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

GRAY, Mr Richard, Executive Director of Regulatory Reform, Group Finance, Westpac Group

TATE, Mr Jim, Acting Chief Operating Officer, Australian Financial Services, Westpac Group

Committee met at 9:01

CHAIR ( Senator Bushby ): Welcome. I declare open the second hearing of the Senate Economics References Committee's inquiry into the post-GFC banking sector. This inquiry was referred to the committee by the Senate on 14 March 2012 for report by 31 October 2012.

The committee has received over 150 submissions, which are available on its website. These are public proceedings, although the committee may determine or agree to a request to have evidence heard in camera. I ask any photographers or cameramen who may arrive to follow the instructions of the committee secretariat and to ensure that senators' and witnesses' laptops and personal papers are not filmed.

I remind all witnesses that, in giving evidence to the committee, they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken and the committee will determine whether it will insist on an answer, having regard to the ground which is claimed.

If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may of course also be made at any other time. I remind members of the committee that the Senate has resolved that departmental officers shall not be asked to give opinions on matters of policy and shall be given reasonable opportunity to refer questions to superior officers or to a minister. This resolution only prohibits asking for opinions on matters of policy and does not preclude questions asking for explanations of policies or factual questions about when and how policies were adopted. I now invite you to make an opening statement.

Mr Tate : I would just like to make a couple of points. Firstly, on banking more generally, obviously Westpac has continued to provide credit and be a central part of the banking functions throughout this crisis period. We regard the prudential regulation under which the Australian banks have operated to be one of the main contributing factors to the stability of the system during the past three to five years. Secondly, there are significant international regulatory changes afoot and these changes are quite understandable and are directed towards the safety and soundness of the system more generally and therefore we would support them. But we would also underpin that when one is seeking a reduction in risk there will be a cost involved. So as long as everyone is aware of what those costs are and how they are derived, then we fully support the regulatory changes which are coming down the pipe.

Thirdly, without any shadow of a doubt, funding costs are the most substantial issue that the banks have faced in the past three to five years. The issues continue and we are in the midst of quite a profound structural change in the way that banks are funded and how they fund themselves. This situation has gone on probably longer than many of us suspected it would and it has certainly become more entrenched as a structural issue rather than a passing pricing issue. Among the strategic issues that we have to confront, without any shadow of a doubt, that is the main one.

The last point is that, on borrowing and lending practices more generally, there has not been any change in the credit standards applied by Westpac or, I would suggest, by the major banks. There have been structural changes in the market where more finance company oriented lenders and higher risk lenders have found the going particularly tough. There has been structural movement of those functionaries out of the market or to a reduced capacity in the market. But, as far as Westpac is concerned, there has been no specific change to the lending practices or the underwriting standards over that time. Those are the main points I would like to make.

CHAIR: Thank you for that. I will start off with a question about bank funding costs. At the inquiry of this committee into the state of competition in the banking sector your CEO, Mrs Kelly, stated that her best guess about when the increase in funding costs would peak would be about 18 months from then, which would be about mid-2012. The evidence that has so far come before this committee suggests that has not happened. Is that correct?

Mr Tate : No. That certainly is the case.

CHAIR: She did say that it was her best guess. I am not criticising her but, at that point, it appeared—

Mr Tate : And I would have agreed wholeheartedly with her at the time. The two biggest issues that have flowed on from there have been the Greek situation and, more importantly, the recent Spanish situation.

As you know, about 30 per cent of the money we raise comes from offshore markets. We are a price taker in those markets and the price of credit in those markets not only has stayed high but is extremely volatile. In fact, if there were an issue that really underpins the riskiness of it, it is more the volatility of the price rather than the absolute level of it. As an indication, we generally borrow around the three- to five-year term in those offshore markets and we would probably be paying about 1½ per cent over the 90-day bill rate. The 90-day bill rate is about 3½ per cent, so in the order of five per cent. We probably would have paid higher than that back when Gail made those comments. But that 150 has moved from being, say, 1¼ per cent up to 2¼ per cent and back and it has kind of settled down in the past couple of weeks around that 150 mark. Any fear that Spain would not repay or that the situation might flow on into Italy will have a profound effect on that.

CHAIR: One concern that the three big banks have raised is why the spread has increased over the official cash rate. With respect to the wholesale funding side of it, deposits are up for a number of reasons: all banks, big ones and small ones are competing vigorously for deposits, which makes it tougher for mutuals who traditionally have relied almost entirely on deposits.

The third factor is the change in the mix, which has partly been brought about for strategic reasons and partly because of regulatory requirements with liquidity and so forth. Deposits will continue for as long as that continues. Wholesale funding is volatile and that depends on factors outside Australia. But with respect to the mixed one I would have thought that banks are going through a transition and you will arrive at a new point in terms of the mix of funding. Is that likely to occur at any point soon where you actually do arrive at that and then that will remove the volatility? At least on that path a greater nexus will return with the movements to the official cash rate.

