Joe Hockey (North Sydney, Liberal Party, Shadow Treasurer) Share this | Hansard source

You should listen to this. Another recommendation is to encourage the Australian Prudential Regulation Authority to investigate whether the major banks are taking unnecessary risks in the name of trying to maximise short-term returns that conflict with the preferences of taxpayers. Effectively, I am saying that the moral hazard that now applies in the international banking system needs to be properly recognised. Of course, in the Wallis report the recommendation was that taxpayers no longer guarantee Australian financial institutions against risk. When HIH fell over I met with the board of APRA. I said, 'How are you going to handle this?' They threw their arms up in the air and said, 'The Wallis report considered this and said businesses will fail.' The second biggest insurer in Australia fails. I said, 'That is not good enough; it is unacceptable because it happened on your watch.' There were literally tens of thousands of people affected, and not just those with existing insurance claims, from people I knew who tragically had broken their necks playing rugby and were living off the annuities provided by HIH right through to people who had had their houses burnt down and were waiting on a payout. After a period of time it became clear that the Australian government had to step in—and we did with over $600 million—to ensure that the people whose insurance company they believed to be viable and well resourced was going to step up to the plate when they most needed it.

I remember the night when the provisional liquidator was appointed to HIH. I was standing in Lane Cove Plaza when I got a phone call to advise that HIH had just had a provisional liquidator appointed. I asked Graeme Thompson, the head of APRA, what this meant and he did not know. That was the thing that most alarmed me at that time. The prudential regulator did not know what it meant. Instinctively, having been a banking and finance lawyer, I asked how many people had car insurance with HIH and FAI. APRA could not answer. All of those people driving cars at that moment suddenly had no insurance—not even third party—and they did not know it. It was ridiculous. I asked how many builders had warranty insurance with HIH. APRA could not answer. All of a sudden, builders warranty insurance—remember that—closed down. The market closed down. I asked how many people who were travelling around the world and were no longer covered because FAI and HIH and all of the various subsidiaries that had provided travel insurance had had a provisional liquidator appointed knew that they were not covered. APRA could not answer.

It was a failure of the prudential regulator to understand the business that they were regulating that was most alarming. But, ultimately, the taxpayers are on the hook, whether we like it or not, and that was most graphically displayed during the financial crisis. We are rapidly entering into a phase where major banks around the world are either owned by governments or guaranteed by governments. The current European crisis involves potential sovereign debt default. When you consider the balance sheets of banks like BNP and their exposure to the sovereign debt of Greece, Italy and others, Societe Generale, Deutsche Bank and a number of other financial institutions in Europe—potentially UBS and Credit Suisse as well—you ask, 'Come on, guys, what is the exposure of the taxpayers to the risk involved in these products?'

More significantly, an issue that has not been properly assessed is the exposure of other banks around the world to derivative products based on that sovereign debt, whether it be a currency risk or some derivative product where the main holders of the sovereign debt have laid off some of the risk. Of course, they have primary risk, but should they in turn fall over in the case of a sovereign debt crisis the contagion impact through the derivatives market may be extreme. These are the issues that need to be properly assessed. That is one of the reasons why there is a significant endeavour in the United Kingdom by the Financial Services Authority and the government to separate out the retail banks from the investment banks. That in itself will raise significant issues and is not an easy process.

I wanted APRA, as the second point in my nine-point plan, to properly investigate the major banks in Australia to reassure the public. I do not think there is any reason to be concerned, but we need to ensure that short-term profit taking by Australian financial institutions is guided by the principles of proper risk management, given that we are now underwriting that risk effectively.

The third recommendation, which I regret the Treasurer has not taken up, is formally mandating the Reserve Bank to publish regular rather than irregular reporting on bank net interest margins and returns on equity profitability to determine whether the major banks are extracting monopolistic profits—that is, whether taxpayers are subsidising supernormal returns. I do not think there is any particular cause for concern again here, but I know the Reserve Bank does have irregular reporting in this area.

Mr Ripoll interjecting—

I am getting to it, don't worry. This is part of the package. Therefore, I think it would be a good idea to have a regular reporting mechanism. Fourthly, I suggested that we should look at using Australia Post's 3,800 branches as a more sophisticated distribution channel for smaller authorised deposit-taking institutions. Now, I have emphasised that Australia Post should not have a banking licence. It is not the role of government to get into banking, although this government seems determined to do so—whether it be Ruddbank, which was going to be a lender to the property industry, or Gillardbank, which is a $10 billion fund that is being set up as part of the carbon tax package. They love banks, the Labor Party, but they have a terrible record with them. Look at the State Bank of Victoria, Tricontinental, the State Bank of South Australia and Beneficial Finance; you guys have a terrible record. The Labor Party should keep well away from banks, let alone set up another one. That is one of the reasons why we think Australia Post would be a good distribution channel. David Murray actually suggested that originally, and I think it is a positive idea.

