Paul Fletcher (Bradfield, Liberal Party) Share this | Hansard source

I now turn to the second point which I wish to address before the House this afternoon, which is the improved capacity which covered bonds offer to banks to raise capital. That is at the essence of the policy intention behind this bill. As I indicated, it is a much better approach to economic management than, for example, the approach of this government in introducing deficit after deficit. We have seen deficits of $26 billion, $56 billion, $49 billion and this year $23 billion. Of course, those deficits simply put upward pressure on interest rates and increase the desperate claims which the government is making on the financial markets. A much more prudent approach to banking policy and economic policy is the one which is contained in this particular bill, and that is the introduction of covered bonds.

It is an uncontentious proposition, which I am sure even the Assistant Treasurer will agree with, that banks play a critical role in our economy as providers of debt capital, and that is vital for home buyers, for business and for growth in our economy. Much of the money which banks lend out comes, in turn, from the money which is put on deposit with them. But, as we all know, Australian banks are not able to source all of their lending from the money which is on deposit with them. According to the Reserve Bank of Australia, as at June 2011 the gap between deposits held with authorised deposit institutions and loans made by those institutions—that is to say, the amount which needs to be secured from other sources—was $700 billion. It is that gap and the need to fill that gap which underpins the policy logic for allowing banks to issue covered bonds. The position is improving: domestic deposits now make up around half of the banks' sources of funds, up from 40 per cent in 2008. But by any measure there is still a significant amount of funding which must be obtained from sources other than deposits. A key means of filling that gap is the issue of bonds and other financial instruments by banks.

That is where covered bonds come in. They are designed to be another form of bond which a bank can issue to tap into the wholesale funding markets, with features which make them attractive to investors and in turn allow banks to raise funds on attractive terms. In that sense they are a form of securitisation, with some important variations which I will come to. Securitisation is a form of financing in which I have had some interest since my days as a banking and finance lawyer at Mallesons in the early nineties, when I had the opportunity to work on some of the earliest securitisation transactions in the Australian market, including the establishment of RAMS.

Securitisation has subsequently got something of a bad name following the global financial crisis, but at heart it is a sensible and useful financing technique under which a bank takes a pool of mortgages, for example, sells that pool of mortgages to a special purpose vehicle, in turn the special purpose vehicle issues bonds backed by the pool of mortgages and funds the purchase from the bank with the proceeds of the bond issuance, and in turn the bondholders are repaid out of the mortgage cashflows. As we all know, securitisation went off the rails because banks started paying less attention than they should have done to the credit quality of the underlying mortgages in part because, with the mortgages having been sold, they no longer had much of an incentive to have an ongoing interest in their credit quality.

I put to the House this afternoon the proposition that covered bonds can be thought of as a form of securitisation in which the holder of the bond issued by the special-purpose vehicle also has a right of recourse against the bank if the asset pool is inadequate to repay the bonds—that is to say, the bond holder also has the benefit of a guarantee given by the bank. I hasten to add that there are some important differences—in particular, a covered bond is issued not by the special-purpose vehicle but by a regulated credit institution. But there is an important similarity, which is that the bond holder continues to have security over the assets held by the special-purpose vehicle. The core idea remains the same: bond holders have their returns funded out of the pool of assets—very typically mortgages—and, in the case of covered bonds, this pool of assets is called the cover pool. There is a significant covered bond market in Europe and elsewhere in the world, but to date Australian banks have not been able by law to issue such bonds and hence tap into that market because, as we have heard, of the inconsistency between covered bonds and the absolute primacy of the claims of depositors in an insolvency.

The attraction of banks being able to issue covered bonds is that they typically allow banks to obtain funds more cheaply than they may be able to do using other forms of financing. Furthermore, covered bonds typically have longer terms than other kinds of wholesale financing and funding. As we saw in the 2008 crisis, where wholesale credit markets dried up, banks with a heavy reliance on short-term funding were very exposed. If they could not roll over their bonds or notes, they faced a liquidity crisis and, in turn, a solvency crisis. There are, accordingly, important systemic benefits in allowing banks to issue covered bonds as it will allow them to access a more stable form of funding and, in turn, that contributes to the stability of our financial system. This combination of longer terms and lower costs will provide an important advantage to Australian banks and, provided that competition is working effectively in the banking sector, those benefits will, in turn, be shared with the banks' customers.

Thirdly, I turn briefly to the question of the impact on depositors, because the point has been made that covered bonds do represent a change in the priority which banks' creditors enjoy. Historically, depositors have had first priority over all other unsecured creditors of banks. I highlight that the priority is only over other unsecured creditors, not over all creditors. That is an important distinction and one which means in practical terms that the value to deposit holders of the existing priority arrangements can be somewhat overstated. Even so, it is a priority which should not be lightly set aside. That is to say, the basis for giving the holders of covered bonds priority with deposit holders now to come second should be very tightly prescribed.

That is done through this legislation in several ways: firstly, through safeguards in relation to the cover pool—that is, the special-purpose vehicle. The cover pool is required to contain 103 per cent of the value of the loan and there must be a cover pool monitor. The second way in which the legislation limits the impact of this change in priorities is a cap on how much of its assets an ADI can contribute to the cover pool. That cap is set at eight per cent. In turn, this limits the amount of covered bonds that the institution can issue. Thirdly, these arrangements will be supervised by APRA, the Australian Prudential Regulation Authority, and it will set prudential standards covering the issue of covered bonds. These provisions, in turn, will lower the risk of the loan.

I conclude by making the observation that we are a constructive opposition and have brought to bear our constructive perspectives on this particular policy area, going so far as to, indeed, promote the concept of covered bonds. We are pleased to support this legislation because it gives effect to an idea that has considerable merit.

See this speech in context