RBA warns on loan risks

INTEREST-ONLY housing loans, and loans for 100 per cent of the property's valuation, could be scrapped in future after the Reserve Bank's annual conference heard that they inflate property booms and busts.

Three papers from key economic institutions found requiring borrowers to finance part of the purchase themselves would help to moderate future housing booms - and reduce the scale of the subsequent bust.

Senior officials of the Reserve Bank, the International Monetary Fund and the Bank of International Settlements separately reported that setting maximum loan-to-valuation ratios could help reduce the damage housing cycles cause to the economy.

The Reserve Bank paper, co-authored by the head of its financial stability department, Luci Ellis, also found similar benefits from requiring borrowers to pay down the capital of the loan over time, rather than taking out interest-only loans.

Most Australian home loans already meet both criteria. But many housing investors take out interest-only loans for 100 per cent of the property's valuation, as do investors in commercial property.

Housing booms and busts, in the United States, Spain and Ireland, were the main cause of the global financial crisis. While Australia escaped relatively unscathed, the Reserve has used this year's conference to work out how the booms and busts could be better regulated in future.

Australia's banks are free to lend as they see fit. But the Australian Prudential Regulation Authority makes them set aside extra capital to cover loans for more than 80 per cent of a property's valuation. There are no bars to interest-only loans.

In a survey of housing policy options, senior IMF researcher Giovanni Dell'Ariccia found the most promising were setting limits on loan-to-value ratios, and borrowers' debt-to-income ratios.

"Containing leverage will reduce the risks associated with declines in house prices", he said. "This will likely result in fewer defaults when the bust comes ... (and) reduce the risk that a large sector of the real economy ends up with severe debt overhang."

The Reserve's paper, by Ms Ellis, Mariano Kulish and Stephanie Wallace, concludes that the terms of loan contracts "matter a great deal for financial stability... Loans that build in some amortisation of principal over time are less destabilising.

"Short-term loans that must be rolled over are particularly dangerous. This helps explain why commercial property lending ... has been so problematic for financial stability."

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We're moving away from big banks

AUSTRALIAN borrowers are dumping their banks to get a better interest rate. A record 35 per cent of all housing loans written in 2011-12 saw borrowers refinance existing mortgages with a new lender, rather than buy or build new property.

Bureau of Statistics figures show all the growth in new lending to owner-occupiers in the past year was in refinancing. Every week, the banks and other lenders refinance $1 billion of existing loans at better interest rates, as borrowers freed from exit fees vote with their feet.

In the year to June, lending to refinance loans swelled by $7.3 billion or 17 per cent from a year ago, and by 30 per cent from two years ago. By contrast, lending to buy existing real estate fell by almost $1 billion, while lending for new construction rose just $24 million.

Australian Prudential Regulation Authority (APRA) data shows the big four banks have been the losers. This year their market share shrank slightly as growth in their stock of home lending was far outpaced by the smaller Australian banks and wholesale lenders.

But the big four remain dominant. At June 30 they held 86 per cent of all the banks' housing loans, up from 75 per cent four years earlier, before they were allowed to swallow their two biggest rivals.

But in the first half of 2012, the smaller banks won 24 per cent of the growth in the stock of home loans. And the banks collectively saw new lending shrink, with all the growth going to non-bank lenders.

The data suggests Treasurer Wayne Swan's campaign to get unhappy borrowers to vote with their feet has been enough to make the big banks take notice.

A spokesman for Mr Swan said the figures show the government's reforms have stirred competition in banking, to the benefit of mortgage holders.

"People are taking advantage of our ban on mortgage exit fees," he said. "This has put more power in the hands of Australian families: they can walk down the street to another lender if their current bank isn't looking after them."

Victoria, New South Wales and Western Australia have been the main battlegrounds. In Victoria and WA, 37 per cent of home loans in 2011-12 were for refinancing, and in NSW and South Australia, 36 per cent.

The bureau figures report the new loans written each month, and they show all the growth this year has gone to non-bank wholesale lenders. In trend terms, between December and June, monthly lending by banks shrank by $224 million or 2 per cent, but wholesale lenders lifted lending by $69 million or 27 per cent.

