Where to from here? Possible responses to changing funding mix and costs
Submissions to inquiries into the banking sector generally raise a
number of possible regulatory changes or issues that need to be addressed which,
in the view of the individual or organisation supporting them, would benefit
the system as a whole in some form. This inquiry received a number of specific
proposals. Significant and complex issues such as the interaction of
superannuation savings with the banking system were also raised. This section
examines these matters.
Tax treatment of deposits
The Henry Review found that tax liabilities for different types of
savings vary considerably, noting that the effective tax rate on income from
interest‑bearing deposit accounts offered by ADIs exceeds a taxpayer's
marginal statutory rate. The report argued:
A tax system for the future would tax these different forms
of investment as consistently as possible, and also take account of the way
inflation affects the effective tax rate on savings.
The relatively unfavourable tax treatment of deposits compared to other
savings and investments is demonstrated by Figure 5.1.
5.1: Real effective marginal
tax rates on savings depend on asset class
Source: Australia’s future
tax system: Report to the Treasurer, part 2: detailed analysis,
vol. 1, p. 67; based on Treasury estimates.
In the 2010–11 Budget the government announced a 50 per cent income tax
discount of up to $1,000 of interest earned by individuals, to commence on 1
July 2011. The policy was subject to a number of revisions; later in 2010 it
was announced that the eligible cap would be lowered to $500 for income earned
in 2012–13; in 2011 it was announced that it the measure would be delayed until
1 July 2013. Finally, in the 2012–13 Budget the measure was abolished
The ABA called for distortions in the tax treatment of various savings
options to be minimised so as not to significantly affect an individual's
We would be very keen to see government policy that removes
tax distortions against people saving and investing through deposits. At the
moment, of course, we are seeing very strong savings rates in Australia and
incredibly strong competition for deposits as banks seek to try to minimise
that reliance on overseas money. But, in the longer term, Australia does not
have a strong record of saving through the banking system and we think part of
the answer lies there.
Abacus expressed a similar view:
The unfair taxation of deposits must be addressed to reduce
pressure on ADI funding costs, to reduce distortions and biases in the taxation
of savings, and to ease the burden on Australian households who choose the
simplest and safest savings vehicle.
While deposits are more expensive for banks as a funding source compared
to the past decade, and this is currently beneficial for deposit holders, if
the higher cost of deposits is sustained it may have an impact on competition
in the long‑term. The RBA was questioned about how the major banks were
able to maintain their net interest margin despite rising funding costs, yet
regional banks and credit unions, which source a greater proportion of their
funding from deposits, were not able to:
Dr Debelle: The regional banks, and particularly credit
unions and the like, have a much larger share of their funding coming from
deposits. Particularly over the last year or so, the competition in the deposit
market has been pretty intense, so the relatively high cost of deposits has a
bigger effect on someone who uses more deposits to fund themselves, which is
the regionals and the credit unions.
CHAIR: That makes sense. Their costs have gone up by more,
but they have not been able to maintain their net interest margins. The large
banks' costs have also gone up, but they have been able to maintain their net
Dr Debelle: Because over that period they potentially had
other sources of funding which have not gone up as much as deposit costs have
CHAIR: So that is the answer? They have a degree of market
power that enables them to maintain their profits?
Dr Debelle: No. As I said, there is plenty of competition in
deposit rates. They pay varying amounts, but they are all pretty much paying
the same amount. In the lending rates, again, there is not much variation
between all the lenders. It just matters if you have more deposits in your
funding base as to whether that means your costs are relatively high.
CHAIR: So if there is a competitive impact at play, it is
probably forcing those banks that have the higher funding costs to have a lower
net interest margin whilst the others can maintain theirs at the level they have
because they have a lower cost base?
Dr Debelle: Yes. That is not a bad way of putting it.
The higher than usual interest rates on term deposits and to a lesser
extent other savings products (relative to other benchmark rates) that the
banks have been offering since the global financial crisis is good news for
deposit holders, although some of the costs are ultimately passed on through
other banking activities, such as lending.