Mr Tate : That is a good question. Let me answer it in two ways. We are actually talking about two mixes—the mix between the retail funds and the wholesale funds which, as I indicated, is about 30 per cent at the moment. We would want to have that number lower. Obviously, we do not want to be exposed more than possible to the offshore market. So the aim is to get that deposit mix higher as an overall proportion of the liability mix. Let us say at the moment that it is around 70-30; we are driving towards making that 75-25 and then 80-20. In a country our size we will never get to 100. We are always going to be an importer of capital because so much of our balance sheet is directed towards quite substantial investments, just like the current account situation. Then there is the mix issue within the deposit market. We are seeing here in the deposit market a growth in the 'at call' and online savings, which are quite a high rate and quite volatile, and then the term deposit market, which has been quite traditional. That is driven by a couple of things. Firstly, you have the overarching issue of people demanding deposits at the short-term end, mostly characterised by names such as ING and Rabobank. They are offering very attractive rates and they attract a rate-seeking group, which is a competitive arrangement. Then you have this massive whack of term deposits. That is where the regulatory issues from overseas will come into play. Obviously, the regulators say: the more stable or the greater proportion of mix you have in that stable base, then the safer your bank will be. I have no trouble with that as a theory. So there is a premium associated with trying to get term deposits because, from a regulatory perspective, they will be regarded as a much more stable source of funding.

One of the mix issues we have to address is: how do we get that stable funding base, even within the overall retail deposit base, higher than what it is at the moment? So to give you an indication, probably around half our deposit base is in that pure term deposit stuff, with quite an average maturity of about six months. Then we have about a quarter of it in the highly volatile, at call, online savings sorts of issues and then about another quarter of it is float and money sitting in cheque accounts and stuff that is used for the transactional mix. Our aim would be to get that term deposit up around 60-40, maybe even slightly higher. That is attractive to us because we need it for the regulatory arrangements. How we get there, whether it is by finding new sources of deposits or paying for them, will be the competitive issue that will play itself out over the next couple of years.

Mutual funds and all those guys will face exactly the same arguments. Just taking the wholesale thing off the table and looking at their retail stuff, they will have the same mix issues within their liability bases as well.

CHAIR: I am asking these questions because of the relationship between the official cash rate and lending rates. Obviously, the net interest margin or the spread between your costs—and we have seen the official cash rate has fallen faster than your costs have fallen, so that spread is relatively higher, even though your absolute costs have probably fallen. I was talking to Treasury yesterday. With respect to where you are heading in terms of greater reliance on deposits, once the spread is settled will that lead to a greater nexus between the official cash rate and your lending rates, given that deposit rates at their core are fundamentally influenced by the official cash rate?

Mr Tate : There is a lot of comment about using the cash rate as a base and I have no trouble with that. But it is a pretty recent connection and you can draw a line between connection to the official cash rate and the volatility in the wholesale market. For that period, say mid-1990s to mid-2000s, where wholesale markets were cheap and freely accessible then it was completely rational to say, in terms of building your price for a mortgage, you would start with the cash rate and add the credit risk and on you go. It is really the volatility element above that that has blown that argument substantially out of the water. As you would anticipate the volatility reducing then you would have more confidence in base rates, which essentially for a bank are the RBA cash rate and the more-than-90-day bill rate—the 90-day bill rate is more of an indicator, really. You would start to get that as a pretty regular and transparent baseline from which to price credit going forward. There is a direct line is that liquidity premium, for want of a better term, associated with volatility. Until it starts to crunch down, which will only come with stability in the global system—

CHAIR: Volatility really only applies to wholesale markets.

Mr Tate : No, there are two—

CHAIR: The competition impact is driving higher costs for deposits, but they are not impacted so much by that volatility. They are more driven by domestic competition.

Mr Tate : There is a connection, because we go back to the mix argument. In 2008 the Australian banks were running at 50 per cent domestic and 50 per cent offshore. We said to ourselves we were too risky a proposition for people to invest in with this base and we had to change this base. That is why all the banks have driven to 60-40 and on to 70-30. The obvious way that plays out is that if the banks cannot go offshore for the money and can only go onshore for the money and still have to lend then the only way to position themselves in the local market is to pay up for it, and so deposit rates went through the roof. It is not a direct causal link, but there is a flow-on due to the mix issue.

CHAIR: But once that mix is settled and there is a greater reliance on deposits then I would have thought that the volatility, in terms of the difference between loan rates and the official cash rate, would or should settle. Your submission goes through Basel III and a number of international regulatory changes. You say you understand where the international regulatory changes come from and the rationale behind why they are happening, but they will come at a cost. Has Westpac made any estimates of what that cost will be in a cumulative sense?

