PART I
Post-crisis developments in bank funding
and regulation
Chapter 2
Overview of the post-GFC banking environment
2.1
This inquiry focuses on developments in the banking sector arising out
of, and linked to, the impact of the global financial crisis. Much has been
written about the causes of the crisis and the impacts it has had and continues
to have on the international and Australian economies. For the purposes of this
report, it is not necessary to restate these details. Some discussion of how
the banking sector responded to the crisis at the time, however, is relevant
for this inquiry. It can be concluded that the Australian banking system
avoided the worst of the crisis. When compared to the events and disruption in the
key international banking centres, Australian banks appeared strong and
resilient. The crisis also highlighted the sound regulatory regime in place in
the years leading up to the crisis and the effective performance of the
regulators charged with supervising the system and ensuring its stability—the
Reserve Bank of Australia (RBA) and the Australian Prudential Regulation
Authority (APRA).
2.2
Nonetheless, an economic event the magnitude of the global financial
crisis unsurprisingly had immediate and enduring effects on the Australian banking
sector. This chapter provides an overview of the overall impact of the crisis
on the sector and other relevant developments which have occurred in recent
years. Distinct and significant issues arising out of the crisis, such as
increased funding costs, changes by the banks to their funding mix, and the
Basel III reforms, are examined in more detail in subsequent chapters.
Impact on bank funding
2.3
As an immediate consequence of the global financial crisis, banks
everywhere were perceived to be more risky while investors became more risk
averse. Given that the major Australian banks continue to be significantly reliant
on offshore wholesale funding, the increased risk premiums demanded for bank
debt following the crisis has impacted Australian banks considerably. The
Australian Bankers' Association (ABA) noted:
As revealed around the world, a high level of reliance on
foreign funding exposes a country to greater shocks. Investors that extend
money do so because they are confident in getting it repaid, and in situations
of uncertainty, there is a bias to investment in their home countries.[1]
2.4
When the RBA was asked about the impact of the crisis, the change in
risk premiums was the main point made in response:
Dr Debelle: ... prior to 2007 risk premia right
across the board were really low. Since 2007 they have gone right up, and that
has affected the banks' cost of funds and, in the opposite direction, it has
affected the government's cost of funds by pushing it down. That is probably
the main source of transmission to the domestic financial system.
Senator CAMERON: So it was a transmission. It was not a
Northern American financial crisis; it did impact Australia?
Dr Debelle: Yes. As I said, because our financial system is
connected to that and the rest of the world it certainly had an impact.[2]
2.5
Westpac also put rising funding costs as the key post-crisis
development:
... without any shadow of a doubt, funding costs are the
most substantial issue that the banks have faced in the past three to five
years. The issues continue and we are in the midst of quite a profound
structural change in the way that banks are funded and how they fund
themselves. This situation has gone on probably longer than many of us
suspected it would and it has certainly become more entrenched as a structural
issue rather than a passing pricing issue. Among the strategic issues that we
have to confront, without any shadow of a doubt, that is the main one.[3]
2.6
Changes to funding sources, mix and costs are examined in more detail in
chapter 4.
Market concentration and competition[4]
2.7
While stability is a feature of the Australian banking sector, the
degree of genuine competition is less clear and has been questioned by market
participants and other observers, particularly as the Australian banking sector
is characterised by the large market shares enjoyed by the four largest
banks—the Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of
Australia (CBA), National Australia Bank (NAB) and Westpac.
Market share
2.8 The market share of the largest firms is often used as a simple way of
indicating a concentrated market; however, another measure of market
concentration often used in the analysis of markets, particularly in the
context of mergers and acquisitions, is the Herfindahl-Hirschman
index (HHI). The HHI takes into account the market share of all
participants in the relevant market. It is calculated by totalling the squares
of each firm in the market (for merger analysis the post‑merger share of
the merged firm and each rival firm is used, and the increase in the HHI is
also considered).[5]
An HHI can be expressed in two ways—either as a number between zero
(representing perfect competition) and one (a monopoly), or as a number between
zero and 10,000.[6]
The Australian Competition and Consumer Commission (ACCC) uses 0.2 (or
2000 using the alternative method) as a guide for its merger analysis.[7]
2.9
It is clear that the banking sector has become more concentrated in
recent years, with the major banks increasing their share of assets, deposits
and home loans (Table 2.1).
