Submission to the Financial System Inquiry 5. Sectoral Trends in Funding Patterns in the Australian Economy

This Chapter analyses some of the key trends in the sources and uses of funds by each sector of the economy. The overall funding needs of the economy reflect the collective saving and investment decisions of the household, corporate and government sectors. Net lenders save more than they borrow, and provide their surplus funds to net borrowers whose demand for funds exceed their saving. Financial corporations intermediate the flow of funds between net lenders and net borrowers. The balance of funding needs that are not met domestically are financed by foreign investors. These flows from savers to borrowers build up over time as asset and liability positions.

The key points of the Chapter are:

  • Australia has recorded current account deficits in nearly every decade of its history. Current account balances are determined by the myriad of saving and investment decisions of Australian households, businesses and governments.
  • Following the crisis, some commentators questioned whether enough capital would be available to meet the needs of Australians, given reduced foreign demand for bank debt globally. In the event, the capital account adjusted, with the price and composition of funding shifting accordingly.
  • In recent years, the household sector has adopted a more prudent approach to its finances, shifting the composition of its financial asset portfolio away from riskier assets, such as equities, and towards deposits. Non-financial corporations have changed their funding mix toward a higher share of internal funding and a lower share of debt.
  • While the Australian domestic corporate bond market remains smaller than in some other advanced economies, it has matured in recent years. This has been evident in greater domestic issuance by lower-rated entities and some lengthening in the tenor of that issuance. Several recent developments in market infrastructure may further support activity.
  • Small businesses are less likely to use debt funding than larger businesses. And most of their debt funding is provided by banks and other credit institutions rather than the capital markets. The available evidence suggests that small businesses in most industries have had tighter but still reasonable access to funds throughout and after the financial crisis, albeit at higher cost during the crisis.

5.1 National Saving and Investment

At the national level, the difference between the level of investment and saving is equal to the current account balance.[1] Investment in the Australian economy has tended to exceed saving, leading to current account deficits (Graph 5.1). The Australian economy has recorded current account deficits in almost every decade for at least 150 years. National saving as a share of GDP declined in the quarter century to the mid 1990s, remained stable until the late 2000s, and has risen in recent years. Investment as a share of GDP hovered around 26 per cent from the mid 1970s to the mid 2000s and has since grown to around 28 per cent. As a result, the current account deficit as a share of GDP has narrowed in recent years to around 3 per cent.

In the household sector, saving has generally exceeded investment. The decade following the Wallis Inquiry was an exception, with saving unusually low as households increased their indebtedness (Graph 5.2). Since the mid 2000s, however, the household sector saving ratio has risen, partly because of the more prudent behaviour adopted following the global financial crisis (Stevens 2011).

The corporate sector includes non-financial and financial corporations. Non-financial corporations have tended to be net borrowers; their gross saving has not completely covered their investment (Graph 5.3).[2] On the other hand, financial corporations are net lenders reflecting their role in intermediation.

Investment by the general government sector has remained relatively stable as a share of GDP over the past 50 years.[3] Gross saving declined for much of the decade from the mid 1970s and then fluctuated with the economic cycle. Government net lending generally declines during periods of weak economic activity owing, in part, to the role of ‘automatic stabilisers’ in fiscal policy. Overall, the general government sector has tended to be a net borrower, except for in the decade prior to 2008.

5.2 The External Sector

The financial counterpart to a current account deficit is net capital inflow from the rest of the world. These sustained net capital inflows (which in turn reflect the investment and saving decisions of Australian residents and foreigners) have accumulated to a net foreign liability position for the economy as a whole (Debelle 2011). Since 2005, the net foreign liability position has been relatively stable at around 55 per cent of GDP (Graph 5.4). This recent stabilisation primarily reflects a modest slowing in net capital inflows over the post-crisis period.[4]

Importantly, however, while Australia has an aggregate net foreign liability position with the rest of the world, it has a net foreign currency asset position. This means that the overall net foreign liability position would not in itself be a source of vulnerability if the Australian dollar were to suddenly depreciate. This net foreign currency asset position arises because around two-thirds of foreign liabilities are denominated in Australian dollars, whereas most foreign assets are denominated in foreign currency. Moreover, the liabilities that are denominated in foreign currency are hedged to a greater extent overall (60 per cent) than foreign currency assets (30 per cent), resulting in a slight increase in Australia's net foreign currency asset position after hedging is taken into account (Rush, Sadeghian and Wright 2013; Graph 5.5). This is because the banking sector tends to hedge almost all of its net foreign currency liability position, whereas the other financial corporations sector (which includes superannuation funds, fund managers and insurance corporations) hedge only a small portion of its net foreign currency asset position.

Net capital inflows to Australian entities have averaged the equivalent of around 4½ per cent of GDP since the float of the Australian dollar and liberalisation of the capital account in 1983. Since the onset of the financial crisis, net capital inflows have declined to an average equivalent to 3¾ per cent of GDP, but have remained within the range recorded over the post-float period. Gross investment flows into and out of Australia have both slowed since 2006, although foreign inflows have slowed by more (Graph 5.6).[5]

At the same time as net capital inflows to Australia declined, their composition also shifted. The private financial sector has not been a net recipient of capital flows since the onset of the financial crisis, while net inflows to the private non-financial and public sectors have increased relative to GDP (Graph 5.7). These changes reflect the saving and investment decisions of entities within these sectors, as well as the portfolio allocation decisions of foreign investors.

5.2.1 Capital flows to the private sector

The Australian financial sector has historically tended to be a net recipient of capital flows. In the decade prior to the onset of the crisis, net flows into this sector averaged the equivalent of almost 4 per cent of GDP. These flows have reversed in recent years, resulting in net capital outflows from the private financial sector averaging equivalent to around 3 per cent of GDP per year.

This shift primarily reflects relatively large net debt inflows to the banking sector prior to the crisis followed by net debt outflows (or only small net debt inflows) in the post-crisis period, consistent with Australian banks' increased use of domestic funding sources over recent years (Graph 5.8). Early in the post-crisis period, some commentators questioned whether enough capital would be available to meet the needs of Australian households and businesses, given reduced foreign demand for bank paper globally. However, subsequent developments have shown that markets tend to respond to such changes by making various other adjustments, including altering the composition of capital inflows. Over the past decade, the composition of capital flows has changed quite significantly, providing contrary evidence to the hypothesis that the current account can only be funded by a single form of capital inflow such as offshore borrowing by banks. Indeed, in each of the past five years there was net capital outflow from the financial sector together with a current account deficit (Graph 5.7).

In contrast to the banking sector, the pattern of capital flows for other financial corporations has been little changed. Firms in this sector invest offshore, particularly in foreign equities, and so they have continued to record capital outflows.

Net capital inflows as a share of GDP to the private non-financial sector have increased from an average of around 1½ per cent in the decade prior to the global financial crisis to around 4 per cent in the post-2008 period (Graph 5.9). In recent years, this has primarily reflected an increase in net capital inflows to the mining sector, which has been driven by foreign direct investment in resource companies operating in Australia (largely in the form of retained earnings) and, to a lesser extent, wholesale offshore debt issuance by Australian-based resources companies (Arsov, Shanahan and Williams 2013).

5.2.2 Capital flows to the public sector

Net capital inflows to the Australian public sector have increased to the equivalent of around 2½ per cent of GDP since the onset of the financial crisis, compared with an average of 0.2 per cent of GDP over the previous two decades (Graph 5.7). The increase has been concentrated in purchases of Commonwealth Government Securities. Some of the increased demand appears to have come from central banks and sovereign wealth funds (although data on the extent of these purchases are not available). In contrast, the share of foreign ownership of state government debt has declined over recent years.

