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Strain on the banks: Financial systems hinge on our health strategy

Only now is it clear how closely bank chief executives and bank regulators have been cooperating with political leaders to agree on emergency measures that can help homeowners, investors and small businesses suspend their repayments.

The first emergency intervention, two weeks ago, saw Treasurer Josh Frydenberg strike an agreement with the major banks and the regulator to make the deferrals as long as possible for small business owners.

The talks on March 19 set the pattern for the help offered later to Australians with mortgages on their own homes and on investment properties – a crucial measure when more than a million people use negative gearing.

The talks in March cleared the way for the banks to announce they would defer loan repayments for small businesses affected by the COVID-19 virus, covering about $100 billion in loans and pausing about $8 billion in repayments.

But the help for small business owners had to be carefully designed to ensure the banking system – in fact, the country’s broader economic system – could carry the new burden.

Australian Bankers’ Association chief executive Anna Bligh spoke to bank bosses earlier that week to raise the idea of a support package, and then went to Australian Competition and Consumer Commission chairman Rod Sims to gain clearance for a collective discussion on a united measure.

Australian Banking Association chief executive Anna Bligh raised the idea of a support package.

Australian Banking Association chief executive Anna Bligh raised the idea of a support package.Credit:AAP

Australia was yet to face economy-wide shutdowns but small businesses were in trouble, the death toll was soaring in Italy and the Morrison government was rethinking its forecasts to consider a health crisis that would last at least six months.

Frydenberg wanted the banks to defer loan repayments from their small business customers so millions of companies and sole traders could avoid bankruptcy when their revenue collapsed.

If this worked, the same pattern could be followed to defer repayments for home owners and property investors worried about their mortgages.

Bligh negotiated the options with Commonwealth Bank chief executive Matt Comyn, in his role as ABA chair, and went to her members with a plan to defer repayments for six months.

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The strain on the industry was significant. The banks usually offer loan deferrals for three months, not six. Any deferral over 90 days would trigger rules at the Australian Prudential Regulation Authority to treat the loan as impaired and adjust a bank’s capital levels accordingly.

Frydenberg was full of praise for the banks for being willing to carry some of the financial cost, but he also knew they were getting help.

Earlier that Thursday, the Reserve Bank had promised $90 billion in funding to the banks in a three-year lending program at a fixed interest rate of 0.25 per cent.

The final voice on loan deferrals was crucial. Wayne Byres, the chairman of the Australian Prudential Regulation Authority, had to be sure the program did not cost so much it became unviable. The entire banking sector had to be able to cope with the load.

Australian Prudential Regulation Authority chairman Wayne Byres.

Australian Prudential Regulation Authority chairman Wayne Byres.Credit:AAP

Byres had considered three months as the likely term for the emergency aid but had to consider whether it could be extended to six.

The analysis by APRA regulators had to test how the banks could support the assistance – or, to use Frydenberg’s term, how far the banks could “stretch” to help their customers.

If the loans were to be treated as impaired after 90 days, the banks would have to hold more capital and write down debts, most likely in the middle of a crisis.

At about 10pm that night, Byres spoke to Frydenberg to tell him the payments could be deferred for six months. The message was: “we can do it”. Frydenberg held a conference call with Bligh and Comyn to relay this verdict.

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This is now the essential template for intervention. Ministers, chief executives and regulators are in a constant discussion over the next measure. What looks simple to the consumer is placing immense strain on the system.

The greatest risk may be to offer assistance that appears affordable but becomes unsustainable if the virus cannot be contained in a few months.

Everything turns on the health strategy to suppress the disease, which currently requires a prolonged period of economic pain from shutdown measures that must last for much of this year.

If the only solution is a vaccine, University of Melbourne epidemiologist Tony Blakely suggests the wait could extend into next year.

Can the nation sustain a waiting period that long? The crisis for tenants will be passed on to agents and, in turn, the landlords who rely on the cash flow to pay down investment property home loans.

The banks are the backstop. The pressure can only be sustained if it can be borne by the big lenders, supported in turn by the Reserve Bank.

This is a different world to the politics of the recent past, when politicians rebuked the banks over their failures to protect consumers. The approach is cooperative.

Frydenberg is careful to avoid any hint that he is “bank bashing” when he asks the big lenders to offer the maximum possible assistance.

He relies instead on the argument that the companies have an “alignment of interest” with their customers.

This is working so far. The banks offered deferrals of six months to small business on March 20 and followed that with deferrals of six months on mortgages held by owner-occupiers and investors.

Some have gone further. Worried that customers would think they were being charged “interest on interest” because the deferred interest would still have to be repaid after the deferrals, the Commonwealth Bank moved in recent days to repay the amounts.

The move is more symbolic than substantial. On an average loan of $350,000, the bank will make a one-off payment of about $45 to offset the effect of interest on interest over the six months.

Frydenberg wants other banks to follow but the truth is it will be small change in a crisis that will wipe out some of those $350,000 loans.

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Even if the virus is contained within six months, the economic shocks will last for years and some households will not be able to carry the mortgages for their homes or their investment properties.

The talks in March on the first intervention reveal the pressure points. A prolonged crisis will raise the question of whether bank customers can gain relief over a longer period than six months. Yet the deferrals cannot be indefinite.

The banks already confront an enormous challenge because they know many of the households in trouble now will not be able to repay their loans.

The help for bank customers cannot be limitless. Every intervention becomes more difficult from here on.

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