Funding Australia’s Future: From where do we begin ? & Implications for Mutual ADIs

1. Funding Australia’s Future:From where do we begin?& Implications for Mutual ADIs Kevin Davis Professor of Finance, University of Melbourne Research Director, Australian Centre for Financial Studies (and Professor, Monash University)

2. Background and Objectives • Funding Australia’s Future project at ACFS • Identify possible developments in demand for and supply of finance • Implications for financial flows and financial sector structure • Impediments to efficient financing • Stage 1: three background papers • Release July 10, Sydney Conference Aug 7 • Stage 2: further commissioned studies on specific topics

3. Rationale and Issues • Financial sector in continual state of evolution • Adjusting to technology, regulation, changing pattern of real sector demand & supply of finance • Future development will be influenced by current situation and recent trends • What does Australian financial sector look like (vis a vis others) and why? • Are recent trends transitory or long-lasting? • What are some scenarios? • & policy and strategy issues

4. Session Overview • Major Post GFC changes • Special Characteristics of the Australian Financial Sector • Future-gazing • Mutual ADI issues

5. Post GFC Changes • Initial table discussion • Identify 4-5 of the major changes in financial trends post the GFC, whether they are likely to be permanent or transitory, and implications • These could include aspects of: financial flows / patterns of financing; sectoral (household, corporate, govt, international) balance sheets; financial products; financial sector prices; financial sector structure; etc • (We’ll then discuss and compare with my list)

6. 1. Financial sector growth relative to GDP has ceased Financial Institution Assets / GDP Both activity level and asset valuation effects are relevant * Table excludes assets of SMSF

7. 1. Financial sector growth relative to GDP has ceased (cont.) Finance & Insurance: contribution to Gross Value Added

8. Australian Financial Instruments: September 2012

9. 2. Growth in Market Turnover (other than debt) declined Despite credit markets being the GFC problem Despite HFT

10. 3. Securitisation slowed dramatically (domestic) and ceased (internationally)

11. 3. Securitisation slowed dramatically (domestic) and ceased (internationally)

12. 4. Funds management industry growth interrupted.

13. 5 Banks shift towards domestic deposit funding

14. With the result that…

15. 6. Increasing scale and leverage of household balance sheets has paused leverage scale

16. Household financial asset composition changed

17. 7. Household savings ratio (Nat. Acc. Basis) has increased Definition: includes increased home equity; imputed income and expenditure; super contributions - Long run Implications for bank deposit growth?

18. Change in household financial position Four Quarter Moving Average Source: ABS cat 5230.0 Table 20

19. Household Sector: Net transactions: eight quarter moving average

20. 8. Long term downward share of NBFI lending to households ended • Mid 1980s: Banks 2/3; NBFIs 1/3 • 2007: Banks 2/3; Securitisers 1/5; NBFIs~ 10% • 2012: similar to 2007 • Few NBFIs left • Share of loans for investment housing increased from 15% in mid 1990s to 30% at GFC and constant since. • Share of owner-occupied housing loans relatively stable at around 60%

21. 9. Gradual decline in corporate leverage in the decades prior to the GFC ceased Liabilities = Debt + Market Value of Equity

22. 10. Increase in net funding of the business sector by households and the ROW relative to financial sector Recent RBA research: large business gross saving by foreign owned miners Retained earnings count as income debits on BOP current a/c Corresponding (offsetting) capital inflow credit Banks have ceased to be main vehicles for funding BOP

23. 14. Finance Sector Funding of BOP declined Source: ABS 5302 Table 84

24. 11. Corporate accumulation of financial assets slowed markedly after the GFC • Corporate sector holdings of financial assets • increased 13.2% p.a. over 2002 – 2007 • increased 3.1% p.a. 2007 - 2012 • Main changes • share holdings: -5.1 % p.a. v 12.1% p.a (partly valuation effects) • accounts receivable growth slowed from 17.3% to 4.3% p.a.

25. 12. Decline in Government Debt/GDP over the prior decade was reversed

26. 13. Increased holdings of Federal Govt debt by the ROW. Government Debt: Percentage held by Rest of World Why the lower interest in semis?

