Banks have increasingly been tormented by the rising cost of regulation and things look to get a whole lot worse.
Having seen Australia follow UK’s financial planning and insurance regulations, Graham Mott, a Deloitte financial services partner, last week told delegates at RFi Group's mortgage innovation summit of his fear that Australia will also follow the UK conduct rules.
These are rules that ensure a fair outcome for customers who buy financial products, including mortgages. And according to Mott, the rules don’t just demand disclosure of risk at the time of lending but through the life of a financial product or loan.
“You can imagine a situation with lenders where you might put up a line of credit. How do you monitor whether that line of credit is being used by your borrower in an appropriate way that isn’t starting to present risk to them. The onus is on you to track it – so its seller beware, not buyer beware,” he told the audience.
“The movie that is playing in the UK is how you price the front book and the back book differently and the impact of that - and if this flows down to Australia then it is huge, absolutely huge."
The other topic du jour related to the general push towards regulation since the global financial crisis, which meant banks were forced to hold greater licks of capital, more expensive funding and ultimately the users bear the costs.
It is clear that higher interest rates lie ahead for property investors in response to the prudential regulator’s ten per cent lending cap –- to stop property prices from soaring even higher, a theme that was readily taken up by JP Morgan banking analyst, Scott Manning.
"I think you will see an ongoing repricing of the banks’ loan book and a lot more selective repricing going forward - to generate the capital to continue to keep the share price moving - given the blunt tools that have been used in the past," he said.
"I think you have seen early evidence of that with repricing of investor and interest-only products. I see that as a toe in the water. I think you will see a lot more of that going ahead over the next couple of years, in particular once the prudential regulator beds down what their idea of 'unquestionably strong' means."
Ripping out costs
Whatever happens, he warned, the the cost of having safer and stronger banks will flow through to mortgage pricing as customers foot the bill.
"Ultimately, the pricing for risk and the pricing to match the regulatory capital weighting of each type of exposure – you will definitely see more of that," Manning argued.
“The biggest change I can see going forward is on the investor book where if exposure is defined as being materially dependent on rental income, the capital requirements will more than triple on that so there will be significant repricing to go through that product."
Costs will increase further especially with Total Loss Absorbing capital (TLAC) so Australians could easily see a quite significant increase in the cost of funds.
On top of that, Manning said that not only are there definitely challenges out there for the banks with analysts demanding that banks rip out some costs as well.
"You don't want to be putting so much burden on the system that ROEs fall below the cost of capital. You need to find the balance there. You want the banks to be strong, but you also need them to be suitably profitable to be able to continue to attract that capital, obviously a high credit rating and high returns.”