Mr Gray : No. We do do analysis on capital and some work on that. What needs to be kept in mind is we are in the middle of these reforms and we do not have final rules on many of the aspects of Basel III. For example, on liquidity which is a significant factor we have a draft standard and regulations. The liquidity standard is going through a review at the moment and we are expecting some recalibration of some components of that, at both the numerator and denominator level. The new ratios that have been introduced are expected later in the year. But that standard is not to be finalised until some time in 2013, for example. The ability to calculate a cost on a whole raft of reforms is almost impossible.

CHAIR: You cannot put a number on it, but you say in your submission: 'The impacts of the components of Basel III are therefore unidirectional and cumulative, increasing the cost of while constraining the capacity for credit provision'. Is the increased cost substantial or negligible? Is it a noticeable cost?

Mr Tate : The rules will work by stating if you have high-risk deposits, online deposits and the like, you have to keep a certain percentage of that in liquid assets to cover in case something goes wrong. Let us say we have $100 of online deposits. Under the rules you have to keep $30 of that in highly liquid government securities and the like. The cost comes from the rule stating that for the $100 you have as a deposit, and let us say you are paying five per cent, on the $30 of liquid securities you have you are probably earning half a per cent less than that because it is in highly liquid government securities. The cost is the difference between what you have on the deposit side and the low government yield on the other side, so the 50-point difference which is what the drag is. If you have that drag then other assets, other forms of borrowing, are going to have to pay for that gap. That is where the cost comes in.

CHAIR: I accept there will be costs, but I am trying to work out whether that cost is substantial and will end up being paid for by consumers in a noticeable way. The RBA in its submission says that the cost of Basel III will be negligible.

Mr Tate : We do not know yet, but the more stable deposits I get the less the cost is going to be. There will be a whole range of things and it depends what negligible means. I would have thought there would be a couple of points in it.

Mr Gray : We have to increase the amount of capital and the quality of capital which is more expensive. We also have to have a fairly profound shift in our liquidity aspects and requirements in terms of how much we have to apply lower-yielding assets. Basel III is one aspect of the regulatory reform agenda.

Senator MARK BISHOP: Thank your for your attendance. Mr Tate, you said currently you are paying 1½ per cent more to borrow funds in the offshore wholesale markets and sometimes had to pay even higher amounts over the last three or four years. We are told regularly that corporate governance and government financial structures in this country are arguably close to the best in the world on a range of funds. Our financial affairs have been well managed by successive governments. We note that a range of huge public companies and international corporates are now buying our debt. We note that a whole range of largish foreign countries are diversifying their investment base by buying government paper—Sweden, Switzerland, Russia, Germany, Asian countries, China. The totality of that appears to be an acceptance that our dollar, our government structures, our finance bases are close to being the best administered in the world today. Why then do our banks, which are also in the top 10 around the world on a range of indicators—solvency, cash flow, reliability, price and those sorts of things—not receive a discounted premium when they seek to borrow in wholesale offshore markets? Why do we pay this continuing high premium when it appears to us that there are grounds to argue for a lower premium than, say, banks in Europe and the United States which arguably are insolvent?

Mr Tate : Not arguably. The point I will take up on this is whether 150 is a high premium. There are probably only 10 AA-rated banks in the world—the Canadians and ourselves, Rabobank and a couple of others. We would all be paying somewhere around that. If I was the treasurer of RBS, NatWest or some other bank at the moment I would probably be paying well over 200 over the base rate.

Senator MARK BISHOP: Is that 350 or 200?

Mr Tate : Their base rate, Libor, is half of one per cent. I am paying 3½ on my base rate—that is, my 90-day bill rate—and I add 150 to that, so that is five per cent. If I were at RBS, London or City Bank, New York—that is, an A-rated bank—I would probably be paying 200 over, but my base rate, Libor, is only half of one per cent, so I am only paying 2½ per cent in absolute terms. But the spread over my base rate, because I am borrowing in US dollars, is actually higher. Let us separate this argument between the base rate, which for us is the 90-day bill rate, and Libor, which at the moment is close to zero, and look at the risk premium. Our risk premium is lower than what those guys are paying. The difference is the difference in base rates which is reflected. It is completely rational when you think about it, because it is part of what the US system is trying to do. Just as the Australian Reserve Bank has taken its cash rate down by more than the overall borrowing costs, it is exactly the same in the US where they are trying to take the Libor rate down as low as possible and build capital back in the banks by creating a bigger spread between the 2½ they are paying for their money all up and the mortgage rate. You would probably get a 30-year mortgage in the US for around five per cent at the moment, so they make 2½ per cent on that. The risk premium associated with our AA status is good—that 150 is good on a global basis.

