One of the best aspects of the Murray Inquiry, from Treasurer Joe Hockey’s point of view, is that it explicitly handed the challenge of increasing big bank capitalisation to the Australian Prudential Regulatory Authority. That takes considerable pressure off the beleaguered Treasurer in what will be a major stoush between the banking oligopoly and the array of forces that want to see higher capital requirements. But the inquiry has replaced it with another issue that doesn’t quite involve the same array of powerful players, but which is potentially thorny indeed for a Coalition government: borrowing by self-managed super funds (SMSFs). Murray wants an end to the seven-year-old ability for super funds to leverage themselves by borrowing in certain circumstances.
Ordinarily, borrowing by superannuation funds is prohibited, which would thus mean we have a vast chunk of our financial system — soon, $2 trillion — unencumbered by leverage. But Peter Costello and John Howard had other ideas: in 2007, as part of their tinkering with the super system that gave high-income earners the opportunity to maximise their use of the lower taxation framework of super, they allowed self-managed super funds to borrow money to negatively gear housing and property purchases. Among other things, this allows some high-net-worth individuals to circumvent caps on contributions and build up asset holdings larger than they would have been allowed without this leverage.
Since then, SMSFs have, to the chagrin of both the retail super and industry super sectors, grown rapidly, as has their use of borrowing. They’re still relatively small compared to the overall size of the super sector, but borrowings were over $6 billion two years ago and $8.7 billion at June 30 this year, according to the report.
Murray and co think SMSF borrowing is a bad idea, and want it knocked on the head before it can grow into a real problem across the SMSF sector. Why is it a bad idea? Because it introduces greater risk into the superannuation sector in the event of a property price collapse, and the risk isn’t just for SMSFs, which form the retirement savings vehicles for an increasing number of Australians, but for the banks that provide the loans, even though those loans come with a higher risk rating for banks (they are “limited recourse” loans, so if it goes bad, the bank can only get the asset involved, even if it has lost value).
“Direct borrowing by superannuation funds could pose risks to the financial system if it is allowed to grow at high rates. It is also inconsistent with the objectives of superannuation to be a savings vehicle for retirement income. Restoring the original prohibition on direct borrowing by superannuation funds would preserve the strengths and benefits the superannuation system has delivered to individuals, the financial system and the economy, and limit the risks to taxpayers.”
In recommending this, the Murray Inquiry Committee has accepted strong calls to do so in submissions from the two key regulators, the Reserve Bank and APRA, saying “the absence of leverage in superannuation funds meant that rapid falls in asset prices and losses [during the GFC] in funds were neither amplified nor forced to be realised. The absence of borrowing benefited superannuation fund members and enabled the superannuation system to have a stabilising influence on the broader financial system and the economy during the GFC. Although the level of borrowing is currently relatively small, if direct borrowing by funds continues to grow at high rates, it could, over time, pose a risk to the financial system.” In its submission to the inquiry, the RBA also noted that SMSF members may not fully understand the risks they’re taking, and were contributing to over-rapid property price growth.
The problem for Hockey is that this change isn’t one he can hand to the regulators — it requires legislative amendment. And the affected sector is a rusted-on section of the Liberal vote — higher income middle-aged Australians. Financial planners have also done well out of the burgeoning SMSF sector, and closing down loans will shut off a source of fees for advisers. The SMSF sector will portray itself as the little guys of super, the representatives of individualism in a sector dominated by socialist greed (industry super) and oligopoly banking (retail super), and axing borrowings just implements the agenda of the big players. But the disparate nature of the sector will be an impediment to its lobbying: there’s an SMSF Professionals’ Association of Australia, but nothing to match Industry Super Australia or the Financial Services Council, the latter of which wields massive influence over the government.
But the real problem won’t be in Canberra — it’ll be out in Liberal MPs’ electorates, where SMSF members will start bending their ears about this outrageous prohibition. And the last thing a Treasurer under a heap of pressure needs is unhappy backbenchers.
There’s also another headache for the government, on super earnings. The inquiry wants to see more sustainable taxation concessions for super, and discusses at length the option of equalising the tax imposed on the earnings rate of super funds between accumulation and retirement (at the moment those rates are 15% at accumulation and zero on retirement), although it concludes the issue needs further consideration for fear of unintended consequences. Hockey walked away from Labor’s decision to impose a 15% tax on retiree income over $100,000. It’s not mentioned, but the extended discussion in the report is an implicit rebuke of that. It’s not an immediate problem, however, because the issue will be picked up in the government’s tax reform paper. But it means that super tax concessions are, to the extent they may not have been before, now a key issue for any serious tax reform process.