Supplementary Submission to the Financial System Inquiry 5. Housing Finance

The Interim Report finds little evidence of a shortage of mortgage finance in Australia, a view that the Bank shares. Even so, the Interim Report raises a number of options in the context of competition in the mortgage market that, if implemented, could result in relatively more finance being directed towards housing. These options should be assessed in terms of the end benefits and risks for consumers and the broader economy. Relevant considerations include whether the policy change might accelerate household borrowing, and the associated implications for systemic risk and the available funding for Australian businesses. As noted in the Bank's initial submission, housing is generally not a particularly risky asset, but because of its size, importance to the real economy and interconnectedness with the financial system it poses systemic risk. To illustrate, some of the options raised in the Interim Report are considered below.

5.1 Capital Requirements

The Interim Report highlighted several options for aiding competition through Australia's capital framework, including changes to mortgage risk weights and providing capital inducements for ADIs that use Lenders' Mortgage Insurance. As noted in the Bank's initial submission, because of the cyclical nature of risk-taking and the large social and economic costs of instability in financial systems, it is crucial that institutions' capital be allocated according to risk (RBA 2014, p 8). Hence, changes to the capital framework on competitive grounds should not come at the expense of greater risk, and should not amount to a weakening relative to global regulatory minima.

5.2 Government Support for RMBS

In considering the need for government support of the residential mortgage-backed securities (RMBS) market, it is important to identify the purpose of such intervention and/or the market failure that is intended to be addressed. Although the government provided targeted support to the domestic RMBS market as part of its crisis response, there would be risks associated with making these kinds of arrangements permanent. Government support for the RMBS market can expose taxpayers to large contingent liabilities and foster imprudent risk-taking, as has been demonstrated overseas (see, for example, Calomiris (2011)). Moreover, conditions in the domestic RMBS market have improved over recent years (Aylmer 2013) and, as the Interim Report notes, there is little evidence of a market failure.

The Interim Report also called for views on whether RMBS should be treated as high-quality liquid assets (HQLA) for the purposes of the liquidity coverage ratio (LCR) requirement under Basel III. APRA, in consultation with CFR members, considered the market characteristics of domestic RMBS against the qualifying criteria issued by the Basel Committee on Banking Supervision. This includes the criteria that assets must trade in large, deep and active markets, and be liquid during a time of stress (BCBS 2013, p 7). In APRA's view, reached in consultation with the Bank, RMBS do not meet all of these criteria (APRA 2013, p 8). Overturning this decision in order to spur competition in this market could reduce the efficacy of liquid asset holdings and hence ADIs' ability to manage liquidity prudently.

Reserve Bank of Australia
26 August 2014