Excluding refinancing, seasonally adjusted new lending rose 2 per cent in June, suggesting the Reserve Bank's interest rate cuts have injected life into the market, as intended. The growth went mostly to finance new construction, rather than existing real estate.

The APRA figures show that even though new lending fell in 2011-12, the stock of money we owe the banks in housing loans grew by $83 billion or 8 per cent. Smaller banks gained $10 billion of that, with Macquarie Bank more than doubling its lending to $3.8 billion, and the Bendigo and Adelaide Bank's lending up by $3.4 billion or 16.5 per cent.

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Slow down, suck it up, banks told

The APRA has warned the banks against trying to meet 'unrealistic' profit expectations.
AUSTRALIA'S bank regulator has warned the banks against trying to meet ''unrealistic'' profit expectations by aggressive cost-cutting or chasing riskier lending, and urged them to just get used to ''life in the slow lane''.

John Laker, chairman of the Australian Prudential Regulation Authority, who won widespread plaudits for keeping the banks away from risky lending in the noughties boom, said the banks were unlikely to match the profit growth of those years in the post-GFC climate.

APRA figures updated by the Australia Institute show the big four banks have increased their post-tax profits from $16.6 billion in 2006-07 to $24 billion in 2010-11, despite the plunge in new lending.

Dr Laker told the Senate economics committee that banks must not try to retain profit growth by cost-cutting that weakens their ability to manage risks.

''The challenge is coming to terms with life in the slow lane,'' Dr Laker said. ''If the current cautious approach of households and businesses towards taking on additional debt persists, [banks] are very likely to be denied the strong balance sheet growth that supported sustained profit increases before the crisis.

''In these circumstances, boards and management may be tempted to chase unrealistic expectations for returns on equity by assuming more risk - through lowering credit standards or seeking new and unfamiliar markets where they may have little comparative advantage - or by aggressive cost-cutting that may weaken risk management capacities.

''These temptations must be resisted in favour of more measured strategic ambitions.''

Dr Laker told the committee APRA had now begun a third ''and we hope, final'' round of consultations with the insurance industry on its review of capital standards, as well as consulting with the banks on its proposals to implement the Basel III capital and liquidity standards.

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Bank switching booms as public anger grows

ANGRY home buyers are breaking with their banks at unprecedented rates. More than 50,000 home owners refinanced a record $12.6 billion of mortgages in the December quarter, as they voted with their feet to get a better deal.

Bureau of Statistics figures show Victorians led the way. The amount switched to other banks, building societies and credit unions in this state soared 50 per cent in two years, hitting $3.6 billion in the December quarter, up from $2.4 billion in the same quarter of 2009.

The amount refinanced shot up 36 per cent in New South Wales in the same time and 30 per cent in Western Australia. In the rest of Australia, curiously, refinancing activity has been steady or even falling.

Industry observers say the competition late last year was led by the big banks themselves, which were competing aggressively by offering larger discounts to home owners to switch banks in a sluggish market.

That competition has now been scaled back, with the banks reducing their discounts this year. Even so, the Reserve Bank reported on Friday that the average rate on new mortgages by the big four banks last month was 6.59 per cent.

This implies an average discount of more than 0.7 percentage points from their standard variable rates. It explains why Treasurer Wayne Swan has urged home owners unhappy with their mortgage to shop around.

Insiders say the standard variable rate is now an anachronism. Few new loans are written at this rate and the banks are usually quick to offer better deals to customers who threaten to leave.

National Australia Bank was the big winner from the consumer shift, because of its well-publicised lower interest rates. Last year it increased its stock of housing mortgages by $20.6 billion or 13 per cent, more than double the average growth rate of the other three.

Commonwealth, with its subsidiary Bankwest, is the biggest home lender with a book of $307.5 billion at the end of last year, according to data published by the Australian Prudential Regulation Authority.

Westpac and its subsidiary St George are second with $284.6 billion of home loans. The NAB is well behind with $177.4 billion and ANZ fourth with $163 billion.