5.3 Household Sector

5.3.1 Key trends in household balance sheets and use of funds

The household sector tends to be a net saver in aggregate, lending funds to other sectors through deposits or purchases of financial assets. In addition to spending on consumption, households use their funds to purchase real assets, primarily housing, which are funded through a combination of debt and savings.

Households' financial behaviour has shifted over the past couple of decades. From the early 1990s to the mid 2000s, both debt and assets increased significantly faster than income and the household saving ratio declined.[6] More recently, debt has stabilised relative to incomes and the saving ratio has stabilised at a higher level (Graph 5.10). Consistent with these movements, the household sector withdrew housing equity during the early to mid 2000s but has injected it since the crisis (Graph 5.11). A number of interrelated factors have contributed to this, including financial deregulation (Chapter 2).

Related shifts can also be seen in the composition of households' financial assets. Since the introduction of compulsory superannuation, assets held by superannuation funds increased strongly, except around the onset of the crisis (Chapter 7). This has resulted in households' exposure to equities, and thus market risk, rising. Direct holdings of financial assets have also risen over this period, but have become more concentrated in deposits since around 2008.

Since the onset of the financial crisis, there is evidence that the household sector has adopted a more prudent approach to its finances, shifting the composition of its financial asset portfolio away from riskier assets toward deposits (Black, Rogers and Soultanaeva 2012). For instance, according to ABS data, from the beginning of 2008 to September 2013, households were net sellers of equities of around $90 billion, but made net deposits of around $320 billion.

5.3.2 Key trends in the sources of funds

Consistent with ongoing innovation in the financial sector and the economy more generally, the range of products that Australian households can source funds through has grown since the Wallis Inquiry.

Over the past couple of decades, labour income, as measured by compensation of employees as a share of GDP, decreased slightly, while the shares of dividends and rent increased (Graph 5.12). This shift in labour income may be the result of an increase in firms' bargaining positioning relative to labour, as well as higher profit margins (Ellis and Smith 2007; Guscina 2006). The decline in gross mixed income reflects a general trend by the unincorporated sector towards incorporation, which, in national accounting terms, has shifted profits from the household sector to the corporate sector (Graph 5.12, right panel).

Households obtain almost three-quarters of their debt finance from banks, with this share broadly constant over the past decade (Graph 5.13). However, the share of debt finance originated by banks is somewhat higher, as banks and non-banks have contributed to the rise in securitised debt. Over the same period, the share of household borrowing from other depository corporations, namely credit unions and building societies (CUBS), has declined; part of this may have been due to some CUBS becoming banks.

5.4 Non-Financial Corporate Sector

5.4.1 Key trends in the uses of funds

Businesses use funds to finance investment, pay interest on debt and make distributions to shareholders (via dividend payments and share buybacks). Net investment includes net physical investment and net acquisitions. Net physical investment generally comprises assets that maintain or increase productive capacity or are used in the ongoing operations of a company, such as machinery and equipment. In recent years, private business investment as a share of GDP has risen to its highest point in over five decades driven by the mining sector (Graph 5.14). Compared with net acquisitions, expenditure on the maintenance of these assets is often less discretionary and financed using internally generated funds.

Net acquisitions – such as the purchase of other companies or large assets – are often discretionary in nature and are more likely to be financed externally. Following the onset of the crisis, this activity was scaled back; some listed corporations sold assets, and others sought to conserve cash by postponing planned acquisitions. Acquisition-related deals in the syndicated loan market were also scaled back to negligible levels.

Within the listed sector, corporate net investment expenditure has typically accounted for roughly two-thirds of the use of funds, with dividend payments accounting for the bulk of the remainder (Graph 5.15). Overall, except for some highly geared corporations, net interest paid is a relatively small component of aggregate expenditure.

Dividend payments to shareholders were curtailed during the early stages of the crisis as earnings fell and corporations sought to conserve cash and repair their balance sheets. Dividends did not fall as much as earnings, however, resulting in an increase in corporations' payout ratios – the ratio of dividend payments to underlying earnings. More recently, as conditions have improved, listed corporations have increased their dividend payments, partly by increasing their payout ratios (Graph 5.16).

Interest payments generally account for a small share of corporate expenditure. However, the interest-servicing ratio of listed corporations increased rapidly during 2007 and 2008 as business credit expanded and interest rates rose (Graph 5.17). The interest-servicing ratio has since declined, reflecting the decline in corporate gearing and lower borrowing rates.

5.4.2 Key trends in the sources of funds

Businesses raise funds internally through their operations, as well as externally from banks, bond markets and equity markets (see ‘Box 5A: Australia's Corporate Bond Market’; Graph 5.18). Prior to the financial crisis, businesses made greater use of external funding – both intermediated credit and market-based instruments such as bonds and equity. Companies continued to raise equity during the financial crisis (Black, Kirkwood and Shah Idil 2009). Since then, they have sourced most of their funds internally.

The composition of this flow of funding, and the structure of businesses' balance sheets, is shaped by the industry structure and the business models that are employed. For example, prior to 2008, infrastructure companies made greater use of external debt funding and were more highly geared than other sectors (Graph 5.19). In particular, they had been borrowing against existing assets, a practice that was supported by rising asset values and favourable macroeconomic and financial conditions. In contrast, resource companies used relatively less external funding and had lower gearing, as their strong profit growth since the early 2000s provided most of the cash flows required to finance investment (Arsov et al 2013).

The funding mix changed substantially with the onset of the financial crisis. Almost all corporations used more internal funding as relative borrowing costs for debt rose, and debt funding became more difficult to access, particularly for lower-rated corporations (Graph 5.20).

Corporations continued to have good access to equity markets during the global financial crisis and significantly reduced their gearing. This occurred in two distinct phases. First, corporations reduced their use of debt noticeably (Black et al 2009). The second phase involved more active balance sheet adjustment once market conditions improved slightly, with many corporations raising equity to pay down debt.

More recently, while bond issuance has been strong since 2012, business credit growth remains quite low compared with past experience. Despite a pick-up in initial public offerings (IPOs) in late 2013, equity raisings by listed companies have generally been subdued in recent years. This reflects reduced demand for external funding given the subdued level of capital expenditure outside of the resources sector, the resources sector funding a significant part of its investments from internally generated funds, and the greater attractiveness of debt financing due to the low level of global interest rates. Since late 2012, some real estate investment trusts have raised equity to fund expansions amid increased competition from foreign investors in Australian commercial property (RBA 2013a). Despite some increase in debt funding, business gearing remains low (Graph 5.19 above).

Box 5A: Australia's Corporate Bond Market

Australian non-financial corporations have traditionally used bank funding to meet the bulk of their borrowing needs. They have also made greater use of equity funding than companies in some other countries, at least partly because the Australian dividend imputation system largely eliminates the double taxation of dividends that applies in some other jurisdictions. As a consequence, Australian companies' use of bond funding has historically been relatively limited, especially compared with larger markets like the United States.

Since financial deregulation and capital account liberalisation in the 1980s, Australian companies have gained greater access to offshore debt markets. The US market in particular has provided Australian companies with access to investors that are comfortable investing in bonds with lower credit ratings and longer tenors than in other markets. In addition, the development of the foreign exchange derivatives market has allowed Australian companies to issue foreign currency denominated bonds offshore and swap them back into an Australian dollar exposure, thus managing the exchange rate risk. Issuing bonds offshore and hedging away the exchange-rate risk can therefore be a substitute for issuing Australian dollar bonds in the domestic market.

