Australian retirees need to be very wary of becoming cannon fodder in the war between the banks and the regulators over leverage and risk.
In fact it’s already happening: savers are being herded like sheep from term deposits into hybrids by the border collies known as bank-owned financial planners, doing the bidding of their masters.
Earlier this month the Australian Prudential Regulation Authority released a discussion paper suggesting that banks should be required to disclose their leverage ratios against total assets, not just risk-weighted assets.
Two days earlier the new chairman of APRA, Wayne Byres, made a landmark speech that shocked the banks, in which he declared that there was an “increasing lack of faith” in the use of internal models to calculate risk-weighted assets.
Yes, it’s true -- Australian banks get to work out their own risk weightings. And guess what? Residential mortgages are weighted very low indeed.
When banks work out their capital as a percentage of assets, international rules allow them to reduce the value of some assets according to their “risk weighting”.
It used to be that mortgages were weighted at 35 per cent -- that is, only 35 per cent of a mortgage is counted as an asset for capital leverage purposes. (It’s a fiction that becomes a little embarrassing when there’s a housing bust, as there was in the US in 2008.)
Australian banks are now allowed to set their own risk weightings, and in July the Australian Financial Review revealed that the average home loan risk weighting of the big four banks was just 18.5 per cent, not 35 per cent.
That means that if APRA required them to report capital as a percentage of undiscounted assets, investors and customers would be horrified at their leverage and demand that they acquired more capital.
The ratios wouldn’t be the 10-11 times that they appear to be now with risk-weighted assets, but a leverage of 50 times or more.
As Wayne Byres said: “the chairman of the Basel Committee has made it clear that there is a problem, and something must be done about it.”
“Unless investors have faith in … risk-based capital ratios, they do not serve their full regulatory purpose. And if that is the case, simpler metrics will inevitably become more important -- and potentially even binding.”
The APRA move is part of a global attack by bank regulators on the way banks manipulate their capital ratios, and therefore their return on equity, with big risk-weighting discounts, especially on home mortgages.
For their part, banks are mobilising a big lobbying campaign to resist this push altogether. The last thing they want to do is report their true leverage against total assets.
They would be inevitably required to hold more capital and their return on equity would plummet.
In the meantime they are taking out insurance by shoving as many savers as possible into hybrids.
Term deposits rates are currently barely above inflation; investors who go to their friendly bank-owned financial planner to seek an alternative are likely to be invited to invest in a bank hybrid.
“Same bank, higher interest,” is the sales pitch. And many retirees, desperate to get their income up, are buying it. Money flooded into the recent CBA PERLS VII at just 2.8 per cent above the bank bill rate, or 5.4 per cent.
The trouble is that a hybrid is not a debt obligation but equity. The customers think it’s debt, but banks get to count the money as capital, not a liability like term deposits.
This is how the banks will keep their ROE up if the dreaded requirement to disclose total leverage comes to pass: by moving as many savers as possible out of deposits and into the disguised equity of hybrids.
And the fact is that the banks control not only the interest rate on term deposits, but they also employ most of the financial planners providing the advice to savers.
They are, in short, hopelessly conflicted, able to exploit the lack of sophistication of most ordinary savers and shift huge sums of money down the ledger from “liabilities” to “capital”.
And it doesn’t really matter what the fine print of the hybrid prospectus says, once a saver is transferred from being a depositor to being a hybrid investor, he or she loses the protection of APRA.
APRA is there to protect depositors, not equity investors. In fact, if a bank looks like failing APRA will do everything in its power to make sure the providers of equity, including hybrids, actually do lose their money -- to ensure the depositors don’t lose theirs.
Do the bank-owned financial planners tell clients that when they suggest moving from a term deposit into a hybrid? I doubt it.