APRA figures show starkly how dominant the big four have become in the market, as the competition regulators have allowed them to successively take over their main rivals.

The fifth-biggest home lender on December 31 was the local arm of Dutch bank ING, with $37.2 billion. It was followed by Queensland bank Suncorp-Metway ($29 billion), the Bendigo-Adelaide Bank ($22.1 billion) and the Bank of Queensland ($21.4 billion).

Last year for the first time since the global financial crisis, the four second-tier banks increased their home loans marginally faster than the big four. Their stock of loans grew by 8.6 per cent to $109.7 billion, against average growth of 7.5 per cent for the big four.

Competition for refinancing came as new lending shrank to the lowest growth rates since statistics began to be kept 35 years ago. APRA data shows the stock of mortgages held by the big four grew by $114 billion in 2008, $117 billion in 2009, $85 billion in 2010, but just $65 billion last year. The refinancing boom gave a misleading boost to the monthly home finance approvals. Year on year, lending for refinancing grew 12 per cent in the December quarter, but all other home lending shrank 3 per cent.

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Banks' recovery rate since GFC of awesome interest

IN THE year to September 2007, just before the global financial crisis, Australia's big four banks made after-tax profits of $16.6 billion. People thought that was huge. Ian Macfarlane, former governor of the Reserve Bank, used to wonder how Australia's banks made such big profits.

In the year to September 2011, the big four made after-tax profits of $24 billion. Many, perhaps most, Australian businesses are doing worse than in 2007. Yet the banks now make profits almost 50 per cent bigger than at the peak of the boom. How much is enough?

ANZ's Australian CEO, Philip Chronican, says it decided to raise interest rates on home mortgages and small business loans by 0.06 percentage points because its margins in retail and business lending had been squeezed in recent months. I don't doubt him, but since when have banks seen these margins as fixed?

Not in the Howard/Costello era, when from 1997 to 2007 they moved in lock step with the Reserve Bank, passing on each rise and fall in the bank's cash rate, no more, no less. That had nothing to do with funding costs or margins. They were just too frightened of Peter Costello to step out of line.

Not since the GFC came. It broke their business model, so they had to raise their margins. The government guarantee and a history of sensible lending allowed them to sail through the GFC with profits only slightly lower. But once out of danger, they kept raising margins; and now their profits have soared.

Yesterday's moves were modest: on a typical mortgage, $13 a month from ANZ, $20 from Westpac. Mortgage holders are the lucky ones. You can go to the bank and demand a discount, or walk out and take one of the many cheaper loans available on the web (websites such as Canstar or InfoChoice can point you to them).

Small businesses are the captive customers. The Reserve tells us that in January, the big banks' average rates were 6.59 per cent on mortgages, 6.70 per cent on big business loans, but 8.25 per cent on small business loans. Small business can't just walk over the street and be sure of finding another loan. And it's their profits the banks are taking.

One question: will the banks pledge to reduce their interest rates in future whenever funding costs fall?

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Column: The big banks' marginal case

LAST weekend I got around to digging up my long-neglected veggie garden, and discovered why the silver birch tree is doing so well. The soil that once grew my veggies was permeated with new root growth, nourishing that beautiful big tree. Tough luck, I told the silver birch as I hacked them off: you'll still be a handsome tree without them.

Right now Australia needs a gardener to do something like that to our beautiful big banks. Since the global financial crisis more or less killed off their competitors, they have been spreading their roots into the soil that nourishes the rest of the economy. We want healthy banks; but we do not want them sucking nutrients from the rest of the economy.

It's a matter of having the right balance. The banks will be healthier long term if they have healthy customers. But that balance has been lost and there is no good reason for the banks to worsen it by using their market power to take even more from their customers.

Today the Reserve Bank is expected to cut its cash rate by another 0.25 percentage points. It might not do so - there are good arguments to cut, and good arguments to wait - but most of the economy is clearly weak. More nutrient, such as lower interest rates, would help it survive, if not thrive.