Moreover, for a number of the largest Australian non-financial corporations, a significant portion of their revenue is denominated in US dollars, because they have export businesses, including of major international commodities, or offshore operations. For such corporations, US dollar denominated issuance provides a natural hedge to their foreign currency revenue exposure.

Bringing these factors together, it is perhaps not surprising that most Australian corporate bonds have been issued offshore and that the Australian domestic corporate bond market remains relatively small (Graph 5A.1). However, because the market and regulatory infrastructure already exist, the domestic bond market serves important purposes regardless of its size. It provides an alternative local funding source that ensures that the market is contestable in normal times, and also that corporations can access funding even when intermediated sources are not functioning properly; in doing so, it therefore both promotes competition and mitigates systemic risk.

Reflecting the dominance of offshore issuance, foreign investors own the majority of Australian non-financial corporate bonds outstanding (Graph 5A.2). These holdings include a substantial investment in bonds issued domestically. At the same time, domestic funds managers hold a portion of the Australian corporate bonds issued offshore. Investment funds and insurance companies (‘Other managed funds’) are the largest domestic holders of corporate bonds while superannuation funds hold around $7 billion.

The domestic corporate bond market has matured in recent years. This has been evident in greater domestic issuance by lower-rated entities and some lengthening in the tenor of that issuance. Several recent developments in market infrastructure should further support activity, including: the publication of new measures of corporate bond yields and spreads by the Reserve Bank; efforts to simplify prospectus requirements for the issuance of retail vanilla bonds; the lengthening of the Commonwealth Government yield curve; and the listing of fixed income securities on the Australian Securities Exchange.

5.4.3 Small-Business Financing

Small businesses represent about 95 per cent of the over 2 million actively trading businesses in Australia. The economic contribution of small businesses is significant. They accounted for around 45 per cent of employment and over a third of production in the private non-financial corporations sector in mid 2012.

There is no single measure of what constitutes a small business. The Australian Bureau of Statistics defines as small businesses those with fewer than 20 employees. Reflecting the available data, the RBA typically categorises loans as provided to small business if the loan principal is under $2 million, or if the borrowing business is unincorporated.

Small businesses generally use a combination of debt and equity to fund their operations, although some are fully funded with equity. Small businesses mainly obtain their debt funding from banks and other financial institutions, as it is difficult and costly for them to raise funds directly from debt capital markets (RBA 2010). Credit cards, secured bank loans and overdrafts are identified as the most common sources of debt funding by small businesses (Table 5.1; CPA Australia 2012).

Unincorporated business owners are less likely to use debt and have lower gearing levels than incorporated businesses. Moreover, survey data suggest that smaller businesses in Australia are less likely than larger businesses to seek ‘external finance’ (debt and external equity funding) (Graph 5.21, left panel). Of the small businesses that choose not to seek external finance, only a small proportion attribute this to an expectation that it will be difficult to obtain. Even so, when small businesses seek external funding they are generally more likely to be rejected than larger businesses (Graph 5.21, right panel). This is partly because smaller businesses are typically viewed as having more volatile revenue streams, and there are often greater information asymmetries, compared with large businesses.

New and young businesses are less likely to use bank debt than to use personal funds. A survey conducted by the Australian Centre for Entrepreneurship Research of 800 ‘new’ and ‘young’ small businesses found that the use of bank debt as a source of financing is low (Graph 5.22) (Davidsson, Steffens and Gordon 2011). When accessing bank funding, new and young firms use credit cards and personal loans rather than business loans.

In contrast, personal savings are a major source of funds for over half of new and young firms. This could be because many new and young firms lack the required financial documentation to obtain bank debt. On the other hand, the low use of debt could also reflect reluctance among business owners to accumulate debt to finance a business when they are still uncertain about its viability. Intermediated funding

Lending to unincorporated businesses by banks and other financial institutions increased over the five years preceding the financial crisis. While this lending slowed during the crisis, unlike lending to the corporate sector, it did not contract (Graph 5.23). The slower pace of growth has continued more recently. Similar trends are apparent in other proxies for small business lending, such as for business loans of less than $2 million.

In September 2013, the four major banks accounted for about 85 per cent of the value of business loans smaller than $2 million, compared with about 70 per cent of larger loans (Graph 5.24). The smaller Australian banks account for most of the remaining lending to small businesses. While the share of small business lending provided by the major banks has been largely steady over the past three years, it increased substantially at the onset of the crisis. Foreign-owned banks provide only a small share of lending to small business, in part because they do not have a substantial branch network. About two-thirds of lending to small businesses is through commercial bills and other loans with variable interest rates. The remaining third of lending is at rates that are generally fixed for between one and five years.

The slowdown in small business credit growth following the crisis reflected both demand and supply factors. RBA liaison reports that small businesses' demand for debt funding has slowed as they have scaled back their capital expenditure plans and focused on reducing existing debt. On the supply side, financial intermediaries tightened their lending standards in the initial stages of the crisis as their non-performing assets rose, though this was probably more relevant for larger businesses in particular segments, such as property development.

More recently, business surveys suggest that the availability of finance has improved and it is not the most significant factor concerning small businesses at present. For example, according to the Sensis Business Index, the share of small and mid-sized enterprises reporting that access to finance is relatively difficult has declined from about 40 per cent in late 2012 to 30 per cent in late 2013.[7] The available data and liaison by the Reserve Bank, including through its Small Business Finance Advisory Panel, suggest that small businesses in most industries have had tighter but still reasonable access to funds throughout and after the financial crisis, albeit at higher cost during the crisis.[8]

Smaller businesses generally pay more, on average, for debt than both households and larger businesses – in terms of both interest rates and product fees (Rudd and Stewart 2012; Graph 5.25). This is because smaller businesses are generally riskier borrowers than most other customer types. Compared with large businesses, they typically have more volatile revenue streams, are more likely to default, and have less documentation and shorter financial histories (Matić, Gorajek and Stewart 2012). Lenders manage these additional risks and costs by charging higher interest rates and/or fees, and by rejecting or modifying a greater proportion of small business credit applications.

While small businesses face higher borrowing costs than large business, lending rates for small business are at historical lows. Accordingly, borrowing costs do not appear to have been a concern for small businesses recently. According to the PwC Private Business Barometer, in early 2013, only 3 per cent of businesses expected the cost of funding to be a constraint in the year ahead, compared with about 30 per cent of businesses surveyed in late 2009.[9]

The role of residential property

Residential property plays an important role in facilitating access to small business finance. By providing residential property as security, a small business owner is more likely to obtain funds from lenders, and at a lower rate. A borrower who is willing to provide collateral may signal to the bank that they are less likely to default. Moreover, in the case of default, the lender will have recourse to an asset which mitigates the potential losses.

It is common for small business owners to obtain funds borrowed through an existing personal residential mortgage, for example by refinancing the loan with a larger mortgage or by redrawing on their loan. Rising house prices increase the amount of equity that home-owners can withdraw from their properties. The MYOB Business Monitor reports that in late 2013 over 15 per cent of small businesses surveyed planned to obtain funding through redrawing on a mortgage or a home equity line of credit (MYOB 2013). This may partly reflect the fact that lending rates for traditional housing loans are typically lower than small business lending rates, even for those secured against property.

Alternative sources of debt

Smaller businesses make use of a range of debt sources beyond mortgages (see Table 5.1). One example is equipment and vehicle leasing. Leases differ from other forms of lending in that the lender receives legal ownership of the collateral asset. A lender may be able to provide a borrower with relatively cheap funding through a lease if the lender is better able to use the tax deductions allowed for depreciation of the collateral asset, and if bankruptcy costs are high.