The government debt is right down because only certain people can buy that, usually other central banks and the like. Other central banks are not going to buy Westpac or Commonwealth Bank paper and the like. There are two different markets. US Treasuries are also down at one per cent or high one per cent. Spanish 10-year government bonds are up at seven per cent. It is really important to separate this concept of risk premium from the absolute rate being paid. I would probably push back a bit and say that our risk premium at 150 is pretty good by global standards. There may be a small level of that above a Canadian or a US bank, only because the volume of Australian dollar issuance is lower than Canadian or US dollar issuance. The US dollar market is so astronomically big that the participants in that market—

Senator MARK BISHOP: But that differences on the margins.

Mr Tate : It is on the margins. That is why I am saying there may be a 10-point or a 20-point difference. If there were at a AA-rated US bank, it might be at 135. But there are no AA-rated US banks, so they are probably up around the two per cent mark.

Senator MARK BISHOP: To the extent that you and the other major banks have consistently maintained your share price and your return on equity is, on average, in the high teens with your internal rate of return probably higher and to the extent that well-run individual banks as part of the overall financial system continue, do you anticipate that 1½ per cent risk premium you have to pay to purchase offshore funds will continue, notwithstanding the continuing anticipated soundness in the economy?

Mr Tate : It may do: I do not know whether it will or it will not. If we were in 2004 that number would have been down at 25 or 30 points. But there is a general view among investors, the people who buy that stuff, that credit was too cheap for too long. The new baseline price of credit is higher, so 150 might be the new normal. They might say that for banks of any description, even well-run banks, having a risk premium of 1½ per cent over the bank bill rate is a completely rational place—that is what a good AA should pay. The question of whether 150 turns itself back into a quarter of a per cent is driven by investor preference, if they love us and are happy with the level of return.

Let us say, for argument's sake, that we stayed at 3½ per cent, and that came down to 50 points. The question is: is the offshore investor happy with four per cent on an Australian risk, or is he going to demand five per cent? It is going to be open to competitive pressure. It depends on what other sources of return he looks at. If you are an investor sitting in New York and you have half a dozen governments and, say, 20 banks to invest in from around the world, you will make comparisons about rates. So it is going to be a demand-and-supply issue.

You would like to think that there would be some longer-term reward for being well run. There should be a differential between a AA bank and a single-A bank. You would think that under normal, ongoing, quite predictable growth arrangements, that spread would come in. But we are not at that point. We are a good five years away from being at that point.

Senator MARK BISHOP: Five years?

Mr Tate : I reckon we are. There is an enormous amount of de-leveraging—that is, people paying back debt to work through this system. We have been at this now for three years. Think of how long it took, after the big property crisis in Australia in, say, 1991—when mortgages went to 17 per cent—before genuine aggression returned to the market. Generally speaking, it is six to seven years. With most cycles, you tend to go down quickly and work your way back up more slowly. We are three years into it. When I say 'five years', bear in mind that we have a lot of regulatory stuff that is going to flow through. It will not really flow through until 2015. There are other forms of regulation that will not come on until 2017-18. Until those regulatory impacts flow through and people are comfortable with them, I think people are always going to hold a bit in reserve in terms of price. That is why I say it will be five years—not because there is no macroeconomic improvement. It is just that these other discontinuities in the market are going to take some time to really feed through and settle down. We have not been in this situation for a long time. I reckon there will always be a degree of premium in the price until people feel 100 per cent confident in the new regime.

Senator WILLIAMS: Does Westpac still offer low-doc or no-doc loans?

Mr Tate : Yes, we still do offer them, mainly through our RAMS brand. It tends to be a product of the self-employed—people who do not have regular payslips or those sorts of things.

Senator WILLIAMS: Take the security of a house, for example. It may be unencumbered and worth half a million dollars, and you might lend $200,000 and basically the literal book work is done. Is that they way those low-docs and no-docs work?

Mr Tate : The loan evaluation for a low-doc will be lower—let's say 50 per cent. So on a $500,000 house it would be a maximum of $250. Say you were a plumber, just starting out. You might have some BAS statements and you might have some other accounting information. It is not going to be as regular, but you will have quite a substantial amount of documentation; certainly the responsible-lending stuff has proved that argument quite a lot.

Senator WILLIAMS: Did you run the lending facility known as Rocket Loans?

Mr Tate : We still do. Rocket Repay is your fundamental mortgage.

Senator WILLIAMS: I have been given some very sad stories. I am very concerned about these low-doc loans; I am very concerned about reverse-mortgage loans. Are you familiar with a company called CGIC Proprietary Limited and AAPB Proprietary Limited? It was run by the Silver brothers, I think.

Mr Tate : Was this in WA?

Senator WILLIAMS: No, I think it was in Queensland.

Mr Tate : No, I am not particularly familiar with them. Are they mortgage brokers?