But the big banks are flagging that they may hold back part of any rate cut from their customers. They point out, rightly, that the cash rate has little relevance to what it costs them to borrow money. And they say their costs have risen, so don't expect to see the Reserve's cut reflected in your mortgage rate.

Let's hear their case. The Australian Bankers' Association says 60 per cent of the banks' funding comes from bank deposits, 20 per cent from short-term bonds (less than a year) and 20 per cent from the long-term bond market. It is the last one that has risen: the extra cost of our banks borrowing long-term from the market rather than each other rose about half a percentage point in the second half of 2011.

The association's chief executive, Steven Munchenberg, pleads for understanding. ''Banks do not underestimate the anger many borrowers will feel if all RBA rate cuts are not passed on,'' he says. ''For these reasons, banks have been absorbing the higher costs of bank funding for over six months now, and have not passed these costs on to borrowers.

''But banks need to balance the interests of borrowers, on the one hand, with the interests of lenders, including retail depositors and superannuation funds, on the other. In globally uncertain times, Australia's banks need a clear signal to investors around the world that our banking system is solid and healthy. A vital sign of this is the profitability of our banks.

''If investors become concerned with Australia's strength, they will charge more for the money they lend our banks, compounding bank funding cost pressures. In the worst case, banks would not be able to raise enough money to meet demand, resulting in a credit squeeze.''

Steve, you can rest easy. Shareholders may fret if the banks' profits stop growing: some of them seem to think bank profits should keep growing even if the economy goes bust. But Australia's bank profits are already in the stratosphere, whether compared with global banks or other service industries in Australia.

As the ratings agencies point out, the main risk to the ratings of Australian banks is their dependence on a property market widely seen as overvalued. If the banks hold back the full RBA rate cut, that would increase the longer-term risks they face, not reduce them.

But the biggest problem with the banks' case is that their main funding source is not the global market. Most of their funds come from ordinary Australians, through our bank deposits. And the rates the banks pay depositors have shrunk in recent months as the rival options, the share and property markets, slid sideways and downwards.

In the six months to last month, the Reserve Bank reports, the average rate the banks paid on term deposits fell from 4.5 to 4.2 per cent. The average rate paid on ''special'' deposits fell from 6 per cent to 5.35 per cent. The banks also cut the rates they paid on cash management accounts, bonus savings accounts, and online savings accounts.

Their funding costs have risen? Show us the evidence.

As Reserve deputy governor Ric Battellino pointed out in December, the banks in fact reduced their market borrowings in 2011; their deposits rose by more than their lending. It adds up to a very weak case for the banks to make off with the relief the Reserve wants to give to those who actually need it.

Why do the banks behave this way? Because they can. As the graph shows, since 2007 they have taken from mortgage customers the equivalent of five interest rate cuts. Some of that was necessary, especially in 2009. But there is now a good case for them to start handing it back - to give customers bigger cuts than the RBA offers.

The worst victims of the banks' greed are small businesses. Since 2007, the margins banks charge them above the cash rate have shot up from 3.45 per cent to 6 per cent - the equivalent of 10 interest rate cuts. Again, some of that was necessary, but it has become excessive and counterproductive.

Julia Gillard and Tony Abbott should unite to tell the banks: hand it back. A healthy garden needs more than four healthy trees.

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Mining boom failing to spark national economy

THE Australian economy has ended the financial year with the brakes biting hard. New data released yesterday reports lending and activity slowing, house prices falling, and job opportunities shrinking.

Separate snapshots released by the Australian Bureau of Statistics (ABS), the Reserve Bank and private research bodies throw doubt on official forecasts that the new financial year beginning today will see a boom in economic activity.

The Reserve has forecast growth of 4.5 per cent over the coming year, and recent speeches by governor Glenn Stevens and assistant governor Phillip Lowe flagged more interest rate rises ahead. Treasury is forecasting growth of 4 per cent, and more than 200,000 new jobs.

But yesterday's figures reported that:

. Net lending by the banks rose just 0.3 per cent in May, after recording no growth in April, as Reserve Bank figures show business and households remain averse to taking on new debt.