Another source of funding for small businesses is debtor finance, which is short-term funding in exchange for the sale of accounts receivables (Graph 5.26). This can be obtained by ‘discounting’, whereby the business maintains responsibility for collecting receivables, or through ‘factoring’, whereby the business passes on responsibility for collecting the accounts receivables (but may or may not assume the risk of bad debts). In Australia, discounting accounted for over 90 per cent of debtor financing turnover in late 2013.

The debtor finance market grew significantly from 2004 to 2008 and has remained broadly flat since then. Industry liaison suggests that it is an attractive form of financing for small businesses that have a large proportion of their accounts receivable outstanding to reputable companies. For these businesses, debtor finance can free up large quantities of funding, typically within 48 hours. Non-bank sources of funding

Businesses can obtain trade credit from their suppliers when they receive inventory, equipment and services without making immediate payment (Fitzpatrick and Lien 2013). Smaller businesses make slightly less use of trade credit than larger businesses, probably reflecting smaller businesses' weaker bargaining position with suppliers (Graph 5.27). Furthermore, many small businesses, especially younger or unincorporated firms, may lack a sufficient financial history for trade creditors or credit agencies to assess their creditworthiness. Studies suggest that trade credit became a particularly important source of funding for smaller businesses during the recent financial crisis, both in Australia (Dun & Bradstreet 2012) and overseas (Carbó-Valverde, Rodríguez-Fernández and Udell 2012).

Trade credit is often cost-effective if the small business can repay its debt before the agreed repayment date; otherwise, it can be considerably more expensive than bank credit. Dun & Bradstreet (2012) show that, on average, both small and large businesses tend to miss their repayment date, which suggests that some businesses are borrowing from other businesses at significant cost. Liaison suggests that smaller business creditors often have their payment terms unilaterally extended by larger businesses. In this case, smaller businesses are effectively providing funding to larger businesses.

Equity funding

Equity financing, like debt, tends to be more costly for smaller businesses. This is because smaller business equity investors (including the owners) require a higher average return on equity to compensate for the higher uncertainty of the return. Despite this higher cost of equity, small businesses use slightly more equity than larger businesses.

Small businesses are likely to use a higher share of equity funding than larger businesses for a number of reasons (Matić et al 2012). First, the higher volatility of small business' cash flows and higher bankruptcy ‘wind up’ costs may make equity more accessible than debt. Second, debt and equity finance provided by professional investors involve costly risk assessments, with associated sizeable fixed costs. Most small businesses do not have a great need for capital to expand, and borrow at a scale that does not always overcome these fixed costs. These small businesses use internal equity finance and external equity sourced from friends, family and business owners, which do not involve large transaction costs and are relatively inexpensive. Third, usually, little information is publicly available for small businesses so the owners have more information about their company's prospects, risks and value than outside investors. The cost of compensating external financiers for their incomplete information may lead small business owners to prefer internal equity over external finance.

There are a number of other forms of external equity funding for smaller businesses. For example, equity might be provided by ‘business angels’ – individuals who invest their own money, time and expertise into promising and risky start-ups – or by venture capital firms, which generally provide somewhat larger intermediated equity funding on behalf of other investors. Surveys suggest that these forms of external equity funding only provide a small share of funding for small businesses.

Government financial assistance

A range of government assistance is also available to Australian businesses. According to the Department of Industry (2013), there are over 500 financial and non-financial assistance programs offered at all levels of government. The Federal Government is the largest single provider of these programs. The Productivity Commission (2013) has estimated that the Federal Government spent over $2 billion on assistance for small business in 2011–12, representing around one-fifth of its total outlays on industry assistance.

Financial assistance can be offered in a number of forms, including grants, subsidies, taxation concessions and rebates. About three-quarters of businesses that access financial assistance are small businesses, although they only represent a low share of existing small businesses (Graph 5.28).[10] Many smaller enterprises are less likely to satisfy the characteristics targeted by the programs, such as an orientation to exports or innovation.

In terms of the type of financial assistance received, small businesses are more likely to access rebates and grants rather than ongoing funding, subsidies or tax concessions (Graph 5.29). Notably, most financial assistance is specific in nature, for certain business purposes, demographics or industries. (See ‘Box 5B: Funding the Rural Sector’ for some details on rural financial assistance). Few government programs provide general assistance to small businesses.

Australian governments also offer a range of programs that provide non-financial support for small businesses more generally. These include information services that direct firms towards sources of business advice or training, the provision of business advice through public agencies, and subsidies for the use of private sector advisers (Department of Industry 2013).

Innovative funding sources

Over the past few years, the widespread availability of the internet has made possible the emergence of new business funding sources such as ‘crowd-funding’ and ‘peer-to-peer lending’. While these funding sources have different operating models, they are all forms of non-intermediated lending. Small business owners and entrepreneurs are directly matched with individuals willing to provide funds through websites.

For example, with crowd-funding, entrepreneurs use the internet to seek funds directly from the general public (the ‘crowd’) rather than through traditional providers of finance like banks or venture capital investors (Schwienbacher and Larralde 2012). While some funds are provided as investments, in many cases they are provided either as donations or as prepayment for the final product to be developed. Business surveys suggest that currently these technological innovations provide a very small share of funding for new or small businesses.

Box 5B: Funding the Rural Sector

The rural sector accounts for a relatively small but important component of Australian debt. Rural debt outstanding has more than doubled over the past decade to be $64.5 billion in June 2013. The increase was partly driven by increased demand for funding for farm improvements and capital investments, including the purchase of land, vehicles and equipment. Declining interest rates also contributed to the increased appetite for debt, as did the reduction in farm incomes resulting from the widespread drought in the 2000s (ABARES 2013).

Similar to other business credit, annual growth in rural lending has declined considerably in recent years, from an average of around 11 per cent over the decade to June 2009 to an average of around 2½ per cent over the four years to June 2013 (Graph 5B.1). Rural demand for debt declined in this period, partly reflecting subdued growth in rural incomes. On the supply side, the removal of the pre-crisis easing in lending standards since the crisis may also have affected growth in rural debt.

Sources of debt funding

Increases in bank lending – particularly for loans over $500,000 – accounted for almost all of the growth in rural debt in the past decade. Lending by finance companies has been fairly weak over this period, and has contracted steadily since mid 2008. Finance companies currently account for only 2 per cent of rural debt, down from around 9 per cent in June 2007. The recent reduction in non-bank lending may have resulted from the difficulty faced by financial institutions in accessing wholesale credit during the financial crisis, with some finance companies exiting the market. This has reportedly made it difficult for some farmers to access credit, particularly in Tasmania (House of Representatives 2009; NFF 2010).

Despite the risks posed by rural income volatility and high debt levels, banks have offered various support measures to farmers, such as offering to restructure existing loans during the drought of the 2000s (Productivity Commission 2009).

The volatility of income and unpredictable returns mean that non-intermediated funding is generally difficult for agricultural businesses to obtain, particularly small farms. However, following declines over the 2004–11 period, foreign direct investment in the Australian rural sector almost doubled over 2012, to $1.2 billion (ABS 2009; ABS 2013). Rural liaison contacts across all states have been reporting an increase in foreign investment, particularly from China. Lending by state and territory government agencies, which has been increasing at an average rate of 10 per cent annually over the decade to June 2013, currently accounts for 3½ per cent of rural debt outstanding.