Table 2.1: Measures of concentration in the Australian
banking market
|
Date
|
Assets
|
Deposits
|
Home loans
|
|
Share of 4 largest banks (%)
|
HHI
|
Share of 4 largest banks (%)
|
HHI
|
Share of 4 largest banks (%)
|
HHI
|
|
1890
|
34
|
.06
|
|
|
|
|
|
1913
|
38
|
.10
|
|
|
|
|
|
1950
|
63
|
.14
|
64
|
.15
|
|
|
|
1970
|
68
|
.16
|
68
|
.16
|
77a
|
.21a
|
|
1990
|
66
|
.12
|
65
|
.12
|
65
|
.13
|
|
Oct 2008 (pre-mergers)
|
65
|
.11
|
65
|
.12
|
74
|
.15
|
|
Oct 2008 (post-mergers) b
|
73
|
.14
|
75
|
.15
|
86
|
.20
|
|
June 2009
|
75
|
.15
|
78
|
.16
|
86
|
.20
|
|
June 2010
|
77
|
.16
|
78
|
.16
|
87
|
.21
|
|
June 2011
|
78
|
.16
|
78
|
.16
|
87
|
.20
|
|
June 2012
|
80
|
.17
|
79
|
.16
|
86
|
.20
|
a Assuming all owner-occupier housing loans were made by
savings banks and accounted for all their loans.
b From 'Oct 2008 (post-mergers)' onwards, statistics for
Bankwest and St George are counted as parts of the CBA and Westpac
respectively.
Note: The table provides an
indication of market share among ADIs—non-bank lenders are not included.
Source: June 2009–June 2012 based
on APRA data; other data reproduced from Senate Economics References Committee,
Competition within the Australian banking sector, May 2011, p. 42.
2.10
The major banks' increasing market share of housing finance has been at
the expense of all other categories of lenders—i.e. smaller banks, building
societies, credit unions and non-banks (Figure 2.1).
Figure 2.1: Lenders' share of housing credit
Source: RBA, Submission 33,
p. 2; based on ABS, APRA and RBA data.
* Includes Bankwest
from December 2008
** Excludes mutual banks
2.11
The major banks' increasing market share of business credit has also
been observed (Figure 2.2).
Figure
2.2: Shares
of outstanding business credit (by lender type)
Source: Treasury, Submission
120, p. 8; based on RBA data.
Notes: Major banks include
Bankwest from December 2008; ANZ, CBA, NAB, St George and Westpac for entire
sample. Other lenders includes cash management trusts, specialist credit card
institutions and securitisers. Other banks include foreign banks as well as credit
unions and building societies rebranding as banks.
2.12
Acquisitions by the major banks of key competitors in 2008 explain much
of the increase in the major banks' market share.[8]
Meanwhile, the activity of foreign banks in Australia has also decreased (Figure
2.2). European‑owned lenders, faced with mounting problems at home, have reduced
their activity in Australia (although countering this to some degree, some
Asian‑owned banks have expanded their operations). Consequently, the
market share of the major Australian banks increased as they filled any
remaining gap in the market. The RBA concludes:
Although the number of foreign-owned banks operating in
Australia has more than doubled since the early 1990s, their share of bank
assets at the end of 2011, at 12 per cent, was broadly the same. From around
the mid 1990s to 2007, they noticeably increased their share of bank assets,
from around 10 per cent to 22 per cent, due to a combination of acquisitions,
new entrants and organic growth. Since the onset of the financial crisis,
however, the foreign-owned banks' share of assets has fallen. Only part of this
was due to CBA's purchase of Bankwest in 2008, which was the largest
foreign-owned bank at the time. The foreign-owned banks that expanded the most
in the years leading up to the crisis have typically also seen the largest
contractions in their assets in recent years.[9]
Figure 2.3: Foreign-owned banks in Australia: Share of banking system assets
(domestic books)
Source: RBA, 'The Australian Financial
System—Box A: Foreign‑owned Bank Activity in Australia', Financial
Stability Review, March 2012, p. 38.