. Job vacancies in the private sector, as measured by the ABS, fell by 12,000 or 7 per cent in the six months to May, with Victoria and South Australia recording the biggest falls.

. House and unit prices nationally have fallen in every month this year, according to the RP Data-Rismark index, dropping by 0.3 per cent in May and by 2.7 per cent since December. In Melbourne, the median price fell by 1.8 per cent over the May quarter to $500,000.

. Hotels, motels and serviced apartments recorded a 0.8 per cent fall in takings in the March quarter, ABS figures show, as Australians profited from the strong dollar to holiday overseas while overseas tourist arrivals remained flat.

While the Reserve Bank would not be concerned to see little growth in debt, or house prices edging down, yesterday's figures come after broader-based measures show employment growth has slowed to a virtual standstill in recent months.

They come amid rising fears for the future of the global economy. The US government is now only a month away from running out of money, with Republicans and Democrats locked in a bitter stalemate on how to reduce the deficit.

Global ratings agency Standard & Poor's warned on Wednesday that US bonds would be downgraded to a D, or junk bond status, if it defaults on debt payments. US Treasury Secretary Timothy Geithner warns this is inevitable unless Congress raises the country's debt limit by August 2.

In Greece, Parliament on Wednesday approved an austerity package to cut its deficit but the fear is this will do little more than postpone an inevitable default, with the Greek government's debt now 150 per cent of GDP.

The domestic economy seems to have entered 2011-12 with mining construction booming but the rest of the economy sluggish. That might not stop the Reserve Bank raising interest rates again in coming months, since it believes the weakness is temporary, and next year it will need to rein in growth to stop the mining boom setting off inflation.

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Battling the big banks

THE public response to Treasurer Wayne Swan's banking reforms seems to be a growl of disappointment. Australians are fed up with being ripped off by bank bosses who are paid several hundred times more than them. They are angry that banks are able to charge us what they like, and get away with it. They want tough action to hit banks where it hurts and these reforms don't do it.

They're right. These reforms won't lower your mortgage rate. They won't stop the big banks jacking it up even higher if they can get away with it. And so long as we ask them for three out of every four home loans we borrow, they will get away with it.

But why didn't Swan go further? Were there tougher reforms that he and his colleagues were just chicken to take on? Or was it that there is no simple way to reduce the market power of the banking cartel and that some of the solutions proposed could end up being worse than the problem?

Let's start by looking at where we are, and how we got here. And we'll start with the positives, because they are big positives.

First, unlike most in the West, Australia's banking system did not collapse in the global financial crisis. That's partly because the Australian Prudential Regulation Authority did an outstanding job as our watchdog before the crisis. It's partly because the government moved in the heart of the crisis to guarantee the banks' debts and deposits. But it's also because our banks were prudent and sensible lenders, when their overseas counterparts were not.

That matters for us, because the banks emerged in good shape to finance the recovery. Mortgage lending alone has grown by $162 billion in the past two years. The banks are greedy, yes, but they're good at their job and that's good for us.

Second, interest rates and bank margins have soared over the past year, but with mortgage rates now typically 7.15 per cent after discounts, it's not crippling. If we're in trouble with rates at that level, then we've borrowed too much.

But there is also a big negative. The banks' margins were driven down in the 1990s and early 2000s by competition from new lenders, who derived much of their funding from securitisation: selling bundles of our mortgages to investors, and reinvesting the proceeds in new loans.

The global financial crisis began when this market was poisoned by American banks filling their securitised bundles with bad mortgages. As they went bad, the market for securitisation collapsed even for Australian lenders, whose bundles remain good. And as it collapsed, so did the new lenders.

The big banks swooped, bought up their weakened rivals, and regained their lost market power. The four big banks now hold 80 per cent of all loans. The other banks have 17 per cent, and all credit unions and building societies, just 3 per cent. They're to be our fifth pillar? This will be a long wait.

We got here partly because the GFC wiped out securitisation and the new lenders, but also because in good times and bad, governments and competition regulators have allowed the big banks to gobble up their rivals.