The Commonwealth Government offers a number of other measures to support rural sector funding, such as the Exceptional Circumstances program and the National Drought Program Reform package. The total cost to the Commonwealth Government of providing farm assistance programs between July 2001 and June 2008 was around $5.9 billion (Productivity Commission 2009). The new Farm Finance program will provide up to $420 million of concessional loans through to 2015 to assist farmers with productivity improvements or debt restructuring.

Determinants of rural lending

Lenders face a number of risks in financing the rural sector. Not only is the agricultural industry characterised by significant income volatility, but many rural operations are seasonal; as such, rural loan arrangements are often required to have relatively long maturities and less frequent repayment instalments to match the borrowers' cash flows.

The level of a firm's debt relative to income may limit their access to credit. The rapid increase in debt, including in the rural sector, over the decade preceding the crisis led to a corresponding increase in the sector's debt-to-income ratio (Graph 5B.2). Although the ratio has fallen slightly over the past few years, it still remains elevated. RBA's liaison with agricultural businesses suggests that some farmers are finding it difficult to access additional funding due to their high debt levels. Nonetheless, the rural sector's interest payments as a share of income have declined considerably since 2008, reflecting slower credit growth and lower borrowing rates (Graph 5B.3).

The volatility of farm income means that lenders place particular emphasis on collateral requirements. ABARES survey data suggest that institutional lenders generally require farms to have debt levels below 30 per cent of assets. Businesses whose debt is permitted to exceed this level tend to be large operations with high cash incomes, or access to off-farm income (ABARES 2013). ABARES estimates that 91 per cent of broad-acre farms and 72 per cent of dairy farms had equity exceeding 70 per cent of assets on 30 June 2012.

Farm land is commonly used as the main source of loan collateral. ABARES reports that land values for broad-acre and dairy farms have declined in some areas since 2009, including the northern pastoral regions. The slowdown in rural land price appreciation is often cited as a factor constraining the rural sector's access to finance, as would be the case for any sector facing a decline in the value of the collateral that it can offer.

5.5 The Financial Sector

The financial sector intermediates between savers and borrowers. This section focuses primarily on the banking sector. The superannuation sector is discussed in Chapter 7.

5.5.1 Key trends in the uses of funds

Over the quarter century to the onset of the financial crisis, credit rose rapidly (Graph 5.30). This resulted in credit as a share of GDP rising from around 80 per cent in the mid 1990s to around 160 per cent by 2007. As discussed in Chapter 2, this partly reflected the increased capacity of households to borrow as nominal interest rates fell in line with the decline in inflation from the early 1990s. Over the past five years, credit growth has slowed to an average annual rate of about 3 per cent. This has been particularly marked in the business sector, where credit contracted during the few years immediately after the crisis.

Lending to households accounts for about two-thirds of the banks' loan books and this is largely for the purchase of homes (Graph 5.31). While most home loans are for owner-occupiers, the share of housing loans to investors increased until the early 2000s (RBA 2002). Since then, around one-third of banks' housing loans have been to investors.

Housing credit grew at a fast pace in the two decades prior to 2005, averaging over 15 per cent per year. In the past three years, the rate of growth has been significantly slower, averaging around 5½ per cent per year. The rapid pace of growth during that earlier period largely reflected the increased capacity of households to borrow, and was also facilitated by the expansion in the activities of non-bank lenders, particularly mortgage originators (Ryan and Thompson 2007).

Personal credit comprises a small share of lending to households. It is roughly evenly split between fixed-term personal loans and revolving credit, with the latter comprised largely of credit card lending. Credit card lending increased for a while after the crisis but there has been no growth over the past two years. The value of fixed-term personal loans also declined after the crisis and, despite a recovery over the past two years, is still below its peak in late 2007.

At the beginning of the crisis, business credit growth increased temporarily because some businesses that had difficulty accessing non-intermediated debt markets turned to the domestic banks for their financing needs. Business credit subsequently fell for a few years, due to softer demand and a general tightening in supply, particularly to the commercial property sector. The latter partly reflects banks reassessing the risks of lending to this sector, in light of commercial property exposures accounting for a disproportionate share of impaired bank loans. It is also because some European banks – which had large exposures to this sector – have scaled back their operations in Australia to focus on repairing balance sheets in their home markets.

The structure of the market for business credit has changed since the financial crisis. Some foreign bank and non-bank lenders have exited, particularly European-owned entities, as their parent entities have sought to scale back their global operations (RBA 2012b). The share of business credit provided by foreign-owned entities has, however, increased a little over the past year, as some Asian banks continue to expand their local presence (Graph 5.32).

Australian banks use funds for purposes other than lending, for example holding cash and other liquid assets to meet withdrawals from customers and other day-to-day operations. Since the crisis, banks' holdings of securities have increased significantly, although from a low base. This partly reflects market and regulatory pressure on the banks to hold more liquid assets (Chapter 2).

The banks' holdings of securities on their investment book have increased noticeably since the crisis while their holdings of securities for trading purposes have declined. This is consistent with Australian banks' greater focus on traditional lending activities than on market operations, compared with many banks overseas, and is also reflected in their small on-balance sheet holdings of derivatives for trading purposes.

5.5.2 Key trends in the sources of funds for the banking sector Funding composition

From the late 1970s, the banking sector's share of deposit funding declined, reaching a low of 40 per cent in 2007. Offsetting this, the share of funding sourced from wholesale debt markets increased, and from the early 2000s securitisation grew as a funding source. Since 2007, the banking sector has shifted away from the use of short-term wholesale debt and securitisation, and back towards deposits (Graph 5.33). This result is consistent with a reassessment of funding risks by banks globally, as well as market and regulatory pressures for banks to secure more stable funding sources.

The funding mix differs across banks, with the major banks having larger shares of deposit funding and long-term wholesale debt, but making less use of securitisation, compared with the banking system as a whole. The smaller Australian-owned banks generally make greater use of securitisation and less use of long-term debt than the major banks. Foreign-owned banks have less deposits, largely due to their chosen business models and restrictions on retail deposit funding for foreign branches, and correspondingly source more funding from domestic and offshore capital markets (Graph 5.34). Deposit funding

The share of deposit funding has steadily increased, rising from about 40 per cent of total funding in late 2007 to about 57 per cent in late 2013. While this trend has occurred across all types of banks in Australia, it has been most pronounced for the smaller Australian banks; their share of funding sourced from deposit liabilities has doubled since 2007. Prior to the financial crisis, these institutions used securitisation more heavily as a form of funding. However, global investor appetite for residential mortgage-backed securities (RMBS) diminished sharply during the crisis, and Australian RMBS were not immune from this.

Much of the post-crisis growth in deposit liabilities was concentrated in term deposits. The share of total funding sourced from term deposits increased by around 12 percentage points between mid 2007 and early 2012. Since then, however, most of the growth in deposits has been in at-call savings deposits, reflecting developments in the pricing of these products.

Much of the increase in the share of deposit funding since the onset of the financial crisis has been provided by households, either directly or through superannuation funds (Graph 5.35). This reallocation is in part because of the household sector's shift to more prudent financial behaviour, as well as a response to developments in relative pricing of deposits compared with other assets. Self-managed super funds (SMSFs) also typically invest a higher share of their assets in bank deposits and assets held by SMSFs have increased rapidly in recent years ( Chapter 7). Wholesale debt

Since 2007, Australian banks have reduced their use of wholesale funding sourced offshore, and more generally reduced their use of funding from wholesale debt markets. This has been particularly true of short-term wholesale debt; its share of overall funding has halved (Graph 5.36). Nevertheless, the Australian banks have maintained a steady debt issuance program over recent years and are able to readily access funds at competitive pricing. The spread on new issuance is now at around its lowest level since 2009 ( Graph 5.37).