Senator WILLIAMS: No, they were a developing company. People would invest in these companies, and they said, 'We'll return 15 per cent on your investment.' Consequently, one of your bank managers, I believe, sold this product very much. I will give you an example. Mrs Heather Simmers, who is now 101 years old, was signed up personally by your bank manager for a 30-year mortgage, for $440,000, at the Clem Jones nursing home in Brisbane. A lady who was part of this company told me—

Senator CAMERON: It must be a good nursing home!

Senator WILLIAMS: And she must have a very good doctor. Anna Bligh could have used them for her health system in the last election. Look, this is really serious, Mr Tate.

Mr Tate : It is.

Senator WILLIAMS: This bank manager—and I do not really want to name him, but I can if the chair requests it—signed her up for a 30-year mortgage for $440,000 at the Clem Jones nursing home, according to this lady who worked for the company, 'as witnessed by me and her daughter, Mrs Del Black, approximately 70 years old, who had a similar Rocket loan. Both mother and daughter are aged pensioners with no other income. I was ordered by Tony and Brad Silver to drive the bank manager to that location. I picked him up at Oxenford that day and also saw the vehicle which he had been awarded for his valuable contributions to the company, CGIC Pty Ltd. This was white Mazda CX-9 vehicle, a 2010 model worth about $50,000. This gift was confirmed by Tony Silver, who stated that a sale was concocted again, according to Silver, to protect the bank manager from any consequences from accepting such items.' Well, this company went broke. This lady is now 101 years old.

Mr Tate : The bank manager got a Mazda?

Senator WILLIAMS: Yes.

Mr Tate : Who did he get it from?

Senator WILLIAMS: From the company that he was telling all his clients to invest in. I think this is a police matter.

Mr Tate : It certainly sounds like it.

Senator WILLIAMS: There is also the case of Mrs Susan Jones, 67 years old, with no income, who had invested $100,000 in cash and was signed on to a low-doc Rocket loan on falsified asset details, showing a bogus investment of $800,000 on her loan application by this bank manager. And Mr Keith Cockroft, who died in November 2011, aged 95 years, had a Rocket loan and was on a service pension. It was yet another case where a false investment with CGIC was created—approximately $800,000—without his knowledge. His surviving son, Peter Cockroft, was recently charged by police over this loan, as he had power of attorney, despite the fact that Peter has never had any financial benefit from the loan.

Another man, Tom, who was 88 years old with a substantial waterfront property in Burleigh Heads, signed up for two Queensland investment properties with the bank manager, funding these via low-doc loans utilising equity in his home. These properties were apparently settled by Westpac in the name of Brad Silver instead of in Tom's name. Silver was then provided with two more loans, at an 80 per cent LVR, on these two properties, which have settled as cash sales. The bank manager was totally complicit in this fraud by writing four low-doc loans on two properties. Tom's brother Kevin, 80 years old, a pensioner, was in a similar situation. It just gets worse and worse. I do not know where you go from here.

Mr Tate : Well, it's fraud, isn't it?

Senator WILLIAMS: It is. And you have a bank manager who is telling people to invest in this company that fell over and who has got a car out of it, according to this lady who worked for the company. I do not think she has any reason to lie to me. What I am saying is that I am aware that in all parts of this country, and probably around the world, we have rogues, sadly. I am aware that you are a good bank, and you try to do your best, and you cannot stand around at the back of every bank manager. But if this bank manager filled these loan applications in for a lady of the age of 98, he could not approve them; surely it went on to someone else. Don't you check the person's age? Or is there a clause in our law that says you cannot consider age when you lend money?

Mr Tate : Well, there is now. But when was this? Was it back before responsible lending?

Senator WILLIAMS: This was about four years ago. I am happy to give you this sheet of paper I have here with the examples on it.

Mr Tate : It was an outright fraud, there is no question about that. Obviously the bank will be disgusted about it, and we would want to take action directly against the person involved, if it has not already been taken.

Senator WILLIAMS: These people have done their money. They were elderly, they were pensioners. As you know, to seek justice in this country you need money; you need a legal team. And they have no money to seek justice. During the Storm inquiry, Mr Ralph Norris said that the Commonwealth Bank had done wrong and that they would right it. I am hoping you will do the same here. This is another concerning paragraph: 'Aged pensioners made up approximately 80 per cent of the clientele, and no client, to my knowledge, ever concealed their source of income. A reliable source has revealed that Westpac is still providing oral references for the bank manager, who has worked as a Mortgage Choice broker since Westpac sacked him.' I am happy to give you a copy of this.

Mr Tate : Please do, Senator.

Senator WILLIAMS: I would like to look at this matter. You are a bank. You have your job. You have an obligation under the Corporations Act to return maximum profits to your shareholders, to be responsible et cetera. But when people's lives get torn apart, it then becomes our job, because they come to us. I would rather do other parts of my job; there are a lot of other things to work on besides these problems. I am deeply concerned about this, and I ask you to address it. If what this lady says is correct—and I have no reason whatsoever to doubt her truth; she has just recently recovered from a brain tumour operation—then I think this should be righted, Mr Tate.