The degree to which different banks, depending on their size, are able
to address these developments without impacting their profitability is an issue
that the committee has been concerned with from a competition viewpoint. The
committee examined this issue in the report of its 2011 Competition Inquiry. It
concluded that the taxation arrangements applied to bank deposits and mutual
ADI deposits should be reviewed by a broad-ranging inquiry into the financial
system. In the committee's view, nothing has alleviated the committee's earlier
concerns. Encouraging domestic deposits would provide banks with a larger
source of stable funding, reducing some of the risk from sourcing funds from
unstable international wholesale debt markets. Further, an increased pool of
deposits may help alleviate any long-term competition implications arising from
the major banks encroaching on a funding source relied on by smaller ADIs.
Inconsistencies between the taxation arrangements applying to interest
earned by individuals on deposits held in authorised deposit‑taking
institutions compared to other methods of saving should be addressed.
Interaction of the superannuation
and banking systems
Australia has substantial domestic savings within the superannuation
system. While some of these savings return to the banking system through the
investments made by superannuation funds, banks remain significantly reliant on
offshore borrowing in volatile wholesale debt markets. Whether there are changes
that could be made to encourage additional superannuation savings to be
directed towards the banking system in a way that helps meet the banks' funding
needs was an issue discussed.
It is an interesting time for this discussion, as superannuation assets
have grown significantly and will grow at an increased rate in the coming years
due to the gradual increase in the superannuation guarantee (from nine per cent
to 12 per cent by 2019–20 starting from 2013–14) (see Figure 5.2). Depending
on the future average propensity to save among households and the
attractiveness of other savings vehicles, this could place pressure on the
level of deposits while, at the same time, banks will need to rely on more
stable funding sources such as deposits due to Basel III. The degree to which
deposits will be able to meet the banks' requirements will be impacted by the
behaviour of household and superannuation funds—while households are currently
risk-averse and deposits are an attractive investment option, an improvement in
economic sentiment could change this. Superannuation funds are also investing
in term deposits at a heightened level at the moment (Figure 5.3), however, the
extent to which this will be sustained is unclear.
Figure 5.2: Total superannuation assets
Source: KPMG and Australian
Centre for Financial Studies, Superannuation trends and implications,
November 2011, p. 5; cited in Australian Centre for Financial Studies, Submission
49, p. 15. Based on APRA data.
Figure 5.3: Term deposits with banks in Australia (as a
percentage of total A$ domestic deposits)
Source: Cameron Deans and
Chris Stewart, 'Banks' Funding Costs and Lending Rates', RBA Bulletin,
March 2012, p. 38; based on data from APRA.
Abacus predicts that:
Competition for deposits will intensify further when the
current period of global instability and uncertainty comes to an end.
Households and other savers will look to alternatives to deposits that are more
favourably taxed, such as equities and superannuation.
The ABA observed that while the level of savings is relatively high at
the moment, from a long-term perspective 'Australia does not have a strong
record of saving through the banking system'. It argues that 'appropriate ways'
of encouraging some superannuation savings into the banking sector need to be
examined as the superannuation sector is more inclined towards investing in
equity compared to deposits and other fixed income securities:
We know that the Australian super industry for whatever
reason is heavily weighted towards equities by international comparison and
underweight things like fixed income products. Were super funds to invest in
some of those products, it would mean money flowing through the banking system
into the economy rather than chasing further returns in the equities markets
here or overseas. What we are not suggesting in any way is that the trustees of
those super funds be under any direction or requirement to do that.
Some banks are already coming up with ways to utilise superannuation savings
to meet their funding needs; at its hearing in August 2012 ING Direct advised
the committee that it would enter the market by launching a basic
superannuation savings product (which it did in September).
Corporate bond market
In Australia, companies have been inclined to turn to banks for funds
rather than to issue bonds. This increased during and since the global
financial crisis when many companies found accessing funds through bond
issuance too difficult or costly.
