Australia’s financial regulators have been navigating largely in the dark when assessing the risks shadow banking and fintech pose to financial stability, particularly in the property market, according to internal Reserve Bank documents.
- The RBA does not have accurate estimates on how much non-banks lend to property developers
- But industry liaison suggests non-bank lending has become much more important as banks pull back on financing new apartment developments
- The RBA was concerned that unregulated lending to developers might exacerbate an apartment glut, especially in Melbourne
Responding to a Freedom of Information (FOI) request from ABC News Investigations, the Reserve Bank has released 153 pages of internal documents analysing the risk that non-bank lenders, often dubbed “shadow banks”, pose to financial stability.
The major takeaway from the RBA’s analysis is the extent to which it, and bank regulator APRA, have been operating in the dark when it comes to data on the size and nature of non-bank loans, particularly to property developers.
As recently as July 29, 2019, the RBA’s Financial Stability Department noted in a memo that “limited data” was available around the scale of non-bank lending to developers, forcing the analysts to rely on anecdotes from within the industry.
“Liaison suggests that non-ADI lenders have been funding significant share of new development,” they observed.
“Charge much high[er] rates than banks, but accept lower pre-sales and/or higher LVRs. Could contribute to overbuilding of apartments but risk seems small given sharp fall in approvals.”
Non-authorised deposit-taking institutions (non-ADIs) are lenders that do not take deposits from the general public and are therefore not subject to oversight by the Australian Prudential Regulation Authority (APRA).
The possibility that non-bank lenders could finance an excess supply of apartments is one that has concerned analysts within the RBA’s Financial Stability at least since early 2017 (the ABC’s FOI request asked for documents created between 2017-2019).
“The alternative market appears to be most established in Melbourne, where there is still strong conviction among developers about the outlook but the pullback by major banks has been relatively pronounced (particularly in inner Melbourne),” noted RBA analysts Michael Gishkariany, David Norman and Tom Rosewall.
“The funding for these firms has historically been sourced from wealthy individuals or families, other developers or construction firms.
“Of late, there has been some funding from a range of institutional investors (super funds, foreign pension funds, hedge funds and PE firms).”
These concerns appeared to have increased a year-and-a-half later, as outlined in an email from David Norman to other members of the RBA’s Financial Stability Department.
“Here’s the graph that makes me think we should not downplay the potential for non-ADIs to contribute to overbuilding in Melbourne,” he wrote.
“Work yet to be done (basically new approvals minus work done) has really picked up in Melbourne this year, and liaison says that a big chunk of this is being funded by non-ADIs.”
This industry liaison also highlighted the high cost to developers of having to rely on non-banks to fund their projects.
“Non-ADI lending to residential property developers is growing faster than banks’ lending,” the Financial Stability Department wrote in a memo dated February 7, 2019.
“Until recently, has not been enough to offset banks pulling back; interest rates were rising — This has changed a bit recently as bank lending has stabilised — Interest rates on these loans are high (>10 per cent for development).”
Non-banks ‘can create systemic risk’
Then, in March 2019, RBA financial stability analyst Calvin Yap warned that lending by non-bank financial institutions (NBFIs) could create risks for the entire banking system, even if the banks had no direct financial relationship with them.
“The activities of NBFIs can create systemic risk through their impact on the value of banks’ assets or collateral,” he warned.
“NBFIs can exacerbate credit and asset price cycles by adding to demand during the upswing or withdrawing from the market during the downturn.”
“While this is also true of banks, NBFIs are not subject to prudential supervision which can, in theory, constrain risk-taking and curb pro-cyclical lending behaviour.”
However, while Mr Yap acknowledged “there is some concern that non-bank lending to apartment property developers may continue to boost supply, placing further downward pressure on property prices”, he concluded, “overall, the financial stability risks from NBFI activity are assessed to be limited at this point, although risks associated with property development bear watching.”
It is hard, though, for the bank to accurately assess those risks, as most non-bank financers of property development are not compelled to tell authorities or statistical agencies how much they are lending, where and to whom.
That is something which may change after new laws were enacted by the Federal Government to enhance APRA’s information collection powers and widen its oversight jurisdiction where the regulator feels that is necessary.