2.13
Non-bank lenders provided increased competitive tension in the
Australian banking system when they commenced operations in the 1990s. Besides
competing on price, these lenders also introduced technological innovations for
consumers, such as internet banking.[10]
The non-bank institutions utilised wholesale funding by securitisation to fund
their activities. The deterioration of the securitisation market during the
global financial crisis challenged these models—while securitisation was
funding over 20 per cent of home loans by mid‑2007 this decreased rapidly
once the crisis hit, returning to late 1990s levels (Figure 2.4). The
consequence of many non‑bank lenders being unable to obtain sufficient
quantities of suitably priced funds is demonstrated by the experience of RAMS Home
Loans, a key non-bank lender that grew substantially in the 2000s. In 2007 RAMS
sold its franchise distribution businesses and brand to Westpac in return for
cash and assistance in securing funding, after advising shareholders that, in
the absence of this deal, it was 'unable to locate alternative sources of new
funding in sufficient volumes to meet the ongoing needs of the business'.[11]
Figure 2.4: Share of housing credit funded by securitisation
Source: Bernadette Donovan and
Adam Gorajek, 'Developments in the structure of the Australian financial
system', RBA Bulletin, 2011, no. 2 (June quarter), p. 39.
2.14
Other factors contributing to the major banks' increased market share include
the 'flight to quality' during the crisis, where nervous customers moved their
deposits and business to the major banks, perceiving them to be safer due to
their size and longevity.[12]
Market contestability and
indicators of competition
2.15
In addition to market share, there are many factors which influence
competition in a market. The CBA considers that, for the banking sector,
determinants include the barriers to entry and exit, the level of customer
demand for banking products and the impact of regulatory reforms.[13]
2.16
There are signs of the banks competing on several fronts. Treasury is of
the view that competition between the major banks 'remains strong', with 'NAB
and ANZ being particularly aggressive in housing credit over the last year'.[14]
The RBA expressed a similar view, noting that in the housing lending market
'the major banks have been competing for most of the past year for market share
in an environment of slower credit growth'; although since early 2012 it has
observed that competition has eased partly due to increased funding costs.[15]
The Mortgage and Finance Association of Australia (MFAA) noted that, despite
funding challenges, non-bank lenders were still competing with the major banks
on standard variable interest rates, with the average non-bank rate in May 2012
0.63 percentage points lower than the average rate of the major banks.[16]
2.17
Regarding deposits, competition among authorised deposit-taking institutions
(ADIs) has noticeably increased as they seek to secure more stable funding
sources. In the ABA's view, 'Australian banks have competed ferociously for
household and business domestic deposits in order to fund growth in credit.
This has been a bonanza for savers who are enjoying very good deposit deals'.[17]
While more restrained in his comments, evidence from a senior officer at the
Treasury broadly supported this contention:
... at the moment ... deposits are tight. Everyone
is competing to build deposits up, so again, on that transition point, the
major banks are seeking to move up their level of deposits to provide a stable
funding source—they are paying for it—to reduce their dependency on offshore
funding. You have got a number of people competing in the same space for
deposits and, again, to some extent that is of benefit to the consumer. They
are getting the benefit of that competition.[18]
2.18
Competition for small business loans, however, has decreased in
intensity since the crisis. Treasury provided the following overview of
competition in this market:
On the competition angle in terms of small business loans you
have to factor in from the lender's point of view that there is a higher risk
with a business loan than there is with a mortgage. You have to factor that in.
Secondly, what we see from our analysis and hear from the major banks is that
between 80 to 90 per cent of borrowers get accommodation from a lending
institution.[19]
2.19
Issues associated with small businesses accessing finance following the
global financial crisis were examined by this committee in 2010, and more
recently by the Parliamentary Joint Committee on Corporations and Financial
Services.[20]
To the extent that it is relevant to lending practices and other matters being
examined by this inquiry, however, the issue is examined further in chapter 6.
