So Much Depends on Super…and the Banks

Lately we have been casting aspersions–or at least thinly veiled barbs–in the direction of Australia’s largest banks. It’s not because we think they are bad businesses, or badly run. By all appearances, they are healthy, reasonably well-run institutions. Our concern is that so much is riding on them.

  1. First, they must manage the entire country’s credit risk. This is a big challange for just a handful of institutions.
  2. Second, they must weather exogenous shocks from the geopolitical world, in addition to interest rate and currency-related shocks.
  3. Third, they play a crucial role in Australia’s superannuation scheme.


As investors, it’s the last job that concerns us the most. It’s never a good idea to have all your eggs in one basket…or to be toting around a faulty basket. The more we learn about it, the more we are concerned about Australia’s “retirement basket,” the show superannuation scheme. It’s not that we are opposed to the idea of retirment. Rather, we are suspicious that millions of people can retire off the income generated from a handful of stocks. It doesn’t add up.

What’s more, the banks themselves have unique exposure to handful of sectors, particularly the housing and resource sectors. If those key drivers of bank earnings slow down, so will the stellar financial performance of the bank, and, perhaps of bank stocks. All of that eventually lands retirees depending on a healthy financial sector in unknown territory.

 The IMF commented on the risks facing Australia in a recent country report. Somebody has to do the hard work of slogging through the fine print of these reports and finding the relevant conclusions. We re-produce a few excerpts for you below.  Emphasis added is our own.

The medium-term challenges facing the banking sector are opportunities for growth and pressure on profitability:  The four largest banks, all of which are domestically-owned, have a significant sectoral concentration—albeit in low-risk residential mortgage loans—and geographical concentration in Australia and New Zealand.

Domestic opportunities for growth and further diversification are relatively limited. With two thirds of ADI assets held by the four largest banks, growth through domestic mergers among these banks may raise concentration and competition issues. At the same time, successful expansion overseas has proven problematic in the past.

These institutions face growing competition from foreign entities and non-bank financial institutions, which has put pressure on profit margins. As lending to the household sector slows, banks are seeking alternative sources of income by increasing their lending to the corporate sector, particularly small- and medium-sized enterprises, placing more emphasis on wealth-management activities, and expanding overseas. This strategy may raise their risk profile and, hence, capital requirements.

The high loan concentration to the household sector is a vulnerability. Households have historically high debt levels, debt service obligations, and gearing ratios, making them more vulnerable to a downturn in economic activity. The debt-to-income ratio is now above 150 percent and the ratio of interest payments to income has almost doubled since the early 1990s despite the fall in interest rates. These indicators clearly point to a heightened household vulnerability to shocks and significant sensitivity to interest rate changes, given that the majority of household debt is at variable rates. Household debt, however, appears to be concentrated in high income groups who have relatively low debt service burdens and significant financial assets. The erosion in residential lending standards raises some concerns.

Increased competition for mortgage clients—also due to the cooling of the housing market— has resulted in rising loan-to-value ratios, and banks are making increased use of brokers and engaging in low-documentation (low-doc) lending to maintain loan volume. The broader use of these strategies raises risks, especially given the slowdown in the appreciation of housing prices.

Also, the IMF had a bit to say on superannuation. We confess we were shocked that super assets represent over a quarter of all the assets in the financial system. It is an issue we’ll be exploring in the near future. 

Superannuation has been the fastest growing sector of the financial services industry in Australia. Assets in superannuation schemes as of June 2005 are estimated to be $A 762 billion, which represents over a quarter of the total assets of the financial system or 85 percent of GDP. It has been driven by (i) demographic pressures, with ageing population; (ii) compulsory employer contributions, which now stand at 9 percent of wages; (iii) significant tax concessions on contributions and invested income; and (iv) real annual investment returns over the last 20 years averaging 6.5 percent.

Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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