Mr Tate : You have my assurance that that will be the case. It is unconscionable; I am not going to defend it. The reason I asked about WA is that there was a firm of brokers in WA that similarly engaged in a range of fraudulent activity, and we made restitution to the people affected by that. Using the same principle, I have no drama in taking that on. So if you can give us the details—

Senator WILLIAMS: I will send it to Mr Bloxham.

Mr Tate : Thank you.

Senator WILLIAMS: Just going back to your brokers, and evidence yesterday from Ms Denise Brailey, we have this Westpac thing, What’s New, which says that low-doc loan policies require the main income earner, or primary applicant, to be self-employed, and that while self-employed status is declared by the customer on the loan application, this information is not validated during the loan approval process.

Mr Tate : It might not be able to be.

Senator WILLIAMS: I have some serious concerns about these low-doc loans. I realise that there is a $50 billion industry out there—with low-doc loans, reverse mortgages and whatever. I realise that Australians' personal debt is very high; they are probably soaked up with debt. But there surely must be a limit to whether you can just keep lending.

Mr Tate : Low-docs constitute two per cent of applications at the moment. Before the responsible-lending stuff, which got much more aggressive and brought licensing into the brokerage side of the argument, which was really important, it was probably running at about 10 per cent. So now two out of every 100 loans would be low-doc. That is directed mainly to the self-employed, such as a guy who is just starting out. There is always going to be the element that you are not going to lend money to someone with the thought that you are not going to get it back. There are going to be people who are starting out in business, and one of the issues is: 'Look, give me a start. I'm a goer; back me.'

Senator WILLIAMS: But a 98-year-old lady is not starting out in business.

Mr Tate : That is not even an issue; I am not going to debate that one. But in terms of a low-doc loan for the self-employed, which that piece in What's New refers to, that is a legitimate part of the market for those guys, because they will not get credit otherwise. Two per cent is an acceptable risk for us to take across the whole portfolio.

Senator WILLIAMS: We have run out of time, but I would really appreciate it if we could address this issue and clean it up.

Mr Tate : No problem.

Senator CAMERON: I just noticed an article in the Australian today. I do not normally quote the Australian; I know the coalition cannot ask a question at question time without reading from the Australian! I do not know if you have seen the article—

Mr Tate : No, I have not.

Senator CAMERON: It was by Anthony Klan. He is stating that low-doc loans remain more than four times as likely to be in default as standard loans. He quotes Standard & Poor's, who say that six per cent of prime low-doc loans were more than 30 days past due and that arrears of low-doc loans have tripled, and there is evidence of loan application fraud against retirees and vulnerable peoples.

Mr Tate : Like what Senator Williams was talking about.

Senator CAMERON: Yes. It might be an acceptable risk for the banks to be dealing in low-doc loans. It might be a necessary aspect of banking because people have been forced into self-employment. The risk is on the individual. They are not in an employment relationship—I accept all of that—but surely this is unacceptable to the banks that this tripling of—

Mr Tate : I think those figures are just plain wrong. I do not know where he is getting his info from.

Senator CAMERON: It says Standard & Poor's—the people that rate you guys.

Mr Tate : I guarantee that is not from Standard & Poor's. I will tell you exactly where the low-doc experience is at the moment: across our entire mortgage book, for every $100 we lend out, we take a loss of around 3c. It is as close to a riskless book as you can get in Australian mortgage books. For low-doc, that number is probably around 4c or 5c. In other words, to say it is four times the default rate passed you, I am just telling you that that is an outright wrong. I do not know where he is getting his information from, and it is certainly not coming from Standard and Poor's—I can tell you that much.

Senator CAMERON: So the Australian has got it wrong.

Senator WILLIAMS: That would be a first!

Mr Tate : I can tell you those default figures. The behaviour in the mortgage books currently is that people are paying off debt faster than we have ever seen. Normally, say, your book is $100, you would expect $10 of that to pay off in any one year. At the moment, it is up around 17per cent, so people are paying off debt actively twice as fast as they have been over the past 30 years. The paradox is—

Senator WILLIAMS: Why is that?

Mr Tate : They are anxious—you mentioned it, Senator: that the household debt ratio in Australia is pretty high. It is mainly because we are big in mortgages, but the mortgage default rates are really low. I think people have just said, 'Look. We've got to get in front here. I don't know what might happen.' This is not just in households; this has been across business now for three years. They read the papers. They see what is going on and they say, 'Debt's not going to be my friend if things go bad, so I'm going to get myself back into a situation where I've got a lot of equity back in the house so that means: let's pay down our debt quickly.' On average, most people have got around 40 to 50 per cent equity in their homes—in other words, our loan devaluation ratio is probably around 55 to 60 per cent.