We obviously have supported the government in trying to make the residential mortgage backed securities market more liquid. For the people in the gallery, that is the market that originally helped to fund Wizard Home Loans, Aussie Home Loans and all those guys, because they are not deposit-taking institutions; they had to raise money on the bond markets and they used securitised instruments in order to do so. So they would get a pool of assets, home loans, and the pool would be properly diversified, and they would sell the bonds into the market and, in turn, raise the money that allowed them to go and lend more money.

That residential mortgage backed securities market was an important market in helping to create competition in home lending, and it was encouraging that they started to get into credit cards. Even though there are a huge number of credit cards and credit card products out there, this is a market that is an alternative source of funding, not just to keep the mortgage originators in play—well, not so much these days, but previously like RAMS, Aussie Home Loans, Wizard, Yellow Brick Road and so on—but also for smaller banks, enabling them to raise money. Even Westpac, I think, is involved in the RMBS market, and maybe some of the other major banks, as an alternative source of funding to bank deposits and the issuance of bonds into the global marketplace.

The sixth recommendation I made was to simplify the Financial Services Reform Act. This is an act that I introduced and I think it is hugely important. However, the Financial Services Reform Act was completely undermined by the onerous red tape that ASIC introduced into the process. It was overinterpreted, overanalysed and overlegalised. At the time, I was reshuffled into the small business and tourism portfolio so I missed the opportunity to see the full implementation of FSR, but I really regret that I did not ride shotgun on that process. So I would like to go back to that and try and simplify it.

The seventh recommendation directs APRA to explore whether risk weightings on business loans secured by residential properties are punitive. This is something that small business continually raise with me, and I think they are perfectly justified in doing so. I do not think there has been enough discussion about this matter. So many small businesses go and borrow money from banks and pay a premium—a significant premium at times, up to 200 basis points, or two per cent, above a home loan rate, because it is a small business rate; yet it is secured against their home. That is the security. Whether it is a home loan or a small business loan, it is the same asset for security. And it is the same income, the income from the business, that is going to make the repayments to the bank. Yet, if it is a small business loan as opposed to a home loan, it ends up being two per cent more expensive, maybe more, which is ridiculous. I think small businesses have a legitimate gripe about it and I do not think there has been enough said about that to date.

The final recommendation I identified was to have a full review of the Australian financial system, which I am absolutely determined to do and is part of the coalition's policy going forward. It is. The nine-point plan stands. The reason why we want a full review is that it is about 30 years since the Campbell review was commissioned by John Howard as Treasurer. It was a full review of the financial system which led to deregulation and greater competition in the financial system in the eighties. Keating claims credit, but it was John Howard who initiated the Campbell review and it was a hugely important review. Then it was Peter Costello as Treasurer in 1996 who commissioned Stan Wallis to undertake the 'son of Campbell' review, a full review of the financial system which, in turn, helped to design the Australian financial services industry and inoculate it against the challenges that were to come forward. For example, it allowed Australian financial institutions to diversify from simply banking into insurance and superannuation, even equities. Similarly, it allowed AMP as a life insurer—and general insurer, to a lesser degree—to diversify into banking and superannuation. It meant that there was this consolidation of the financial services industry so that banks in particular could not be accused of having lazy balance sheets, an accusation that was the great fear of the banks in the late nineties. In the case of Europe and the United States, it drove so many banks to engage in riskier behaviour, and that resulted, in part, in the contagion impact of the financial crisis.

But in Australia, even though financial institutions wanted to merge with other institutions—I well remember Westpac wanting to merge with DBS, but we would not allow it, and at the time that was a very wise decision—we were convinced that the aggregation and conglomeration of the Australian financial services industry ensured that we could better supervise a smaller number of institutions with a diverse range of products. But each product of course had its own product disclosure regime and, depending on how the product was sold—whether it was over the phone, face to face or through agents—different regulatory regimes applied, and that is when FSR came into play. This is the nine-point plan that represents coalition policy on banking. This bill is just one of the nine points. As I said, we would welcome the government supporting this initiative.

To be clear, covered bonds are attractive to investors because they are a very low credit risk. The bonds issued by a financial institution are secured or covered by a pool of assets. The legislation provides that the value of assets in the covered bond pool must be at least 103 per cent of the value of the covered bonds. In this sense, the bonds are oversecured. There is an argument that issuing covered bonds is expensive for the banks, but they are important as a diverse funding entitlement to the banks, particularly when there is the looming threat of a blowout in the cost of overseas money.