27. Is the Australian financial system different? • Table Discussion • In what ways does the Australian financial system differ from those found in other advanced economies? Are there any implications for business opportunities, risks etc for ADIs • Differences could relate to types of institutions; financial markets; financial products; demand, supply and allocation of finance; etc

28. Current Features of Australian Financing Patterns • banks and superannuation funds dominate the financial sector, holding approximately ¾ of financial sector assets. • relatively few financial assets held by non-prudentially regulated financial institutions (excluding SMSFs)

29. Australia has one of the largest pension fund sectors in the world, both in absolute terms and relative to GDP FUND ASSETS AS A PERCENTAGE OF GDP

30. Australia’s Stock Market is large by international standards And 13th largest in USD terms 2010-2011 (CIA Factbook)

31. Listed Companies/Population

32. Relative to GDP, Australia’s domestic bond market is of comparable size to most other OECD countries But few non-financial corporate issues

33. The Australian banking sector is of comparable size to that of other OECD countries • bank assets/GDP = 131.4 in 2010 versus median bank assets/GDP = 130.9 for the OECD). • (There is significant dispersion in this measure with the USA = 64.6 and the UK = 202.6). • Similarly bank deposits/GDP of 98.8 (a lower figure reflecting the role of wholesale and equity funding of assets) is close to the OECD median

34. But “Bloody Big Building Societies”

35. Household sector a net borrower from banks. • Bank deposits $660 bill; loans from banks $1,130 bill. • Household equity in super and insurance $1,491 billion • shares in financial corporations $151 billion, prepaid insurance premiums $54 billion. • Loans from securitisers $310 billion; loans from other depository corporations $100 billion. • Net claims on financial corporations overall (incl. super) of around $857 billion. • Since 1990s share of financial assets in household total assets has been relatively stable (37 to 42 per cent) • increased value of superannuation assets largely matched by increased valuations of housing.

36. Aggregate Household balance sheet not unusual by international standards Sources: OECD Economic Outlook No. 92 (database); RBA Bulletin

37. Low Corporate Leverage

38. Limited Corporate Use of Debt Capital Markets

39. Low Government Debt/GDP

40. Finance and Insurance Sectors: Share of Gross Value Added  Figures – treat with caution, but… Explanations?

41. Equity Bias in International Investments Share of FDI in stock of overseas assets has fallen from over 40% at start of 2000’s to around 30% (growth of superfund portfolio investment)

42. Significant Financing by Rest of World

43. Foreign Direct Investment (Stock)

44. Net Stock of FDI Outward FDI relatively low (but lots of portfolio investment)

45. Large Overseas exposure to AUD

46. Sector Financial Positions: Dec 2012 ($Trillion) Owed by to Assets / liabilities Include equity & debt

47. An Overview • Financial sector not markedly different to others, but: • Household savings flow into super for ultimate investment • Households major borrowers from banks • Australian companies use less debt • Large ROW financing: was a large role for bank borrowing • Small Aust. corporate and government bond market • Large financial sector by developed world standards

48. Thinking about the Future • GFC provided transitory shock to financing patterns • But unleashed regulatory reform with major implications for future financing patterns • Took attention away from long term issues • Financing patterns haven’t fully adapted to implications of compulsory superannuation • Flows of funds, liquidity creation • Tax system features are a major influence • Incentives for household sector risk taking • Patterns of corporate financing • Structural changes in financing likely

49. Financial System Structure “Lagging” • Superannuation has “re-routed” financial flows • Household savings increasingly fund securities investments, not lending and real sector project assessment (or the creation of securities) • Some credit / project risk appraisal by super funds and new security creation - commercial property, infrastructure. • Should there be more (super & home mortgages?) • What are consequences of increasing ownership of national capital stock by super for: achievable returns, innovation & entrepreneurship, capital stock growth?

50. Financial System Structure “Lagging” • Long-term household portfolio balance • Short run dynamics complicated: deposits = money • Banking sector still focused on “liquidity creation” (eg LT housing loans, ST deposits) • Even though large stock of illiquid savings exists (super) • Basel 3 “penalizing” bank liquidity creation