Senator CAMERON: Mr Tate, this is all very interesting. It is not what I am interested in right at the moment, to be honest. My colleague has led you away on another issue. I have got a few issues I would like to ask you about before we go down that track, and maybe Senator Eggleston might want to go further down that track. I want to ask you about the ABA submission yesterday. Were you consulted about the Australian Bankers—not you, but—

Mr Tate : I am certain the bank was, yes.

Senator CAMERON: The bank was consulted about that submission. So you support the submission that says there should be a brake—and these are my words—put on the legislative approach and the amount of legislation that is coming through on banks.

Mr Tate : I would say that the pace at which it is coming through and our ability to keep up with it is difficult. If that is the thread of what they are saying, the atmosphere within our bank would be: we completely understand the rationale for this. We have to change systems, and this is why the offshore stuff around Dodd-Frank is important because we operate in the US and the UK, so we have got to meet standards for them as well. It is just the pace of it.

Senator CAMERON: It would be a courageous bank that railed against regulation after the global financial crisis, wouldn't it?

Mr Tate : A courageous decision—it would be.

Mr Gray : On the regulatory aspects that we are facing, there is a very significant agenda. It is being accelerated, particularly as Jim said. He mentioned Dodd-Frank. There are extraterritorial effects, some of which probably weren't originally intended, that we are suffering from and we are having to respond to very tight time scales in relation to that when they have not even finalised the rules. I think there is a whole range of regulation and legislative change, which is coming quite quickly.

Senator CAMERON: But you understand why there is a rush of legislative change.

Mr Gray : I think Westpac has been very forthright in supporting the whole regulatory reform agenda in terms of its philosophy. It is just that the pace of it at the moment is significant.

Senator CAMERON: You are interested in the cost to the bank; as legislators we are interested in the cost to society. So we have to balance up what is more important: some increased costs to the bank in terms of legislation or another global financial crisis because we do not have the legislative framework right. I put it to you that you have to go for the cost to society issue. Even the banks—you would have to agree with that, wouldn't you?

Mr Tate : Stability is the main thing.

Senator CAMERON: You raised the issue of Libor but, again, the Huffington Post is saying that after the Barclays' fiasco and Libor:

… one thing we've learned over the years, it's that these bankers will screw you every time they get the chance—

this is the Huffington Post, the US online news agency. This is a big problem for the banks, isn't it?

Mr Tate : A massive problem.

Senator CAMERON: The basis of this inquiry is looking at some of the macro issues, but we are now being subsumed by people ringing us and giving us details of bad culture, bad banking practices, illegal practices. I am just wondering how you deal with that in terms of culture in the bank. I will just take you through a few points and ask you to respond. In Joe Stiglitz's latest book—you know Professor Joe Stiglitz; I am sure you are aware of him, the Nobel-prize wining economist—

Mr Tate : Yes.

Senator CAMERON: has books called 'The Price of Inequality.' On page 269 he goes through a number of issues about reducing rent seeking—that is in banks—and levelling the playing field and covering the financial sector. He says that we should cover excess of risk taking and the too-big-to-fail and too-interconnected-to-fail financial institutions—that is one point—that there should be restrictions on leverage and liquidity; that we should make banks more transparent, especially in their treatment of over-the-counter derivatives; that we should make the banks and credit card companies more competitive to ensure that they act competitively; that we make it more difficult for banks to engage in predatory lending and abuse of credit card practices; that we should cut the bonuses that encourage excessive risk taking and short-sighted behaviour; and that we should close down offshore banking centres such as Cayman Islands. Does any of that strike a chord with you in terms of issues that the bank would have to deal with?

Mr Tate : Libor is a good example where when you get this behaviour going on, the effect that flows through to even the good banks is profound. Very briefly—

Senator CAMERON: Barclays were supposed to be one of the good banks, weren't they?

Mr Tate : Yes, that is right. I will get to the flow-on, because it ties in with this too-big-to-fail argument. Libor is the rate set at 10 o'clock every morning in London. What happens in Australia when we set the bill rate is that Reuters go through and see where the trades occurred and they average a price. In Libor, they used to just ring up and ask where would you make the price, so there is a different process there. But that does not solve anything. It goes to this too-big-to-fail argument, because in a way every bank is too big to fail. So in the Australian environment, if Bendigo Bank suddenly fell over tomorrow for argument's sake, in terms of its global influence, it is not profound—I am not having a go at Bendigo in that regard. There would be a flash up on the news that would say, 'Australian bank fails.' If you are an investor in Westpac, CBA, NAB or any of those guys you are going to immediately say, 'What on earth is going on in Australia?' and away you go. You would rerate that price.

Senator CAMERON: But, Mr Tate, on that point, this is what we hear all the time. Everything is done at the macrolevel but you never come back to the point that some poor bugger who has got their savings in Bendigo Bank is destroyed. I never hear this argument from the banks.