The corporate bonds that are issued are generally in overseas markets. The Australian
Financial Markets Association (AFMA) advised that at the end of March 2012,
$146 billion in bonds were on issue in those overseas markets. The AFMA
gave some insight into where these issuances were targeted and why:
The US private placements market is particularly attractive
to Australian companies and an important source of finance to them because it
has good liquidity, long dated debt finance is available and deals may be
brought to market quickly.
A number of submitters called for the development of a stronger
corporate bond market in Australia. The ASF argued that such a market could
potentially reduce the banking system's reliance on offshore funding, thus
insulating 'to some degree, Australia's vulnerability to shifts of sentiment
amongst offshore investors'.
This is linked to the superannuation system as, assuming the bonds are
attractive to the superannuation funds, they could invest in these bonds rather
than offshore investments and equity. NAB explained that, rather than lending
directly to large Australian corporations, if it could lead them to a developed
Australian bond market with superannuation funds willing to invest in the
bonds, it would 'not put stress on the bank balance sheets'.
NAB also contended that Australia's superannuation is 'poorly allocated at the
... arguably, by international standards, typically at
least 50 per cent of superannuation money should be in fixed income securities
like bonds, government securities and the like. In Australia it is not—the vast
majority is in equities.
As Professor Davis put it in a March 2012 article:
On the one hand, almost everyone seems to support initiatives
to develop a local corporate bond market to broaden corporate funding sources.
On the other, almost everyone believes that super funds have an excessive
equity bias and need more fixed interest (bond) investments.
However, Professor Davis noted some issues that, in his view, would
impede the development of a stronger corporate bond market in Australia:
If banks focus more on leading corporates to the debt markets
rather than on-balance sheet lending, their funding requirements also decline.
One possible adjustment process could be reduced bank reliance on international
capital markets, with more of our balance of payments financing involving
direct foreign purchase of Australian assets such as equities. While that might
help super funds reduce their equity bias, it is only one among a wide range of
adjustment possibilities (about which we understand relatively little).
Another possibility could be less bank reliance on domestic
term deposits, with investors switching from deposits to corporate bonds. And
here is a real killer in terms of the much desired retail corporate bond
market. What yield must be offered to individual investors (including self
managed super funds) to encourage them to invest in risky corporate bonds
rather than bank deposits which are guaranteed up to $250,000 at each bank.
The 2009 Johnson Report recommended that regulatory requirements on
corporate debt issuance to retail investors be reduced. It concluded that a
deeper domestic corporate bond market would improve the diversity of potential
funding sources for companies and place added competitive pressure on banks as
a source of corporate finance.
Since that report, there have been some policy announcements regarding the
development of a bond market—as part of the 2010 Competitive and Sustainable
Banking System package, the government announced that it would streamline
disclosure requirements and prospectus liability regulations.
However, the steps to implement this have taken some time. In December 2011, a
year after the initial announcement, a discussion paper was released by
Treasury on streamlining disclosure and liability requirements.
Submissions closed in February 2012.
That Australian banks need to obtain a significant share of their
funding from volatile offshore wholesale debt markets when Australia has
substantial, and growing, savings in its superannuation system is a curious
aspect of the financial system. Attempts to influence this apparent imbalance
must be carefully considered. Superannuation trustees need to make investment
decisions that are in the best interest of the funds' members. The committee
supports measures to encourage the growth of a more diverse range of attractive
domestic investment options, such as the regulatory changes underway to help
facilitate a deeper and more liquid corporate bond market. However, the
committee considers that the interaction of the superannuation system and the
banking system warrants further consideration. This issue is discussed further
in chapter 10, which examines whether a broad-ranging independent inquiry into
the banking system is required.