The average maturity of Australian banks' long-term wholesale debt is over five years at issuance. After declining during the financial crisis, the weighted average maturity of domestic debt at issuance has risen again to be over five years, while for offshore issuance it has increased to just under seven years driven by the issuance of relatively long-term covered bonds (Graph 5.38; Stewart, Robertson and Heath 2013).

During the crisis, banks and other financial institutions around the world found it increasingly difficult to access wholesale debt markets to raise funds. Following the institution of government debt guarantees in a number of countries, in October 2008 the Australian Government introduced the Guarantee Scheme for Large Deposits and Wholesale Funding (Chapter 3; Schwartz 2010). The Scheme was designed to ensure that Australian authorised deposit-taking institutions (ADIs) were not placed at a disadvantage compared with their international competitors, and permitted Australian ADIs to issue securities with maturities of up to five years that were fully guaranteed by the Australian Government.[11] The bulk of these securities have now matured, or been bought back by the issuer, with the remaining stock rolling off by early 2015 (RBA 2013b). Covered bonds

ADIs have been allowed to issue covered bonds following the passage of enabling legislation in October 2011.[12] Investors in covered bonds have a preferential claim on a pool of assets (called the cover pool) in the event that the issuing institution fails to make the scheduled payments on the covered bond (RBA 2012a). If the cover pool is insufficient to meet the issuer's obligations to investors, they have an unsecured claim on the issuer for any residual amount.

Covered bonds typically have a higher credit rating than that of the issuer because: the cover pools are usually comprised of high-quality assets such as prime mortgages; covered bondholders rank above unsecured creditors; and extra collateral is held in the cover pool. Australian banks' covered bonds have consistently been rated AAA, which has allowed the banks to attract new funding from investors with AAA mandates. There is some evidence that covered bonds have allowed Australian banks to access a geographically more diverse investor base; for example, central banks in some Asian countries have purchased some of these bonds. Demand has also come from foreign banks in jurisdictions where covered bonds are eligible to count as liquid assets under the Basel III liquidity rules.

The existence of depositor preference in Australia has meant that Australian ADIs have historically been prevented from issuing covered bonds. The reason was that covered bondholders would have preferential access to the cover pool, thereby subordinating the claims of other unsecured creditors, including depositors, over those assets (Turner 2011). There is a cap on covered bond issuance by ADIs to limit the subordination of depositors to covered bond investors. An ADI must limit the value of its cover pools to a maximum of 8 per cent of its assets in Australia. At present, each of the major banks have utilised roughly one-third of this limit. While there is some variation across banks, Australian ADIs have set their cover pools at close to 120 per cent of the value of covered bonds; this implies that covered bonds could provide up to around 6¾ per cent of total on-balance sheet funding for Australian assets.

About $70 billion has been raised through covered bonds by Australian banks, predominantly in offshore >markets (Graph 5.39). This represents about one-quarter of the banks' wholesale debt issuance since October 2011. Covered bonds have also enabled the banks to increase the tenor of their issuance, which has helped to smooth the maturity profile of their outstanding debt. The banks have typically issued covered bonds at tenors of 5 to 10 years, compared with a norm of 3 to 5 years for their unsecured issuance. Securitisation

Over the decade leading up to the financial crisis, securitisation was a rapidly growing segment of the financial sector globally and in Australia (Graph 5.40). Securitisation was an important means of funding for smaller regional banks and some building societies and credit unions (Debelle 2009). Prior to mid 2007, regional banks securitised around one-third of their housing loans while the major banks securitised less than 10 per cent. As a result, despite their smaller size, the regional banks accounted for roughly 40 per cent of RMBS issuance whereas the major banks accounted for 20 per cent.

The reappraisal of risk brought on by the financial crisis led to demand from international investors for RMBS retreating faster than domestic demand (Debelle 2010). Many offshore structured investment vehicles, which comprised a sizeable share of the international investor base, were forced to shut down and liquidate their portfolios. This included selling their Australian RMBS into the secondary market, even though the securities and the collateral underlying the loans had been performing well and have continued to do so.

In 2008 the government announced a support program for the industry by participating in new issues through the Australian Office of Financial Management (AOFM). Conditions in the securitisation market have improved significantly since late 2012, with issuance volume increasing and pricing at issuance at some of the lowest spreads since late 2007 (Graph 5.41). The decline in the cost of issuance has extended to non-bank lenders and smaller banks (Aylmer 2013). As a result of the recovery in demand from private investors, the AOFM's program was halted in April 2013.

RMBS currently account for a negligible share of the major banks' funding, but are more important for the smaller financial institutions.[13] Despite the recent narrowing in spreads, the cost of new securitisation funding is significantly higher than prior to the financial crisis. Notably, spreads on RMBS are fairly similar for the different types of banks (and also for non-banks) because the securities are bankruptcy remote from the issuer. This means that securitisation is relatively more cost-effective for the smaller banks, given that spreads on their on-balance sheet wholesale debt (particularly long-term debt) are significantly higher than for the major banks.

The market for Australian asset-backed securities other than RMBS has historically been small in comparison to the RMBS market. Before the financial crisis most of these securities were commercial mortgage backed securities (CMBS); however, issuance of CMBS has been weak since 2007. Issuance of other asset-backed securities, chiefly securities backed by a mix of assets, but predominantly by automobile leases, remained more robust during the crisis and has increased in recent years (Graph 5.42).

5.6 General Government

5.6.1 Key trends in the uses of funds

General government demand (essentially government spending excluding transfer payments) was broadly stable as a share of GDP throughout most of the 1990s and early 2000s (Graph 5.43, left panel). Over this period, annual growth in real government payments averaged 2.6 per cent, with the stability as a share of the economy consistent with favourable macroeconomic conditions and steady growth in private sector demand.

More recently, the fiscal stimulus enacted during the financial crisis contributed to an increase in total payments as a share of GDP, and an associated increase in government demand, driven largely by investment. Since its peak in March 2010, government demand has been trending downward toward its pre-stimulus level as a share of GDP, as the temporary stimulus measures have unwound. Transfer payments

Personal benefits spending encompasses old age, unemployment, family and child, disability, ex-service pensions, health and other benefits transfers to the private sector. Personal benefits spending remained stable at around 8 per cent of GDP throughout most of the 1990s and early 2000s, after increasing noticeably during the 1970s (Graph 5.43, right panel). In line with trends in the total number of unemployed persons, spending on unemployment benefits trended lower over the first half of the 2000s, before increasing as the unemployment rate rose. Despite a brief spike during the financial crisis, personal benefits spending has been slightly lower as a share of GDP and as a share of government payments over the past decade. Investment

General government investment remains relatively small as a share of GDP. Investment has been reasonably stable as a share of GDP since the late 1990s, at around 3 per cent, apart from a notable increase during the financial crisis due to stimulus measures such as the Building the Education Revolution program (Graph 5.44). In aggregate, general government investment remained somewhat elevated following the fiscal stimulus, supported by increased expenditure on transport infrastructure, principally on roads. General government investment is projected to remain around its pre-stimulus share of GDP in the coming years. See Box 5C for further information on infrastructure investment.

Box 5C: Financing Infrastructure Investment

In Australia, infrastructure investment has averaged around 6 per cent of GDP over the past four decades (Graph 5C.1).[1] Infrastructure investment reached a peak of almost 7½ per cent of GDP in 2009–10, and has since declined to just under 6½ per cent.[2] The share of private infrastructure investment grew steadily from the mid 1980s, reaching just above 55 per cent in 2008, driven by both a decline in the level of infrastructure investment by federal and state Government Trading Enterprises (GTEs) and a pick-up in private infrastructure investment.