An important point is that in the event of insolvency the holder has recourse to the pool of assets underpinning the bonds—that is the difference. Depositors usually or almost always rank No. 1, ahead of everyone else, when it comes to a bank falling over—they have first dibs on the assets of the bank. Under this situation the holders of covered bonds have first right to the pool of assets that covers the bonds. This is a contentious aspect to the covered bonds bill, but the government has wisely limited the exposure of the banks so that they can raise only a limited amount of money in covered bonds as per their balance sheets.

Even though covered bonds sound similar to asset backed securities like the RMBS which I talked about, they differ in two crucial respects. The first is that asset backed securities are backed only by certain specified assets and the cash flows are linked directly to those assets. If those assets go bad, as happened in the United States with some mortgage backed securities, then the cash flows and value of the bonds commensurately fall. With covered bonds the pool of assets can be substituted; bad assets can be rotated out and good assets can be put in. Inevitably there will be some impaired loans that may be part of the asset pool from time to time, particularly if there is a slight economic downturn. Covered bonds are a good initiative in that the assets can be rotated. The other difference is that the covered bond debt and the underlying asset pool remain on the issuer's balance sheet. In the event of default, the investor has recourse to both the pool assets and the issuer.

These advantages mean that covered bonds carry lower risk than other secured investments. They also mean cheaper funding for financial institutions although the returns might not be as high as they might be, but the costs of funds are not as high as they would be for other instruments. I see this an important step forward in broadening the financing options for Australian ADIs. I recognise that APRA had deep reservations about this and I think even Treasury had some reservations, but this bill properly addresses those concerns.

Of course, covered bonds are likely to be mainly used by the four major banks in Australia because those institutions have the capacity to issue bonds in a size likely to be attractive to institutions. The government's bill appropriately does provide for smaller ADIs to enter into an aggregating entity to issue covered bonds. This means that two or more smaller institutions can join together to issue bonds over a combined pool of assets. This will help achieve a marketable size of issue that could not be achieved independently.

This leads me to current financial conditions which are important because the government, after doing nothing for the 12 months after I suggested this idea, came to us and said this needed to be dealt with urgently so that banks in the current environment can issue covered bonds to the market before Christmas. There has been an express concern about a dramatic blowout in the cost of funds for Australian financial institutions raising money in the international marketplace because of the sovereign debt crisis in Europe. European and, to some degree, American financial conditions have deteriorated in recent months. Obviously lenders are more risk averse and are looking at the exposures of banks and the asset quality of their counterparts.

Some European banks are now experiencing significant difficulty in raising funding in the wholesale markets. Large-scale recapitalisation of banks by European governments is looking increasingly likely. It is important to emphasise that Australian banks have not been directly affected by these concerns because their exposure to European sovereign debt appears to be low. However, any tightening in the global funding environment can indirectly impact on the availability and cost of funding for Australian banks, given their relatively high reliance on offshore wholesale markets. I understand that access to long-term funding markets in Europe through the issue of traditional banking instruments has become more difficult for Australian banks. In this environment it is prudent to broaden the funding opportunities available to Australian banks.

To reassure people that covered bonds are not a wildly new financial instruments, their first recorded use was in 1769 in Prussia. They have been widely used in Europe since then. In July 2008 US Treasury Secretary Paulson announced that the Treasury would take steps to encourage a market for these securities in the US to provide an additional form of fundraising. In June 2010, the Bank of New Zealand announced that it had launched the first covered bond program in Australasia. So we are quite late to the marketplace and that is perfectly understandable—we have always been cautious in moving ahead of others in relation to some of these areas.

Banking reform, as I said, is not yet finished. There is much to do in banking reform and it is an ongoing area of challenge. The reason that I do want a granddaughter of Campbell or a son or daughter of Wallis is because Australia deserves to have the very best financial system in a part of the world that is increasingly complicated but also, importantly, increasingly competitive. The lesson out of both Campbell and Wallis was that we prepared for the next round of challenges. That is what happened. This government has a history of calling for reviews, summits, working groups and everything and not accepting the recommendations and not implementing them. Just look at Henry, the 2020 Summit and so on.

Our commitment is to follow a process very similar to Campbell and Wallis in that you have the private sector looking at the challenges for the financial system on a global basis, recognising those challenges, and preparing a suite of initiatives that allow us to innoculate Australia against some of the volatility that we are going to see in the financial system for the next 15 to 20 years. Let's be fair dinkum. The financial system globally is going to be volatile. Capital markets are going to be volatile for the next 10 to 15 years until the debt challenges of Western nations and the trade imbalance across the globe is properly resolved. Therefore, let's be fair dinkum about inoculating the Australian financial system. All wisdom and knowledge does not come through the air conditioning here in Parliament House, down at Treasury or anywhere else, it has to come from those people involved in the industry day to day. Our commitment to considered, balanced further reform in banking is undiminished and this is a good step forward which the coalition as the initiator of the idea is happy to support.

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