“Recently passed legislative changes to the Financial Sector (Collection of Data) Act 2001 (FSCODA) mean that many entities that previously had no or only voluntary reporting requirements will have mandatory reporting to APRA,” the RBA told a Council of Financial Regulators meeting in August 2018.
“These changes will improve regulators’ ability to monitor shadow banking activities and their financial stability implications.”
APRA has also gained the power to make rules relating to the lending activity of non-ADI lenders where “APRA considers that the provision of finance by one or more non-ADI lenders materially contributes to risks of instability in the Australian financial system”.
However, the documents released under FOI reveal that discussions were still continuing between the RBA and APRA over which extra entities should be compelled to report data to the regulator, meaning it could still be some time before financial authorities have an accurate picture of how much property developers are leaning on non-bank finance to keep projects afloat.
Fintech boom flying under the radar
Another area where regulators and policymakers have inadequate visibility is the burgeoning ‘fintech’ sector — mainly non-bank lenders offering consumer or small business loans.
More than two years ago, Calvin Yap from the RBA’s Financial Stability Department labelled it “a small but fast-growing subset of the shadow banking system”.
As with shadow banking in general, Mr Yap pointed out that, “there is limited data on the sector as most fintech credit providers are non-ADIs with minimal reporting requirements”.
The RBA cited the Asia-Pacific Alternative Finance benchmarking report produced by the Cambridge Centre for Alternative Finance (CCAF), which estimated that fintech companies lent $738 million in Australia in 2016, representing just 0.1 per cent of shadow bank lending activity and a trivial share of the $3 trillion in total loans outstanding.
“Financial stability risks from this activity are limited given the small size of the industry, but there is already some evidence that a few banks are lowering their lending standards in order to remain competitive,” Mr Yap cautioned.
“There are already some examples which suggest that banks have begun to compete on lending standards.
“NAB has developed an in-house ‘fintech’ business loans unit QuickBiz that competes directly with fintech lenders by offering unsecured small business loans with a fast turnaround; it recently doubled the maximum loan size on offer to $100,000.”
However, Mr Yap added that there were other risks.
“An alternative is that instead of competing, banks could facilitate growth in fintech as a way to avoid prudential oversight and circumvent lending restrictions. This could create a system-wide loosening in credit standards and contagion risk between fintech credit and banks.”
All of Australia’s major banks, and many of the smaller lenders, have invested in or partnered with third-party fintech companies, although there is no evidence so far that they have done so to evade tougher APRA regulations on bank lending standards.
Although Mr Yap did note that fintechs often targeted riskier borrowers.
“There is some evidence which suggests many fintech lenders are targeting borrowers that would not qualify for bank loans, such as businesses with shorter operating histories and without assets for security,” he wrote.
“For example, the ASIC survey found that almost all outstanding fintech consumer loans and at least three quarters of fintech business loans were unsecured.”
For many fintechs, which are peer-to-peer lending platforms that simply connect lenders to borrowers for a fee, Mr Yap said there was little incentive to ensure the loans could be repaid.
“Fintech platforms have a short-term incentive to lower credit standards to approve more borrowers because they rely on origination revenue and credit losses are borne by investors (similar to the conflicts of interest of securitisers without ‘skin in the game’),” he argued.
Although Mr Yap added that this could have economic benefits as well.
“This could lead to more efficient credit allocation by facilitating credit provision to previously underserviced market segments, reducing the time taken for borrowers to access money and lowering the cost of finance for some borrowers.”
While the RBA appeared to be relatively unconcerned about the broader financial stability risks from fintech back in November 2017, Mr Yap did sound this warning:
“Fintech platforms are particularly reliant on investor confidence and subject to investor herding and swings in risk appetite, particularly where retail investors make up a larger proportion of funding,” he cautioned.
“Fintech credit currently poses limited risks to financial stability due to its small size. However, it has been growing very rapidly and is likely to continue doing so — especially if banks continue to be ready suppliers of funding.”
All the evidence over the two years since that RBA report is that the fintech sector is continuing to grow apace, and therefore the financial stability risks it carries along with it.