Murray recommends no borrowing in SMSFs
08 December 2014
The Financial System Inquiry by David Murray has been released and will keep business commentators busy in the run up to Christmas. There are many elements of particular interest to DIY super fund operators. One is the recommendation that self-managed superannuation funds should be banned from borrowing to buy assets such as property and shares.
There were a number of other recommendations for super:
The FSI recommended superannuation funds be forced to tender for the right to manage hundreds of billions of dollars in default savings.
Super fund boards should be be forced to appoint a majority of independent directors.
The FSI recommended Trustees subject to the same penalties for misconduct as directors of managed investment schemes.
The objectives should be enshrined in legislation.
The FSI recommended super fund trustees to pre-select a comprehensive income product for members' retirement.
Of great interest to SMSF investors was the recommendations for the banks. Banks are a key target for SMSF investors because of their high dividend payouts. If Murray's recommendations are implemented, it may affect profits and therefore dividends:
David Murray's Financial System Inquiry has called for the nation's banks to become "unquestionably strong" to prevent the cost of a financial crisis that could be as large as $2.4 trillion.
The FSI which was released today in Sydney took aim at the banks claims that they were among the safest in the world calling on the banks to lift their capital rations to be among the safest quartile of banks in the world. Murray also called on the big banks to capital as a way to increase competition the system.
The FSI called for bank capital levels to be raised amid evidence that the banks were not the quartile of international banks when it came to high capital levels.
An increase in capital levels would make the banks safer on a standalone basis and reduce the "implicit government guarantee" and reduces the recourse to taxpayer funds.
The Murray report recommended that the banks should target being in the top quartile of international banks as far as capital levels are concerned.
The FSI said that the top quartile level was increasing as other banks "caught up" and on latest levels the average 9.1 per cent capital levels of the Australian banks was below the median of 10.5 per cent and below the 12.2 per cent required to get into the top quartile.
The FSI said any increases in capital should take the form of common equity capital.
The FSI said the cost to the economy of increasing capital ratios was small for the overall economy relying on RBA numbers.
Deutsche Bank has calculated the effects on the banks. It woudl mean higher interest rates:
We estimate that the FSI report is likely to see the major banks need $16bn
- $23bn of CET1 over the next 3-5yrs with organic capital generation and DRP’s (at ~20% participation) more than sufficient to meet the capital increase.
From an ROE perspective this can be offset through a ~14-18bps of asset repricing. The impost on ANZ and NAB is the highest while the regional banks will also likely need to boost capital levels. Overall this review is largely inline with our expectations and unlikely to negatively impact share prices.
The FSI has suggested that all ADI’s will need capital ratios in the 75th percentile of global banks. This is not a straight forward target with no global comparable CET1 ratio adjusted for all national discretion available.
That said piecing together what the FSI, APRA and BCBS are saying we estimate the major banks would need to increase capital by $16bn to get to the 75th percentile or $23.5bn allowing for a 50bps buffer. We also estimate an additional $1.5bn for regionals or $2.2bn with a 50bps buffer."
It will also effect the treatment of mortgages, which will have a run on impact on housing:
The FSI also suggested increasing RW on housing to an average of 25%-30%.
This is well above the current global levels and would require additional capital of $9.5bn–$16bn. We would caution against adding this onto the capital required to meet the 75th percentile target as other international banks are not subject to this requirement and hence the RW increase would be excluded in the group harmonised calculation.
We do not believe the banks will attempt to raise capital in the near term with implementation likely to take 3-5yrs given: i) the government review will take 6mth, ii) the FSI recommending that sufficient implementation time be given and iii) APRA still has to figure out how to benchmark Australian banks vs international peers. We estimate organic capital generation and DRP’s (20%
participation) over the next 3-4yrs sufficient to meet the higher capital levels.
Our estimates suggest that the banks can offset the impact of higher capital through a 14-20bps repricing of gross loans. Assuming housing is the mechanism for repricing then the increase is 25bps – 35bps.
All these are just recommendations, of course. As Adele Ferguson points out in the AFR, it all depends on how much of it is implemented. But if it is it will mean a tighter market for residential mortgages and perhaps a more sensible property market:
"The financial system inquiry was always going to be a juggling act of competing vested interests – and protecting consumers – but its success or failure in creating a blueprint to improve stability and efficiency will depend on the government, the industry and the regulator’s appetite for change.
The average capital required to be held by the big banks for Australian residential mortgages is $1.50 to $1.80 for every $100 in loans. The FSI explored whether this was enough and decided it wasn’t.
It also contemplates raising the minimum benchmark for total capital by one percentage point of risk-weighted assets. It calculates that raising capital ratios by one percentage point would increase the average interest rates on loans by less than 10 basis points “which could reduce GDP by 0.01-0.1 per cent”.
According to BBY’s Brett Le Mesurier, the major banks would have to set aside in aggregate $30 billion in extra capital should the inquiry’s recommendations be adopted. If the banks don’t pass on the costs associated with this to customers, it would result in a 5 to 10 per cent reduction in the share prices of the big banks, compared to their current position."