Consider this list: since 1990, the competition watchdogs have allowed the Commonwealth Bank to take over the State Bank of Victoria, the State Bank of NSW, BankWest, Colonial State Bank and Wizard Home Loans. They allowed Westpac to take over Bank of Melbourne, RAMS home loans and St George (in addition to its earlier acquisitions: the Challenge Bank, Advance Bank and Bank SA).

Three times, the regulators allowed one of the big four to swallow up the next biggest bank: first, the State Bank of Victoria, then the Bank of Melbourne, then St George. The result is a cartel that, by and large, does not compete on price.

What could the government do? The most effective way to boost competition would be to set up its own bank, using the post offices as retail outlets. But that would need to be a big venture, with outlays rivalling the national broadband network. It's not surprising Swan turned that down.

It could require the banks to offer loans with margins fixed over the Reserve Bank's cash rate. University of Melbourne finance guru Kevin Davis points out that Australia's variable loans are unusual in requiring borrowers to bear all the risk of rising interest costs. But wouldn't it be better to try to fire up the competitive pressures that will bring those margins down?

That's essentially what Swan's reforms aim to do. One stream of changes would make it easier for us to change lenders by banning exit fees on new loans, and possibly by giving us portable account numbers and thus put pressure on all lenders to compete on price.

A second stream aims to widen the funding sources for potential competitors: by continuing and publicising heavily the government guarantee of their deposits, which was due to expire next October, and by the government buying up another $4 billion of mortgage securities.

The third stream of reforms is aimed at a separate problem: stemming the foreign debt. It will allow banks and credit unions to issue covered bonds a variant of securitisation in which the risks lie with the institution rather than the investor to attract the super funds to invest at home. And the government will try to set up an Australian bond market, to increase options for investors and lenders.

None of this will reduce your mortgage rate next year. But bit by bit, it will build competition, and that will lower rates.

If you're paying too much for your mortgage, you'd better find your own solution: tightening your belt to pay down your debt, refinancing with a credit union, whatever. Best of luck.

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Treasurer's sensible attempt to drive change

WAYNE Swan's banking reform package is a persuasive read. But what difference will it really make to borrowers' ability to get a better deal?

We might have to be patient. Most of these reforms are sensible and small-scale: giving consumers more information, giving lenders more funding options. But there are two things on Swan's list that, in time, could make a difference.

The first is his plan to ban exit fees for new mortgage loans from July 1 next year. It will apply only to new loans. It won't cover almost $1 trillion we owe already on existing mortgages. Nor will it apply to small business loans .

Is that a copout? No. Think ahead.

Including refinancing, we take out 600,000 mortgages a year. Two of the four big banks have scrapped exit fees already; the rest will follow.

That might not make us better off. There are real costs to banks when customers break off loans early and banks have ways to get that money from us.

But in future, they won't be able to do it by locking us in to a lousy rate when the credit union over the road offers cheaper deals. We will be free to move.

The second potentially significant reform is the review by Bernie Fraser of the feasibility of giving each of us a personal account number that we take with us if we change our bank.

It's subtle, and it's not certain to happen. But if it does and it probably will that too would slightly shift the balance of power between the bank and you in your favour.

I can't believe the Australian Competition and Consumer Commission will ever succeed in prosecuting a bank for "anti-competitive price signalling", but it won't hurt to give it that power.

And when so many vulnerable people get into serious strife over credit card debt, Swan's changes to tighten the rules are reforms that matter.

But where will the competition come from? New Zealand's Labour government set up Postbank in its post offices. Swan prefers to help credit unions and building societies become a "fifth pillar" to challenge the banking cartel.

It's a big ask. Swan's package would widen their sources of funding. But his biggest step is to pledge that the government's guarantee of deposits will continue in some form after it is due to expire next October.

And as the guarantee will apply equally to credit unions and building societies, they will be free to advertise "government-protected deposits".

These are changes at the margin. They won't put banks at risk. If they work, it will be over time. But they are a serious bid to drive change.

