Mutuals covered on bond reform

Small banks, including mutuals, will be able to pool assets in order to make effective use of covered bonds once they become a funding option later this year.

The exposure draft of the Banking Amendment (Covered Bonds) Bill 2011, released yesterday, outlines two models that mutuals seeking to pool assets might follow.

One is an "aggregating" model that allows a second entity to sell debt instruments secured by covered bonds already issued by a small bank.

A second and seemingly more expensive option is to establish a dedicated, APRA-regulated, deposit-taking entity that would acquire assets from small banks and then sell covered bonds.

Under either model, the smaller banks would still be subject to the same cap on the allocation of assets to covered bonds as other banks, which the bill sets at eight per cent.

The exposure draft confirms the assets that banks may use in covered bonds, which are: cash; government debt; home loans secured by a first-ranking mortgage over residential property, with loan-to-valuation ratios of no more than 80 per cent, and commercial property loans with LVRs of no more than 60 per cent.

While banks, and especially big banks, have lobbied hard for the amendments to the depositor preference provisions of the Banking Act to cater to covered bonds, the Reserve Bank of Australia yesterday provided some cautionary commentary on their merit.

In the Financial Stability Review, the RBA reminded readers that the market for covered bonds in Europe was not immune to the crisis in late 2008.

The RBA also questioned whether covered bonds would assist banks in lowering their overall cost of funding.