Profitability of Australian banks
2.20
Profitability is another indicator of the level of competition in a
market. For financial institutions, profitability can be indicated by three
main measures:
- return on equity (ROE)—the net income returned as a percentage of
money invested by shareholders—i.e. how efficiently the shareholders'
investments are being used to generate income;
- return on assets—the net income returned as a percentage of
assets—i.e. how efficiently assets are generating income;
- net interest margins (NIM)—the difference between what a bank on
average receives in interest payments compared to what it pays on average in
funding costs.
2.21
The following paragraphs will examine the profitability of Australia's
major banks compared to their profits prior to the global financial crisis,
other major Australian companies, international banks, and other ADIs.
Comparison with pre-crisis profits
2.22
The RBA provided the committee with information indicating that the ROE
of the major banks is currently around its long-term average (Figure 2.5).
Figure 2.5: Major banks' profitability
Notes: The chart shows
underlying half-yearly profitability. In 2006 the banks began reporting on an
AIFRS rather than an AGAAP accounting basis; data prior to 1998 are on a yearly
basis.
Source: RBA, Submission 33,
p. 7; based on RBA data and banks' annual and interim reports.
2.23
Treasury similarly provided information regarding changes to the major
banks' NIMs over the past decade. Treasury observed that the major banks' NIMs
were reduced during the global financial crisis but are currently, on average,
around pre-crisis levels.[21]
As Figure 2.6 shows, since the peak of the crisis there has at times been
significant variation in the individual NIMs of the major banks, particularly
during 2010.
Figure 2.6: Major banks' net interest margins
Notes: Data is half yearly and
calculated as net interest income to average total interest earning assets on a
group basis. ANZ data unavailable prior to 2004.
Source: Treasury, Submission
120, p. 11; originally sourced from major banks' financial disclosure
documents.
2.24
While Treasury considers that NIMs provide 'useful, although lagging,
indicators of the impact of funding costs on profitability',[22]
the CBA questioned the usefulness of comparing pre-crisis NIMs with current
levels. The CBA acknowledged that NIMs are 'one of the key drivers of
profitability', but argued that they are inflated by the higher levels of
capital banks now hold and that pre-crisis NIMs have not been adjusted for the
under-pricing of risk at that time which, in the CBA's view, 'makes that a
misleading reference point'.[23]
The CBA also gave evidence that they have been seeking to increase their
productivity, allowing the bank to maintain its profits despite higher funding
costs.[24]
Comparison with other Australian companies
2.25
A bank's ROE can be compared against many other sectors and points in
time. The RBA considers that the ROE of Australia's major banks are similar to
those of other major corporations in Australia.[25]
The CBA asserted that, although it is ranked second for market capitalisation
on the ASX, by ROE it is ranked 34th.[26]
The ANZ argued that, given that Australia's major banks are among the largest
companies in the country, 'the dollar amount of profits made by the four major
banks is a reflection of the size of the companies and the amount of capital
employed'.[27]
The ANZ continued by pointing out that its 2010–11 statutory ROE of 15.3 per
cent is lower than that of the resources and telecommunications sectors and
similar to the healthcare and supermarket sectors.[28]
2.26
Comparing bank profits with those of mining companies during a mining
boom, however, is not a helpful comparison (and one purposely avoided by Treasury).[29]
Additionally, as similarly observed by this committee in 2011,[30]
one could counter that these comparisons are with other businesses operating in
oligopolistic industries or otherwise have limited competition due to high
barriers to entry or other obstacles, and thus have the opportunity to earn
abnormally high profits. There are, however, factors unique to banking that
affect the approach to profits, such as regulatory requirements. The CBA noted
differences between how banks are expected to manage their business compared to
other companies:
... banks need to earn profits in excess of their cost of
capital so that they can build up a buffer of equity which can be called upon,
if necessary, in difficult times. If there is no buffer, the institution is
more likely to fail in the first downturn. Banking is a cyclical and highly
leveraged industry so that buffer must be significant.[31]
Comparison with major international
banks
2.27
The Bank for International Settlements has published figures showing
that the major Australian banks are the most profitable in the developed world,
with 2011 pre‑tax profits equal to 1.19 per cent of total assets.
Canadian banks, in second place, were the only others to have pre-tax profits
above one per cent.