Mr Tate : Give me a chance to make you one, Senator. There are two levels to this: the interconnectedness—that is the point I was trying to make. No bank operates completely in a closed system, so that is the fundamental point on that level. The next level down is that you would say, 'Within Australia, what are the things we've got to do to make sure that, if something happened to a Bendigo Bank, that those depositors are being protected?' which led to the financial claims scheme. If that happened, there is no insurance scheme. We rejected the insurance scheme argument, with which I agree. Those savings would be made good under the financial claims scheme up to a maximum of $250,000 to protect the system.

It is vastly in our interests to make sure Bendigo Bank survives or that, if it is to go, it is done on a rational basis. We have had plenty of experience of this in Australia over the past 20 years: State Bank of Victoria, State Bank of South Australia; Adelaide Bank—all of those banks were taken in a situation where one of the majors or one of the other substantial banks in some cases made an orderly merger. You look at state bank of Vic into the Commonwealth Bank—that was done in an orderly manner. We have to look at the system such that if a Bendigo goes that way, who is going to write the cheque out to defend that? I think it is completely rational as part of our discussion—and APRA would be good at this; and they have been good at this in saying, 'If this situation exists, then everyone is going to have to put their hand in their pocket to make sure confidence is retained in the system.' Why we have to build a system where it is important for Bendigo to survive—or the Illawarra Permanent Building Society—is because there is no upside for me if they fall over. That was my first point. It is completely rational and in my interests to see those organisations survive.

One of the ways we do that currently, quite apart from the financial claims scheme, is that there are some of these organisations where the big banks lend to them for them to onlend and mortgages and the like—mainly through securitisation programs. We have got a situation where the Australian Office of Financial Management will buy the securities of those smaller banks, not of the big banks. All of those are towards building liquidity confidence in those smaller banks such that if anything happened, they could be defended; or if they were to be subsumed by someone else, it would happen on a rational basis.

Mr Gray : You asked if that resonates with us. We are implementing and the regulators are implementing reforms under the Basel accord in relation to all of these areas. To curb 'too big to fail', we are having to prepare recovery and resolution plans to deal with that exact issue. There is also a domestic, systemically important bank reform which we have received the early draft of and it will be dealing with putting in place greater resilience for banks so they do not fail, that the recovery and resolution planning process deals with a situation where we may have to deal with it—that is targeted directly at the too-big-to-fail issue. The leverage and the liquidity that you mentioned—there is a new leverage ratio that is being introduced under the Basel reforms. We have got a whole liquidity standard, so there are comprehensive measures on liquidity. The transparency of OTC derivatives—a lot of that is being driven out of the US, because of the problems that we are seeing there.

There is a comprehensive range of G20 reforms that we are having to implement in OTC derivatives. There are standards that have been brought in for excessive risk-taking and remuneration. APRA introduced standards in remuneration that are risk based and risk related. I was talking to our team just this week about that very issue and we are implementing risk based remuneration at Westpac. It is being refined, and we are engaging with APRA on that. It can apply ex ante, ex-post, at the group level, at the division level, at the business level and at the individual level. That resonates with us because we are seeking to implement the reforms that are being put in place.

Senator CAMERON: Are details of that available?

Mr Tate : No.

Senator CAMERON: If you could provide details of that, it would be good.

Mr Tate : Okay.

Senator EGGLESTON: I was quite interested in the question: are the banks too big to fail? I am also interested in the impact of what is happening in Europe on the Australian economy and the Australian banking system. We survived the global financial crisis very well—as did the Canadians—it was said, because we were well regulated. But this is a different sort of situation where quite a number of European countries seem to be in very profound economic trouble. I was wondering what your view was about how Australia might be impacted if there was a succession of economic failures in countries like Italy, Spain, Ireland and so on?

Mr Tate : It depends on the pace at which it happens. At the moment the system is self-correcting within Australia. In other words, the demand for credit is low so we are not lending as much as we have previously. In fact, mortgage growth rates are around five per cent. Normally you would see that at about 10 per cent as a trend line over the last 30 or 40 years. People are putting money in the banks, so savings are right up. People are paying off debts.

The system is correcting itself quite quickly. The real issue for us is to restrict the extent to which we have short-term money owing in Europe. We spend a lot of time trying to get $30 in every hundred dollars that we borrow from offshore in longer-term borrowing arrangements. The real crisis in 2008 and in any situation will come at the short end—that is, less than six months. If you are funding your bank with six-month money you are going to get smashed if things go pear shaped. You will be seeing Dr Debelle later and he would be good to speak to in this regard. We are speaking with him almost daily and asking: what is that proportion that you have got short—because you are always going to need some flexibility there—and what have you got long? I feel quite confident that if you are managing your short end quite tightly, you are going to be able to weather some substantial storms on the way through.