Interest withholding tax
Another issue also examined by the 2011 Competition Inquiry was interest
withholding tax, and the implications this has for competition in the banking
sector. Interest withholding tax is a tax levied on interest paid by an
Australian borrower to a non-resident lender. The tax is particularly relevant
to bank funding costs and competition in the banking sector as it applies to
interest paid by Australian subsidiaries of foreign financial institutions when
they borrow money through their offshore parent and use that money in
Both the Henry Review and the Johnson Report recommended that financial
institutions operating in Australia should generally not be subject to interest
withholding tax on foreign raised funds. The Johnson Report observed that the
application of the tax on offshore borrowing by financial institutions:
... sits uneasily with the Government's desire to develop
Australia as a leading financial centre and is putting Australia at a
competitive disadvantage with respect to overseas financial centres, which
increasingly do not charge interest withholding tax on such transactions.
The government has announced changes to the application of interest
withholding tax, but they have not yet been implemented. In the 2010–11 Budget
it was announced that interest withholding tax on financial institutions would
be phased down from 2013–14.
In November 2011, however, the government announced that this would be deferred
ING Direct argued that interest withholding tax inhibits its ability to
bring an offshore pool of funds into Australia in a more cost-effective manner:
Mr Richtor: ... one of the challenges is that if we look
to the offshore capital markets, unless we meet certain strict conditions, if
we bring the funds back in we have to pay withholding tax, which makes it
unattractive for somebody to lend us those funds. Basically, we have to go out
to funds that are capable of wide distribution—and, forgive me, I have
forgotten the detail of this—whereas there are many investors who would happily
give us money but they are not going to wear the withholding tax. If we pay the
withholding tax—and I think that is the same for all banks; it is not just for
us, it is more of an Australian issue—then of course it is much more expensive.
Mr Baker: The key point that we would just add is that there
are means. There is the section 128F exemption that allows us to do wide
distribution debt issues, but it is the rule that inhibits associates from
giving you funds. That is the block that puts the inability to bring ING funds
from other jurisdictions into Australia.
Senator WILLIAMS: So if you go to do that you have to pay the
Mr Baker: That is right, yes.
Interest withholding tax distorts funding decisions and is an impediment
to foreign banks competing in the Australian banking sector. Although removing
this tax from applying to financial institutions creates a direct financial
cost to the government, by providing an impetus for greater competition in the
banking sector such a reform would have wider benefits to the economy.
Accordingly, the committee supports the removal of interest withholding tax
applying to foreign bank branches and other financial institutions, although it
acknowledges that such action would need to be sensitive to budgetary
That interest withholding tax applying to financial institutions be
abolished as fiscal circumstances permit.
The Canadian securitisation model
Non-banks have previously played a key role in injecting competition
into the market for residential lending. As discussed in chapter 2, one of the
results of the global financial crisis is the significantly diminished market
share that non-bank lenders now have. To address this development, the MFAA
called for the securitisation market to be supported in a way similar to the
model adopted in Canada and administered by the Canada Mortgage and Housing
The Australian Government, if it is serious about attacking
the hard issues, must closely examine the success and characteristics of the
Canadian Mortgage and Housing Corporation's securitisation programs, viz
Mortgage backed Securities and Canadian Mortgage Bonds. These programs provide
a proven efficient and effective template for competitively priced mortgages,
whose features should be incorporated into the Australian mortgage market.
The CMHC undertakes two securitisation programs under its mission to
promote housing quality, affordability and choice for all Canadians. The first program,
National Housing Act Mortgage-Backed Securities (NHAMBS), commenced operation
in 1987. As its name suggests, the program follows the passage of the National
Housing Act (in 1985) which was during a period of high interest rates and
associated concerns about housing affordability. The NHAMBS program was
intended to respond to these high interest rates, instability of rates and the
prevalence of one year mortgages.
The second program is the Canada Mortgage Bonds (CMB) program, which was
introduced in 2001. As CMBs are bullet bonds,
it was intended that CMBs would be a more attractive option for investors than NHAMBS
The proceeds of the bonds are used to purchase mortgage backed securities
issued under the NHAMBS.