Table 2.2: Profitability of major banks
Notes: Largest banks in each
country by total asset size. The number of banks in the 2011 data is indicated
in parentheses. Operation costs consist of the sum of personnel and other
operating costs. For Japanese banks, no personnel costs included.
Source: Bank for International
Settlements, 82nd annual report, 24 June 2012, p. 79; Bankscope.
2.28
It should be recognised that these data provide comparisons of
post-crisis profits where, given the ongoing problems in other banking sectors
and economies, Australian banks have clearly outperformed most of their
international counterparts. When asked about the relative profitability of
Australian banks, a senior Treasury officer's immediate response was to ask 'is
it very surprising'? He went on:
The traumas that other countries have had with their banking
systems, to me, probably reflects the market and that they are being reasonably
well run. We have had strong prudential regulation. The banks came through the
GFC in a very strong position and that means that the whole ADI sector—I am
not saying just the majors. One would think that you have got to get some
benefit out of that.[32]
2.29
On a pre-crisis basis, the RBA considers that the returns on equity of
Australia's major banks are similar to pre-crisis ROE of banks in other
countries.[33]
This point was also made by the CBA in relation to the United States and some
European countries.[34]
Comparison with smaller banks,
credit unions and building societies
2.30
Another basis for comparing the major banks' profits is by examining how
they compare to their smaller competitors. Treasury provided the committee with
some information about this (Figure 2.7).
Figure 2.7: ADIs' return on equity
Source: Treasury, Submission
120, p. 12; based on APRA data.
2.31
Treasury's submission stated that '[o]f note, other Australian banks
were consistently more profitable than the majors in the period leading up to
the GFC'.[35]
However, the chart also shows that the other Australian banks have been
consistently less profitable than the majors in the period following the
crisis. Also of interest, the gap between the major banks' profits and other
Australian banks has widened significantly, with other Australian banks
achieving an average ROE of approximately five per cent in September 2011,
compared to the more than 15 per cent obtained by the majors.
International regulatory changes
2.32
Another feature of the post-crisis banking sector is the amount of
regulatory change from various international sources. This was a topic raised by
a number of banks and their representative groups. They did not argue about the
merits of the changes—Westpac argued that it had been 'very forthright in
supporting the whole regulatory reform agenda in terms of its philosophy'[36]
but warned about the pace of the reforms, and implications of the changes in
terms of added costs—costs that may be compounded by inconsistency between
different jurisdictions. The CEO of the ABA provided a useful overview of the
sector's view that the benefits of added regulation and its costs need to be carefully
considered. He acknowledged that some changes are not unreasonable because 'if
we learnt anything out of the global financial crisis it is the extent of the
harm that can be caused by instability and collapse in parts of the financial
system', however:
One of the things that policy makers need to continually bear
in mind is that stability, as desirable as it may be, does come at a price.
What the banking system is really about is managing risk. At its most simple
level, we take the risk of lending money to people and the risk of being able
to pay money back to those who have given us money to look after for them. You
cannot remove risk from the banking system—that is what it is about. The more
that you try to do that the more you are going to have these impacts around the
availability of credit, the price of credit and the willingness of banks to
fund marginal parts of the economy particularly—and in marginal I am including
things like the entrepreneurial parts of the economy. We have to constantly
check that balance between very desirable stability and the consequences of
pursuing that stability.[37]
2.33
Westpac added:
Regardless of any debate on the need or merits of the
elements of the reform agenda, it must be taken into consideration that the
impacts of such reforms will undeniably be that credit will be more expensive,
and supply constrained relative to the experience of previous decades.[38]
2.34
Accounting for different regulatory regimes and changes can be
particularly challenging for foreign banks, as they have to comply with the
requirements of multiple regimes, which may place them at a competitive
disadvantage in some markets. ING Direct stated:
... the fact is that in the end the group itself is
subject to specific regulation by its home regulator, the Netherlands. Here we
are subject to our regulation that comes to capital. There are differences
between the two systems but the fact is though, we have to comply with both, so
in the end we have to take the strictest interpretation or the most severe
interpretation of the legislation.[39]
