Question

Financial Regulation and Financial Institutions

The Australian government has shut down the economy in response to COVID19, resulting in millions of Australian being unemployed and under-employed.

Many of these newly unemployed have home mortgages with banks, which now face growing (interest rate, market, credit, liquidity, operational) risk from such customers who are no longer able to meet their repayments. The RBA has also mandated new financial regulation that requires banks to freeze mortgage repayments for up to six months. Holding all else constant, this lack of income for an extended period, whilst still having to meet all business obligations, causes a challenging increase in (operational, credit, liquidity, interest rate, market) risk.

In order to maintain the confidence of government and the public, banks have started to (lower, raise, buy back) new equity, that provides (profitability, capital adequacy, liqudity management) and signals that growing bad debts can be absorbed. These extraordinary operating conditions places (neutral, upward, downward) pressure on bank profitability, where the (Interest Received, Interest Paid, Total Assets) component of Net Interest Margin (NIM) faces clear contraction.

For example, by 2019 end, NAB's NIM was 1.8%. Given that total assets remain largely unchanged in 2020 at $847 billion and half-year profitability of interest received less interest paid is set to fall by -$1.4 billion, the June 2020 NIM of NAB is expected to be (1.61%, 1.65%, 1.59%, 1.63%) .

While the financial regulation that allows for mortgage repayments to be frozen for up to 6 months is designed to ease the (credit, operational, liquidity, market, interest rate) risk faced by the newly unemployed, the frozen repayments will simply be added back to the balance of the loan, resulting in (lower and longer, higher and shorter, higher and longer, lower and shorter) loan repayments and loan terms respectively.

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Answer 1

The Australian government has shut down the economy in response to COVID19, resulting in millions of Australian being unemployed and under-employed.

Many of these newly unemployed have home mortgages with banks, which now face growing credit risk from such customers who are no longer able to meet their repayments. The RBA has also mandated new financial regulation that requires banks to freeze mortgage repayments for up to six months. Holding all else constant, this lack of income for an extended period, whilst still having to meet all business obligations, causes a challenging increase in credit risk.

In order to maintain the confidence of the government and the public, banks have started to raise, new equity, that provides capital adequacy and signals that growing bad debts can be absorbed. These extraordinary operating conditions places upward pressure on bank profitability, where the Total Assets component of Net Interest Margin (NIM) faces clear contraction.

For example, by 2019 end, NAB's NIM was 1.8%. Given that total assets remain largely unchanged in 2020 at $847 billion and half-year profitability of interest received less interest paid is set to fall by -$1.4 billion, the June 2020 NIM of NAB is expected to be (1.61%, 1.65%, 1.59%, 1.63%) .

While the financial regulation that allows for mortgage repayments to be frozen for up to 6 months is designed to ease the (credit, operational, liquidity, market, interest rate) risk faced by the newly unemployed, the frozen repayments will simply be added back to the balance of the loan, resulting in lower and longer loan repayments and loan terms respectively.