Government should look to pilot tracker mortgages, says competition report

The Better Competition, Better Prices report put forward 44 recommendations to government after 14 months of evidence gathering and analysis from numerous sectors of the economy.

The committee received more than 60 submissions from stakeholders across industry and government and followed up with many stakeholders and other experts at a series of 18 public hearings.

In its report, it noted that some of the most important decisions Australians make in life, such as taking on a mortgage to buy a home, are “(unknowingly) heavily influenced by the level of competition and dynamism in the economy”.

It read: “As Paul Keating said, the banking system can be likened to the arteries of the economy. Some areas warrant regulatory tightening – such as variable interest rates charged to residential mortgage holders, particularly those who are not financially savvy; and the interest rates charged on deposits, particularly where complex bonus or introductory rates are offered.”

The report therefore set out options for introducing “behavioural prods” to ensure more efficient and fair outcomes for consumers (some of which were initially put forward by the ACCC Home Loan Price Inquiry in 2020 and which the government has suggested it will respond to in due course).

These include:

• That the Treasury Competition Policy Taskforce examine mechanisms to increase consumer engagement with mortgages and deposit products. Initially, this could take the form of pilots of one or more of the following:
• a) A requirement that banks should notify the base interest rate at the end of the introductory period where a retail deposit product is offered.
• b) A requirement that banks should clearly notify retail deposit holders of changes to their interest rates, changes to the eligibility requirements for a bonus interest rate and, where practicable, alert customers when they are approaching a threshold for eligibility for a bonus interest rate (e.g. a minimum balance level).
• That APRA provide an independent benchmark (or series of benchmarks) for variable rates for new/switching customers over the preceding 12 months. That this benchmark be published for use by mortgage brokers and financial advisers to improve their capacity to contact new clients to improve churn rates.
• That the government examine the merits of adopting a government-backed residential mortgage-backed securities (RMBS) scheme, taking into account the characteristics, and evaluation, of the Canadian RMBS model.
• That the Australian Prudential Regulation Authority examine the suitability of macroprudential regulation of medium and smaller banks and, in particular, their capital holding requirements.
• That the government explore co-operating with the banking sector in the development and evaluation of a pilot in relation to tracker mortgages.

The recommendations came after the committee found that “even though rates of [repricing/refinancing] engagement have increased over the past 18 months, there remains a large cohort of passive, disengaged consumers who are at risk of being charged interest rates above the rate they could achieve if they sought a better deal from their own bank or a rival bank”.

It outlined that the banks had been “sceptical” about previous suggestions that they should bring in “behavioural prods” – noting that ANZ had warned of the risk of unintended consequences of an annual prompt from banks to home loan customers given servicing changes. For example, it suggested that it could mean that someone who is prompted to refinance but whose application is rejected on suitability grounds risks having a negative credit score.

However, the committee said while it acknowledged the higher levels of engagement by mortgage holders with their banks, it “remains concerned that engagement may fall away in the medium to long term”.

“Accordingly, the Committee supports measures to institutionalise such customer engagement,” it said.

Tracker mortgages

Dr Daniel Mulino MP, chair of the committee, added: “Additional mortgage products for consumers could also be considered, such as tracker mortgages and residential-backed mortgage securities.”

Tracker mortgages – which automatically change interest rate as the cash rate (or a related measure of bank funding) set by a country’s central bank changes – have not been common in Australia, despite the fact that Australia has a higher proportion of households on variable interest rates than most OECD countries.

Some banks – such as Auswide Bank – have a rate tracker loan in place, but take-up has been minimal among many lenders due to net interest margin concerns. (When appearing before the House of Representatives economics committee in October 2016, CBA, NAB, and Westpac said that when interest rates were rising the measure could be a risk to a bank and to the stability of the financial system – when funding costs are increasing, but banks are unable to reprice their loans. NAB had added that its substantial holding of funds offshore was not linked to the cash rate, which would add further complexity and risk to pricing of tracker mortgages.)

However, the committee said that one of the advantages of tracker mortgages is that “they reduce the likelihood of disengaged consumers drifting away from the best available rate”.

“In this light, the Committee notes that people with tracker mortgages are at less risk of paying an interest rate above the best available rate at the time, even if they do not pay attention to the market,” the report read.

A public RMBS to improve competition

Touching on the need for a government-based RMBS system (as championed by former ASIC chair and current AFG chair Greg Medcraft), the committee said that Australia could look into whether a public RMBS system (like what is in place in Canada) could be useful here.

One barrier to competition in mortgages is access to funding for smaller banks that offer home loan products, in particular customer-owned banks, a point made by several witnesses to the inquiry.

This is largely because customer-owned banks, which generally focus on residential mortgages, have higher cost-to-income ratios and lack the extra income sources of the major banks through their more diversified business models. Additionally, higher relative compliance costs can adversely affect the ability of smaller banks to deliver on a key point of competitive difference – their direct interaction with customers.

However, it noted that the Canadian market has a similarly concentrated banking system as Australia, with six large banks.

“The Canadian Government invests in some residential mortgage-backed securities (RMBS), which reduces the costs of accessing funding for all banks but disproportionately so for smaller banks,” the committee outlined.

“Through this public securitisation of mortgages, Canada has a lower spread between bank deposit and lending rates, i.e. a smaller margin between the interest rate banks charge on loans versus the interest rate banks pay out to depositors. In 2019, Canada’s spread was at 2.5 per cent, with Australia’s at 3.5 per cent.”

The committee said it was “troubled by the significant difference in profitability between the major banks and the smaller banks”.

“Scale and diversification clearly confer significant advantages but the Committee also recognises the potential for major banks to leverage this scale to squeeze out competitors to the detriment of consumers, especially in the area of residential mortgages, and businesses,” the report read.

“For smaller and customer-owned banks, the obligations of regulatory compliance could force them to direct resources away from areas of natural competitive advantage, such as customer service, innovation, and attractive product pricing. This situation does not reflect well on competition in Australia’s banking sector.”

Given the disparity in profitability and underlying risk between large and smaller banks, the committee has therefore suggested that the government should explore the potential for government-backed bonds (public securitisation) as a way to lower borrowing costs for smaller lenders and thus boost competition in the mortgage sector.

[Related: Make mortgages great again: 4 recommendations from the ACCC]