Both securitisation programs provide a guarantee to investors,
ultimately backed by the Canadian government, that payments of interest and
principal will be timely. As the MFAA explained, the government guarantee lends
the sovereign rating to the instruments (currently AAA) and for this guarantee,
the government profits through the premium charged:
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
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
Mr Naylor: The government makes a profit out of it.
The MFAA provided further evidence on how aspects of the programs,
including risk, are managed:
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 ... 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.
The Canadian approach to securitisation may be particularly instructive
given the similarities in the Australian and Canadian economies and financial
sectors, such as the similar population size, number of major banks and size of
the mortgage market, as well as that the banking sectors of both countries
avoided the worst of the global financial crisis.
While the MFAA is strongly supportive of such schemes being adopted in
Australia, others are less sure. Professor Davis argues:
I would suggest that we should stay away from it, because it
involves governments providing guarantees in various forms. The Canadian system
is a very complex one, as far as I can see—it is not simple. And I think the
last thing governments should be getting into is providing guarantees. It is
very hard to price them, and very hard to operate them, I think. So I think
there are other ways in which we could get the securitisation industry back
into a better position to provide greater competition in the housing market
than going down that route.
In 2009, Treasury noted that a Canadian-style program 'could potentially
enhance smaller lenders' access to funds', however it balanced this view with
the following statement:
However, it is not clear that such an intervention would
necessarily result in substantially greater choice and lower interest rates for
mortgage borrowers, or that the benefits of the proposal would outweigh the
associated risks and costs.
The RBA expressed similar reservations, noting that the mortgage market in
Australia is 'reasonably competitive at the moment' and advising the committee
that it was aware of issues being raised about the Canadian programs:
Dr Debelle: ... The Canadians at the moment are
dealing with a situation where they are a bit concerned about where their
housing market is going, particularly in terms of the lending side of things.
So that might be a reasonable test of the resiliency of the system they have
had, over the next couple years.
Senator CAMERON: On the up side or the down side?
Dr Debelle: On the up side.
Mr Aylmer: In fact, they are concerned about the exposure of
taxpayers, now, to the Canada Mortgage and Housing Corporation, because it is a
government financed thing.
While it is desirable for the securitisation market to be reinvigorated
to enhance competition in the sector, the committee is aware that a
Canadian-style scheme would be a significant change to the Australian banking
sector; and one that would commit the government to be involved in the
securitisation market on an ongoing basis. The committee is particularly
concerned about the transfer of risk from the private sector to taxpayers.
The committee is not dismissing the scheme entirely, as the Canadian
scheme has apparently operated effectively for some time. In the report of its
2011 Competition Inquiry, this committee recommended that further research be
done into how the Canadian model could be applied in Australia so that it could
be implemented quickly in case of future deterioration in the securitisation
market. At this time, the committee maintains this view. The potential benefits
and costs of such a scheme would need to be closely examined, and this could
perhaps take place as part of a broad-ranging inquiry into the financial
Other securitisation issues
The Australian Securitisation Forum (ASF) advised the committee that
demand among investors for Australian securitisation has been impacted by
changes in the attitude of central banks in key jurisdictions towards what
securities are eligible for repo operations.
The ASF advised that up until 2010 the European Central Bank (ECB) accepted
Euro‑denominated bonds collateralised by Australian assets (such as
RMBS), but since then the ECB has restricted eligible bonds to those where the
collateral is from Europe or G8 countries outside Europe.
Investor demand and the liquidity of Australian asset-backed securities
could be enhanced if foreign currency bonds collateralised by Australian assets
were "repo‑eligible" in foreign jurisdictions. While this is a
matter for the central banks concerned, the government could push for wider
acceptance of Australian securitisation.
To enhance investor demand for Australian securitisation, the committee
recommends that the government encourage central banks in other jurisdictions
to accept Australian asset-backed securities denominated in foreign currencies
for repurchase agreements in the foreign jurisdiction.
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