2.35
The most significant of the regulatory changes is Basel III, the latest
iteration of the Basel Accords. Chapter 3 focuses on Basel III and its
implementation in Australia, however, some of the banks' observations about the
Accord are relevant here. A main argument put forward by the banks is that Australia
was diverging from how Basel III was being implemented in other
jurisdictions, and that this inconsistency was posing compliance challenges and
increasing their costs. The ANZ Deputy CEO provided a summary of his bank's
view:
One of the concerns that we had about the fragmentation that
was happening around Basel III, and the different rules, was that we were
starting to see different regulatory regimes across many countries. We operate
in 32 countries. So, if you have to build a bank across multiple regulatory
regimes, it increases your costs and the complexities of doing business—which
is not good.[40]
2.36
In addition to the Basel reforms, the committee was advised of a number
of regulatory changes in other countries which, through extra-territorial
effects, have impacted Australian banks. Legislation from the United States in
particular was highlighted. Mr Tony Burke from the ABA explained why the US
legislation was being framed in this way:
The US is constructing very complex laws and is determined
that smart bankers and their lawyers will not find ways around those laws. So
it cast them very widely and inadvertently captures a whole range of activities
outside of the US's borders or unrelated to US entities. The laws have quite
strong punitive clauses as well and it effectively brings in operations
overseas.[41]
2.37
Examples provided in submissions include:
- the US Dodd-Frank Wall Street Reform and Consumer
Protection Act (particularly the Volcker rule);
- the US Foreign Account Tax Compliance Act (FATCA); and
- the UK Bribery Act 2010.
2.38
The Volcker rule would prevent banks that take retail deposits that are
federally insured in the US from (a) engaging in proprietary trading that is
not directly related to the market making and trading they do for customers;
and (b) owning or sponsoring hedge funds or private equity funds. The ABA
argues that the drafting of the rule effectively captures any connection
whatsoever with the US. An example given was the use of exchanges based in the US
by non-US banks when the exchange relates to foreign transactions and does not
pose a risk to US taxpayers.[42]
For these and other reasons, a number of foreign governments have questioned
the extra‑territorial implications of the Volcker rule. The US Securities
and Exchange Commission's website lists submissions on the Volcker rule from,
among others, the Canadian Finance Minister, the UK Financial Services
Authority and the European Commission.[43]
Formal public representations by the Australian government or its agencies do
not appear to have been made. It was perhaps with this in mind that NAB felt
obliged to write in its submission:
Industry associations in the US have advised that direct
government to government/regulator comments are affective [sic] at influencing
the way the regulators in the US approach final regulation. Any additional
support the Australian Government could provide to the industry, either
directly or via regulators would be appreciated.[44]
2.39
FATCA was another piece of US legislation whose extraterritorial effects
were highlighted by Australian banks. In its submission, the ABA explained that
the objective of this Act is to recover lost US tax revenue, but to help
achieve this aim it places customer identification and reporting obligations on
foreign financial institutions globally.[45]
A further explanation of the implications for Australian banks was given as
follows:
... because of connections that Australian banks have with
the US, it requires us—we are still sorting it out—to identify American
citizens here in Australia and report directly from the banks to the Inland
Revenue Service in the US the banking activities of US citizens. We run into
all sorts of difficulties with going to Customs and asking if you are a US
citizen or not. Of course, there are big penalties if we do not find all the US
citizens ... It is inadvertent but is very problematic for us. It is
fair to say the US administration does not the rate the concerns of other
countries terribly highly in its own issues at the moment.[46]
2.40
ING Direct also highlighted FATCA, noting that the US government is the
only beneficiary of the law and that it was requiring Australian banks to incur
costs 'that are not actually relevant to our being good at providing the
services to our customers locally'.[47]
2.41
There have been recent developments regarding the compliance burden imposed
by FATCA. In July 2012, France, Germany, Italy, Spain, the UK and the US
announced a model intergovernmental agreement to address these issues. The
agreement seeks to minimise compliance costs by establishing:
... a framework for reporting by financial institutions of
certain financial account information to their respective tax authorities,
followed by automatic exchange of such information under existing bilateral tax
