The People’s Bank

Today, the Australian Greens announced a desire for the Reserve Bank of Australia (RBA) to originate home loans to increase the rate of home ownership in Australia. The Greens’ proposal seeks to allow up to 60% of a home’s value to be borrowed at low rates, capped at AUD $500,000.  This article will look to some of the questions raised by such a proposal in the context of the modern banking environment.

Déjà vu

Without historical context this proposal could either appear as a blindly obvious initiative, perplexing as to why it’s never occurred before. As with much in life, however, it has. Australia’s largest bank by assets, the Commonwealth Bank of Australia, started with this exact purpose in the early twentieth century. Originally operating as commercial bank, it quickly evolved to serve Australia’s need for a central bank. This dichotomous entity was found wanting, and legislation was soon passed creating two entities: the Commonwealth Bank of Australia, acting any modern commercial bank ; and the Reserve Bank of Australia, taking on the mantle of central bank.

A king’s castle

Home-ownership remains a quintessential piece of Australian identity, from our infatuation with a backyard barbeque, to its influence in modern Australian cinema. To combat the continued decline in home ownership, residential mortgages would be brought back into the realms of government of service provision. The inclusion of home loan lending within the purview of the RBA would see a dramatic change in its current operations. In it’s purest form the Reserve Bank of Australia acts in concert with government to provide stability to the Australian currency, pursue full employment, and foster economic prosperity for Australia (s.8, Part II, Reserve Bank Act 1959). It has a variety of tools at it’s disposal, including the ability to take deposits and lend. In the modern Australian economy it most relevantly plays a vital role in monetary policy implementation through the setting of policy rates and control of the Australian Payments System.

The lending problem

Beyond cosmetic arguments regarding the lack of RBA retail lending infrastructure, the introduction of home loan lending to the central bank raises interesting questions.

To engage in such a scale of lending, any lender must expect some instances of default, regardless of how stringent screening procedures may be. The proposal relies on the private market to provide the remaining loan funds, but how would these interact? Should the government maintain first lien over property, the cost of private funds would dramatically increase given the increased likelihood a private lender takes a haircut in event of a default. Any net increase in the aggregate interest rate can be seen as ineffective policy, as funds become more expensive to access. With increased regulatory capital costs and risk management associated with the standardised approach to capital adequacy, it is hard to see the Greens’ proposal on aggregate being more affordable.

Even in the wake of the Global Financial Crisis, the securitisation of loans in Australia forms a asset management technique for retail banks. As of 2017, AUD denominated residential mortgage-backed securities have returned to pre-GFC levels. But would the RBA seek to make use of the Australian loan securitisation markets, or would the loans be kept on Government books until amortisaton? Should these assets be sold into the RMBS market, they are most likely to be very desirable to institutional investors, such as superannuation funds. This may then cause the higher-risk commercial bank RMBSs to be less desirable and less profitable, putting further upwards pressure on commercial bank interest rates. This process would seem at odds with the intentions of the proposed initiative, but hypothetical retention of mortgages by the RBA brings the question of risk to the fore.

The risk problem

If it is accepted that the loans are not on-sold, the RBA would place itself in an interesting situation. The accumulation of long-lived, illiquid, and risky assets has long been an issue for banks to manage. Whether an implicit government guarantee of solvency exists regarding the RBA proposal is an open question. Should a shock occur to the Australian economy, RBA held loans could prove a useful additional monetary policy tool: the direct control on the economy through interest rate manipulation may prove a boon. Of a same token, however, it may double-down the volatility of the system. Reduced rates are rarely immediately passed on by commercial banks. Should the RBA decrease the target cash rate, in addition to the RBA home loan rate, the likelihood of commercial bank rates following suit would decrease as economic outlooks worsen. The impact of such a dramatic change to the RBA’s monetary policy tools is particularly uncertain.

The interaction of such a bank with international and domestic regulation provides a challenging area for such a proposal to overcome. It is unclear as to whether a home loan originating RBA would be subject to capital adequacy requirements under the Basel Accords. Given the proximity of the RBA to the Government, would capital be considered the holdings of the Australian Government deposited with the RBA? Would capital not be required due to an implicit or explicit government guarantee? The questions of the banks standing in the regulatory sphere become murkier and murkier, as the parameters of the Greens’ proposal are increasing indistinct.

Reserve and Residential Bank of Australia

Housing affordability continues to be one of the biggest economic questions facing contemporary Australia. Innovative policy is required, and courageous ideas sought but that doesn’t allow for relaxed rigour. The modern banking environment has moved well beyond the formative days of the Australian economy, and the worth of an independent, focussed Central Bank should not be underestimated. As with any significant proposed departure from the economic status quo, many questions still beg for answers. Many of the questions of the Greens’ proposal cannot be answered without a firm position on one : How much of a commercial bank do you want the RBA to be?

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