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Crazy-brave Norris calls Swan and Hockey's bluff

COMMONWEALTH Bank chief Ralph Norris must be crazy-brave. As our political leaders compete to show themselves tough on banks, he has invited them to do their worst.

The decision by Australia's biggest home lender to raise its interest margin by 0.2 percentage points on top of the Reserve Bank's 0.25 percentage point rise gives Wayne Swan and Joe Hockey the perfect excuse for reforms to make the big four banks face real competition.

Norris has bet that, in the end, their bank-bashing will be mostly talk, little action. And he is probably right.

The big four are now a firm oligopoly, controlling 87 per cent of housing loans. Since the mid-90s, our competition regulators have allowed them to gobble up their main rivals, and the global financial crisis saw off the rest.

Joe Hockey's nine-point plan has some good elements such as a new financial system inquiry but let's be frank: their impact would be marginal.

There's only one way to create serious competition to such a strong cartel: do what Prime Minister Andrew Fisher did in 1911, when he set up the Commonwealth Bank as a government-owned competitor. Our politicians won't do that.

The Commonwealth claims its borrowing costs have risen more than its mortgage lending margins. That may be, but its business lending margins have grown sharply, and Reserve Bank figures show the big four's total lending margins are now at their highest level since 2004.

Let's test the banks' good faith. If they regard their pre-GFC interest margins as sacrosanct, will they now commit that when funding costs fall as they will they will pass on all that fall to their customers?

If not, then this is simply a selfish use of market power. The banks are charging us more because they can get away with it. Shareholders pay Ralph Norris $16.2 million a year $310,500 a week to do just that.

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Make banks pay for risk: IMF

BIG banks with a serious mismatch between their asset and liability maturities could be forced to pay a surcharge or take out insurance against the risks they pose to the financial system, the International Monetary Fund has suggested.

In a review of the October 2008 liquidity crisis that forced governments to guarantee trillions of dollars of bank debts not least in Australia the IMF calls for wide-ranging reforms to reduce systemic liquidity risks in future.

The proposals were revealed overnight in a chapter released early from its Global Financial Stability report, to be published next week at the annual meetings of the IMF and the World Bank in Washington.

The IMF singles out the Australian banks as examples of financial institutions that lent long term but borrowed heavily short term and then were stranded in October 2008 when lenders would not roll over their debts.

At the onset of the crisis, it says, 32.2 per cent of Australian banks' funding came from short-term borrowings, on domestic and global markets. While the banks used the period of the government guarantee to diversify their funding sources and lengthen their maturity structure, at the end of 2009, 25.6 per cent of their funding was still short term.

"Any robust systemic liquidity framework would need to encourage appropriate pricing of liquidity risk in good times to limit its negative impact in times of market stress, and minimise the moral hazard problems", the IMF argues.

"Market participants should be paying the full price of their idiosyncratic liquidity risk".

It urges consideration of an insurance fee or surcharge where the mismatch between asset and liability maturities exceeds a set safety limit.

The IMF also proposes bigger buffers against risk, tighter matches between maturities on each side of balance sheets, more rigorous valuation of collateral and due diligence into the credit risks posed by counterparties, and more use of central counterparties for clearing.

In a second chapter from the report, the IMF also takes on the three global credit ratings agencies Fitch, Moody's and Standard & Poor's calling on them to issue estimates of the probability of default and expected losses by borrowers.

Amid widespread concern, particularly in Europe, over the ratings agencies' failure to warn of the crisis, and of the contagion effects of their downgrades of one country on others, the IMF finds the agencies have done better than their enemies suggest but worse than their own guidelines suggest.

On one hand, it reports, all sovereigns that have defaulted since 1975 were rated below investment grade a year earlier.

On the other hand, the record shows almost one in 1000 corporate bonds given AAA ratings by Moody's has defaulted, roughly 30 times its own estimate of default probabilities.

The IMF urges government investment agencies and central banks to eliminate regulations that "hard-wire" their investment portfolios to ratings changes, warning that these tend to amplify the "cliff effects" of a change on the borrower's access to credit.

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