treaties or tax information exchange agreements. It addresses the legal issues
that had been raised in connection with the Foreign Account Tax Compliance Act,
simplifies its implementation for financial institutions and provides for
reciprocal information exchange.[48]
2.42
The Australian government recently announced that it is 'is exploring
the feasibility of an intergovernmental agreement with the US' as an
alternative to individual agreements between financial institutions and the US Internal
Revenue Service. Treasury initiated a consultation process on this proposal on
28 August 2012.[49]
Formal discussions on an agreement have commenced.[50]
Libor-fixing scandal
2.43
During the course of this inquiry, a number of international banking
scandals occurred. A US Senate committee released a report revealing that HSBC,
which it had selected as a case study, failed to act on laundering of drug
money and other suspicious funds.[51]
Standard Chartered was accused by a New York state authority of hiding
transactions with Iran—in contravention of US law—and accepted a fine of
US$340 million.[52]
2.44
The most dramatic scandal, however, was the admission that Barclays Bank
had been manipulating Libor (the London interbank offered rate). Libor indicates
the cost of unsecured borrowing in the London interbank market and is a key benchmark
globally for short term interest rates.[53]
While the integrity of Libor had been the subject of some earlier speculation, in
June 2012 it was publicly confirmed that traders at Barclays had been submitting
false rates. Barclays acknowledged that, generally between 2005 and 2008,
certain traders requested rates that would benefit their position and requested
traders at other financial institutions to also arrange for favourable
submissions for their institution. Further, to avoid media speculation that the
bank's high US dollar Libor submission might reflect liquidity problems,
between 2007 and 2009 Barclays' management ordered its submission to be
lowered.[54]
As a result, various US and UK authorities imposed fines on Barclays totalling
around £290m.[55]
However, as it seems that a bank acting alone would have a limited ability to
influence Libor, a number of other investigations by regulatory authorities
have commenced.[56]
2.45
Given the importance of Libor, the committee was concerned about
possible implications for Australian consumers and financial institutions. The
RBA was questioned about this; Assistant Governor Dr Guy Debelle provided his
analysis of the possible consequences for Australia:
There is an Australian dollar Libor; banks in London are
asked what their Australian dollar borrowing costs are. Very few financial
products that we can work out actually reference that. There are some but it is
a handful. The impact here is not a big deal. Do Australian entities, including
the banks, borrow or have contracts which reference Libor? Yes they do.
Australian banks raise money in the US and borrow at a rate that would be Libor
plus some spread. They then take those US dollars and swap them back into
Australian dollars. That swap contract is also Libor. From the Australian banks'
point of view, Libor basically washes out. That is true of an Australian funds
manager who is hedging something or BHP when it is borrowing in US dollars and
swapping them back to Australian dollars or any Australian corporates that do
that. I am sure there are some people who have products which are affected by
Libor but a fairly large chunk of Australian borrowing would not be that
affected by it.[57]
2.46
The committee was also concerned about the likelihood of similar conduct
occurring with Australia's equivalent, the BBSW. The BBSW is referenced in many
financial contracts in Australia, however, the RBA advised that how the BBSW is
calculated by the Australian Financial Markets Association (AFMA) differs from
how Libor is set. The two major differences are:
- the composition of the panel—for calculating BBSW, AFMA uses a
panel which consists of the four major banks (as the issuers of bank paper) and
ten dealers (the buyers of bank paper); and
- the question that the panel responds to—'what is the rate that a
prime bank in Australia can borrow at?', whereas Libor asks the banks what they
think they can borrow at.[58]
2.47
Accordingly, in the RBA's view, the BBSW is less susceptible to
manipulation than Libor, although the RBA noted that AFMA is examining BBSW in
light of the developments in the UK.[59]
Committee comment
2.48
The admission that Libor, a benchmark rate referenced in an enormous
number of contracts globally, was being manipulated for a number of years
during the global financial crisis is a troubling development and indicative of
the worst types of conduct in the financial system. The committee understands
that the Australian benchmark rate, BBSW, is calculated in a fundamentally different
manner to Libor and that regardless, the process for calculating BBSW is being
examined by AFMA. However, the committee considers that AFMA should make public
the results of its review of BBSW to ensure that there can be greater public
confidence in the Australian equivalent of Libor.
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