAMERON: Would not the argument be—as you get the argument here—that the market should simply determine the outcome in the banking industry and there should be no government intervention. I am not arguing that point but that is the sort of nonsense you would probably hear from some groups in Australia—that this is not an area for government involvement, governments should not be there and it should be simply the industry and the market operating.

Mr Naylor : I think the mantra is that when the market is working competitively then, yes, governments should stay out of it. When it is not working appropriately, as we argue and demonstrate that it is not, then government has a role, not in micromanaging the market but in facilitating a better market. I have heard you ask questions before about more regulation. We would certainly argue that we do not want more micromanagment regulation but we certainly want regulation that facilitates better working of the market. That is what the Canadian system does.

Senator CAMERON: But my argument, in terms of what you describe as micromanagement, is to make sure that individuals do not get ripped off by the banking system.

Mr Naylor : I would certainly support that. I guess, without understanding whatever points you have on that, we would argue that the recently introduced National Consumer Credit Protection Act does that, or is intended to do that. From what we can see, it has been doing that. When we first raised the Canadian issue in 2008, Treasury, the Reserve Bank and the four majors all opposed it on the basis that 'we are just going through a cycle and it will all be better in a couple of years and be fine'. Well, it is not all fine.

Senator CAMERON: 'Let the market work itself through.'

Mr Naylor : Yes. We argue that in a perfect market, or in a working market, that is a good strategy but when the market is not working competitively—and we would argue that it is working less competitively now than it was in 2008 when we made that first submission—

Senator CAMERON: So would your submission be that there are market failures in the banking system?

Mr Naylor : I would say in the lending sector because the lending sector goes outside the banking sector as well. It is not working as a true market—I hesitate to say a 'perfect' market because there is not a perfect market—but it is not as competitive a market as it should be.

Senator CAMERON: Is the lending sector not a core business for banks? You say there is a problem in the lending sector as if that is just a minor role. Surely the lending sector is a core business for the banks?

Mr Naylor : It is. What I was saying was that the lending sector covers more than just the banks. It covers credit unions, building societies and the non-bank lenders. The non-bank lenders are close to our membership and the history demonstrates that whilst they are weak, competition in the industry is weak; whilst they are strong, competition in the industry is stronger. If you can give them access—and I do not mean giving them a free kick or a hand up—along with everyone else to more competitively-priced funds, the market will adjust itself. But it will never adjust itself if it is left to its own device as it is at the moment. To add to that, I mentioned in our submission that if you looked at the changes to the lending sector over the last 30 years, none of those occurred because of the market of its own actions made the changes. The big change was deregulation of the industry back in the eighties and nineties. That then caused some competitive forces—international banks came into the market; the non-bank sector started to emerge. It is strongly arguable from our point of view that nothing really much has happened since then. If left to its own devices, the market does not have a vested interest in innovating.

Senator CAMERON: I suppose, but deregulation is supposed to have led to better competition.

Mr Naylor : I'm sorry?

Senator CAMERON: Deregulation is supposed to have led to better competition but your submission would lead us to believe that it has not.

Mr Naylor : No, it did at that time but in the intervening period the securitisation market around the world died. The Australian securitisation market died not because it was bad or was a good market but because it was just a rounding error in the global system. It suffered from the odium that came from the securitisation market in America. It was as strong as the Canadian market, as a private market, but the additional strength that the Canadian market had was that it was government backed.

Senator CAMERON: Just on that last point, what would be your preference: a rebirthed, if you like, securitisation market or the Canadian model?

Mr Naylor : I do not think there will be a rebirth of the securitisation market unless there is some facilitation to make it happen. The Canadian model is the best example I can see of a way to make that occur.

Senator EGGLESTON: You have talked a lot about the Canadian model and what it might be able to bring to Australian monetary affairs. In your submission you note that some of the recent parliamentary inquiries into banking have focussed on particular aspects of the banking system and not the system as a whole. It has now been some 15 years since the Wallis inquiry. Would you and your group support a wide-ranging independent inquiry into the banking system at this stage? Would that be beneficial for the people of Australia?

Mr Naylor : I think Senator Bushby asked me the same question three years ago and I said, 'Yes, but you had better hurry up because there is not much time left'. My answer now would be the same.

Senator EGGLESTON: So you would like to see a broad-ranging inquiry, which presumably would consider also the Canadian model and the entire banking system.

Mr Naylor : Absolutely, but I would make the point that we made this submission four years ago and a lot of water has gone under the bridge in four years, most of it bad water. If we are going to have a wide-ranging inquiry we need to get into it pretty quickly. I would not want to be back here in 2015 making the same submission and saying to you, 'There is that poor old canary in the gold mine—he carked it in 2013'. Competition in the lending sector now has disappeared and the banking sector has 97 per cent of the market.

Senator EGGLESTON: Thank you. You have made your point quite strongly.

CHAIR: I have a final question on the Canadian system. Do you know whether they charge differential premiums according to who is accessing the scheme. Do they discriminate between the larger, more stable and better rated institutions than those that are less well rated?

Mr Naylor : They have a reverse auction so they say, 'We have $25 billion in the pool' and they invite people to tender for it. The big banks, the small banks and the non banks can all tender for it. There are a lot of requirements around the integrity of the process. No one lender can access more than 25 per cent of the pool so that means the smaller guys can get a chop at it. I think the minimum tender has to be $20 million. To take a point that Senator Cameron referred to before, you have to have skin in the game. This is not a free handout. You have to be able to show that you are part of the system, that you have skin in the game so that you are assuming some of the risk. If you are interested, there are reams and reams of rules about how the system works and the type of loan that is acceptable, who can invest and all that sort of stuff.

CHAIR: Thank you Mr Naylor for that.

Proceedings suspended from 12.29 to 13:31