These trends were driven by a number of key developments. First, many federal and state GTEs were privatised over the period – including Telstra, Qantas and a number of airports and state utilities. Second, the mining boom spurred significant investment in private transport infrastructure, such as ports and private roads (BITRE 2012).

Since the global financial crisis, the share of private infrastructure investment in Australia has fallen below 50 per cent. Given that bank funding, particularly syndicated loans, is traditionally the predominant source of private infrastructure investment, the reduction in lending globally by a number of banks over the past few years (principally those headquartered in advanced economies) may partly explain the decline in the share of private investment (Chong and Poole 2013).

How projects have been funded

Public infrastructure investment predominantly comes from state and local governments and their GTEs (Graph 5C.2). These investments are financed through a combination of transfer payments from the federal government, state tax revenue, debt issuance by the state borrowing authorities and asset sales.

Debt finance is a key source of funding for private infrastructure investment, particularly for projects with less volatile income flows. Total debt of listed infrastructure firms is about $40 billion, or roughly 5½ per cent of banks' total business lending. However, this may understate bank lending to infrastructure companies as a large part of the infrastructure sector is unlisted.

Australian infrastructure companies tend to be more highly geared than most other listed companies (Graph 5.19, right panel). Most of the debt financing of infrastructure companies is obtained from financial institutions. Private sector research indicates that unlisted infrastructure companies tend to have even higher gearing than their listed counterparts (Pereira 2008).

Private infrastructure investment can also be financed through equity, with investors classified as primary or secondary investors. Primary investors are directly involved in decisions regarding the construction of the infrastructure asset (construction companies, for example). Once projects are in operation with a proven revenue stream, equity is often sold in the secondary market. Initial Public Offerings (IPOs) were a popular form of equity raising prior to the global financial crisis, reaching a peak of over $3 billion in 2005. However, since 2009 there have been no infrastructure IPO-equity listings on the ASX.

Public-private partnerships

Infrastructure projects financed by the private sector fall into two categories: those that are fully owned and operated by the private sector (for instance private telecommunications networks); and those commissioned by government but are at least partly financed by the private sector, commonly known as public-private partnerships (PPPs). A PPP generally refers to a long-term contract between a private party and a government agency for providing a public asset or service, for which the private party bears significant risk and management responsibility (World Bank 2012). In many PPPs, private parties have sole responsibility for sourcing finance.

Private financing through PPPs is only feasible under a certain set of conditions, including:

  • the existence of credible and regulatory frameworks that give strong legal protection to investors
  • public sector capacity and resources to structure and manage PPPs effectively
  • appropriate project selection and identification of the most efficient bidder
  • appropriate risk sharing between the private sector and government.

PPPs can be more costly than traditional government procurement due to the higher cost of private financing compared with government debt. Therefore, the net benefit of PPPs may depend on the extent of the efficiency gains achieved by private participation in the project.

The Productivity Commission (2014) notes that PPPs can lead to a lower overall cost of providing infrastructure services for example, when they facilitate:

  • access to private technology or innovation, including specialised contractors and operators
  • enhanced private sector incentives to deliver projects on time and within budget
  • opportunities for competition for the market in provision of infrastructure and its services
  • long-term value for money through appropriate risk transfer.

Despite their high profile, PPPs account for a small share of infrastructure financing in Australia. Since 1995, PPP projects totalled just under $50 billion, or around 5 per cent of total infrastructure investment. New South Wales, Queensland and Victoria are the only states that have been significant users of PPPs over the past two decades (Graph 5C.3). The use of PPPs has been declining since the financial crisis (Chong and Poole 2013).

The high-profile restructure of several large PPPs for toll roads may have made these types of infrastructure projects less attractive to private investors. Moreover, persistent losses on recent toll-road developments such as the Cross City, Lane Cove and Airport Link tunnels created a need for a demand-risk guarantee provided by the government in order to attract private participation.

Tighter financial conditions following the crisis may have contributed to the decline in PPPs in recent years. Financial institutions have incurred losses on a number of loans after several infrastructure projects suffered significant revenue shortfalls and were unable to service their debt.

The government can directly alter the risk and return to private investors from infrastructure projects through the use of guarantees, where the government takes some of the risk from private investors. The funding and some risks (such as construction risks) associated with infrastructure projects can also be shared between multiple parties within the private sector.

PPPs have had mixed success in raising funds and transferring risk for infrastructure projects from the government to the private sector. Even where PPP contracts are well designed, the ultimate risk and corresponding costs of the project reside with government, since the public may hold the government ultimately accountable for the provision and quality of infrastructure services.

Superannuation funds and infrastructure

Institutional investors can gain exposure to infrastructure projects in several ways, including by:

  • providing debt finance to the owners or operators (e.g. through bond purchases)
  • purchasing the equity of an infrastructure company (e.g. a special purpose vehicle for a project), or of companies that are exposed to infrastructure projects
  • investing in listed and unlisted equity infrastructure funds.

Infrastructure investment may be suited to superannuation funds because the underlying assets can provide maturity matching, inflation-hedging (through inflation-linked assets), and a stable and predictable income stream. Superannuation funds typically invest in brownfield infrastructure: that is, existing infrastructure assets where the investment does not directly contribute to the construction of new infrastructure. This is due to the well-established revenue capacity of brownfield infrastructure.

Australian superannuation funds allocate, on average, 6 per cent of total funds under management to infrastructure exposures, compared with a global average of around 3¼ per cent (Preqin 2012). This comparatively high level of investment may be partly due to the greater availability of infrastructure investment opportunities: since the early 1990s, Australian governments have actively privatised assets that are attractive to superannuation funds, such as airports and ports, creating a ready stream of brownfield assets. It could also partly be the result of superannuation regulations allowing Australian superannuation funds to invest in illiquid assets to a higher degree than some other countries.

Most of this investment is made indirectly through investment in infrastructure funds. This is likely because only Australia's largest superannuation funds have the capacity to provide the level of resourcing and investor sophistication needed for direct investment in infrastructure.

5.6.2 Key trends in the sources of funds Commonwealth Government Securities

The federal government funds shortfalls in its revenue over intended expenditure by issuing debt securities (Commonwealth Government Securities (CGS)). Most CGS are issued as fixed coupon bonds to match the government's funding requirements, but the AOFM (which is responsible for managing federal government debt) also issues a small amount of inflation indexed securities, or Treasury inflation-linked bonds (TIBS; Graph 5.45, left panel). To manage the intra-year cash flow mismatch between revenue receipts and outlays, the government also on occasion issues short-term Treasury notes (with an average maturity of around three months). The short-term nature of these instruments means that although gross issuance during the year can be sizeable, net issuance is negligible as the portfolio matures relatively quickly, so that the stock of outstanding Treasury notes remains low.

The stock of outstanding CGS declined from 1997 to 2007 in both nominal terms and relative to GDP, reflecting sustained federal government budget surpluses (Graph 5.46). Gross CGS issuance continued during this period to maintain the stock of outstanding CGS at a level that was sufficient to support liquidity in the CGS market; this was in recognition of the role of CGS as a benchmark that is used to price other securities. In 2011, a panel of financial market participants and financial regulators, including the Reserve Bank, agreed that the stock of outstanding CGS should be maintained at around 12 to 14 per cent of GDP over time to maintain a liquid and efficient bond market.[14] Drawing on this advice, the government at the time committed to maintaining liquidity in the CGS market, even when issuance of debt is not required to fund a budget shortfall (Australian Government 2011).

