Q+A-Will Australia's move to allow covered bonds lower mortgage rates?

Dec 14 (Reuters) - Australian Treasurer Wayne Swan announced a series of bank reforms on Sunday designed to calm voter anger at rising mortgage rates, in part by allowing lenders to issue covered bonds and thereby reduce their borrowing and lending costs. [ID:nL3E6NC00K]

WHAT ARE COVERED BONDS?

Covered bonds are a form of debt backed by pooled assets, mostly mortgages, that remain on a bank's balance sheet. Australia is one of the last developed countries in the world that bans its banks from issuing covered bonds because they rank ahead of depositors for payment in the event that a bank fails.

Because bond holders have first claim on the banks' assets, the lenders are easily able to issue such bonds and obtain the cheapest form of long-term funding.

WHY IS THE GOVERNMENT SUDDENLY KEEN ON ALLOWING COVERED BONDS?

Global issuance of covered bonds has risen 45 percent to a record high $311 billion in 2010, Thomson Reuters data shows, as the safety of these instruments appealed to investors in the aftermath of the global financial crisis, which was stoked by off balance sheet borrowings by banks.

That has put Australia's top four banks, among the world's most profitable and stable lenders, at a disadvantage compared with their peers because they can't access this pool of cheap debt.

The banks -- National Australia Bank , Commonwealth Bank of Australia , Westpac Banking Corp and Australia and New Zealand Banking Group -- have around A$150 billion in annual funding requirements between them. Banks have lobbied hard for covered bonds on the argument it will lower their funding costs, and thus take upward pressure off mortgage rates.

WILL THE MOVE REALLY IMPACT BANKS' OVERALL COST OF FUNDING?

Not by much. While covered bonds are much cheaper -- perhaps half of the cost of senior bonds -- the local regulator is thought likely to impose a cap on how much they can issue, equivalent to around 5 percent of bank assets.

"Covered bonds will only have a marginal impact to be honest. It will help funding costs around the edge but it is far from being a game changer given caps on the issue size," said Ed Henning, a banking analyst at CLSA.

Phil Bayley, principal at consultancy firm ADCM Services, expects top banks can sell covered bonds at 50 percent lower cost than senior debt. A five-year senior bond is being sold at about 120 basis points above bank bills.

Bayley said based on current assets of banks and assuming a 5 percent limit for covered bond issuances, Australian banks can sell up to A$100 billion in such bonds. However, he expects them to sell up to A$5 billion each in the first year.

WOULD IT MEAN LOWER MORTGAGES RATES?

Not really, because the Reserve Bank of Australia (RBA) wants mortgage rates at their current level as part of a moderately tighter policy aimed at heading off inflationary pressure.

"The loan rates in the economy are roughly speaking about where we think they ought to be for the macroeconomic needs we have," said Glenn Stevens, governor of the RBA, at a Senate enquiry into banking competition on Monday.

This essentially means that if the banks were to independently lower their mortgage rates, the RBA would merely lift its cash rate to push those rates back up to levels it considers appropriate for the whole economy.

A PUBLIC RELATIONS EXERCISE BY THE GOVERNMENT?

It's certainly seen as helping divert away some of the anger directed at the government for letting banks increase mortgage rates faster than the central bank. The central bank has raised rates by 175 basis points since October 2009 while the banks have gone up as much as 205 basis points over the same period.

Politically, it is much easier for the government to attack the commercial banks for higher rates, than to challenge the well-respected central bank. (Editing by Ed Davies and Muralikumar Anantharaman)