Net issuance of CGS increased after 2007 to fund the federal government's budget which moved into deficit after the onset of the global financial crisis. As a result, the stock of CGS on issue is expected to increase to over $300 billion in 2014 (equivalent to 20 per cent of GDP). The most recent projections suggest that the amount of CGS on issue will continue to increase, albeit broadly in line with growth in the economy after 2015. The Commonwealth Inscribed Stock Act 1911 was amended in December 2013 to remove the legislative debt limit of $300 billion to facilitate the expected continued growth in the stock of federal government debt (Australian Government 2013). Semi-government bonds

The state public sector, comprised of the state and territory governments, local governments and public trading enterprises (PTEs), funds the shortfall in its revenue through the issuance of debt securities and to a much lesser extent through bank loans. The funding for each state's public sector is raised by a dedicated Central Borrowing Authority (CBA) – a specialised financial corporation that is fully owned and explicitly guaranteed by the respective state government – and is then on-lent to the state public sector. The CBA maintains a small stock of short-term securities to manage short-term funding requirements of the state public sector. However, for the most part the CBA raise debt by issuing long-term bonds, both domestically and offshore, in what is commonly referred to as the semi-government bond market (Graph 5.45, right panel). CBAs issue primarily fixed-income bonds, but they also issue inflation-linked bonds to meet demand from PTEs for inflation-linked borrowing and, more recently, floating rate notes which are attractive to banks investing in semi-government securities. Nearly two-thirds of the outstanding semi-government securities are issued by Queensland and New South Wales, with issuance by Victoria and Western Australia accounting for most of the remainder.

Unlike CGS, the stock of outstanding semi-government bonds remained relatively steady in nominal terms between the mid 1990s and the mid 2000s (Graph 5.46). Net issuance of semi-government bonds increased from mid 2005 to fund the state and territory governments' budget deficits and capital expenditure by the PTEs, with the latter reflecting increased infrastructure investments by the states. As a result, the stock of outstanding semi-government securities has risen to $240 billon (equivalent to 16 per cent of GDP) and the most recent projections (based on the CBAs' funding plans and the states' own budget forecasts) indicate that the outstanding stock will rise further over the next four years. Cost of government borrowing

Government yields in major markets have declined considerably since the beginning of the global financial crisis and CGS yields have declined similarly. Despite some increase in CGS yields since mid 2012 in line with the global trend, the federal government is currently able to fund its deficit at very low nominal rates (Graph 5.47).

The explicit state government guarantees mean that the CBAs have the same high credit ratings as the respective state and territory governments (currently AA to AAA) and have resulted in semi-government bonds trading typically at small spreads over CGS. Nevertheless, during episodes of global financial markets stress, semi-government bond spreads over CGS generally widen, as investors in Australian securities seek to hold more of the safest and most liquid Australian securities – namely CGS. In particular, the spread between semi-government securities and CGS widened to over 120 basis points in late 2008 and then again in mid 2012 (Graph 5.48). Maturity profile of debt outstanding

For a number of years prior to 2008, most CGS issued were at terms greater than one year but less than 10 years as the AOFM sought to maintain liquidity in a small number of key maturities. More recently the AOFM has sought to lengthen the maturity profile, in part to provide a longer risk-free reference rate for other financial products. CBAs seek to borrow at the longest maturities possible, with the maturity profile of the CGS market generally constraining issuance at longer tenors (Graph 5.49). CGS provides primary pricing for the domestic fixed-income market, and hence it is difficult for semi-government bonds to be issued at longer maturities than CGS. The weighted average residual maturity of the semi-government market is comparable to that of the CGS market – 5.8 years compared with 5.6 years. Holders of Australian government debt

The high credit rating of Australian CGS and their higher nominal yield relative to the yields on government bonds in other developed economies have made CGS an attractive investment in an environment of low global yields. As a result, the foreign ownership share of CGS has risen.

Domestic investors, particularly Australian banks, have increased their holdings of semi-government securities since the onset of the global financial crisis (Graph 5.50). This partly reflects the need for banks to hold higher levels of liquid assets that have been introduced as part of Basel III regulatory reforms. Under these requirements, the RBA determined that the Australian banks could reasonably hold the equivalent of around 30 per cent of the outstanding stock of CGS and semi-government securities without impairing market liquidity. As a result of the higher yield available on them, Australian banks are now the largest investors in semi-government securities, holding 40 per cent of the outstanding stock.

Offshore issued semi-government bonds were a significant part of the market in the past because non-resident investors' holdings in these had more favourable tax treatment than their holdings of domestically issued semi-government bonds. However, legislative changes in 2008 extending the interest withholding tax exemption to domestically issued semi-government bonds removed this differential tax treatment, and the CBAs have since then actively sought to refinance their offshore bonds with domestic bonds to the point where the stock of outstanding offshore issued bonds is almost negligible.


Differences between the current account balance and gross savings less investment reflect statistical discrepancies. [1]

Public corporations are included in this analysis because separate data on private corporations are not available prior to 1989/90. [2]

The general government sector includes activities undertaken by the local, state and federal levels of government, but excludes public corporations. [3]

While valuation effects related to a change in the prices of foreign assets and liabilities and the exchange rate influence the net foreign liability position, these have had only a small net effect over recent years. [4]

The ‘foreign investment in Australia’ measure is equal to new foreign investment in Australia less repatriations of existing investments in Australia by foreign resident entities. Similarly, the ‘Australian investment abroad’ measure is equal to new Australian investment abroad less repatriations of existing foreign investments by Australian resident entities. [5]

Part of this decline in the saving ratio is because of the shift of some unincorporated enterprises, which are part of household sector in the national accounts framework, to become part of the corporate sector over the past few decades (Connolly and Kohler 2004). [6]

The Sensis Business Index is based on a sample of approximately 1,800 small and medium sized enterprises from metropolitan and regional areas of Australia. [7]

The Small Business Finance Advisory Panel is a group of small business operators from around Australia that the Reserve Bank convenes to discuss finance conditions in the small business sector (see <>). [8]

The PwC Private Business Barometer surveys around 300 private businesses with annual turnover between $10 million and $100 million. [9]

There are about 700,000 businesses with less than 20 employees while there are about 70000 with 20 or more employees. [10]

The Scheme also permitted ADIs to offer guaranteed deposits of more than $1 million. [11]

Banking Amendment (Covered Bonds) Act 2011. [12]

Major banks, along with other banks, may use so-called ‘self-securitisations’ to package assets so as to be eligible for the Committed Liquidity Facility that will be provided as part of the Australian implementation of the Basel III liquidity rules. These structures do not, outside of crisis situations, constitute a form of funding for the banks that create them. [13]

The panel consisted of representatives from Reserve Bank of Australia, the Treasury, the AOFM, the Australian Prudential Regulation Authority, the NSW Treasury Corporation, the Treasury Corporation of Victoria, and a number of private sector market participants. [14]

Box Footnotes

Infrastructure can be defined as the structures and facilities that are necessary for the functioning of the economy and society. Economic infrastructure refers to the physical infrastructure that is a direct input to economic activity, for example roads, electricity networks, telecommunication networks and water and sewerage facilities. Social infrastructure refers to the facilities that aid the provision of social services, such as schools and hospitals. [1]

This is likely to overestimate the amount spent on infrastructure. It is calculated using data on gross fixed capital formation in the transport, communications, education, health care, utility and postal sectors, not all of which will be related to infrastructure investment. [2]


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