The much anticipated final report from David Murray’s Financial System Inquiry (FSI) has urged the government to prohibit certain SMSF borrowing arrangements.
The panel has recommended a removal of the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements (LRBAs) by superannuation funds.
“Government should restore the general prohibition on direct borrowing by superannuation funds by removing section 67A of the SIS Act on a prospective basis,” the report stated.
“This section allows superannuation funds to borrow directly using limited recourse borrowing arrangements.”
However, the report stated the exception of temporary borrowing by superannuation funds for short-term liquidity management purposes should remain.
While the FSI acknowledged the level of borrowing is currently relatively small, the report suggested if direct borrowing by funds continues at current growth rates, it could pose a risk to the financial system.
The report stated this recommendation seeks to prevent the unnecessary build-up of risk in the superannuation system and the financial system more broadly.
The report noted that lenders can charge higher interest rates because of the higher risks associated with limited recourse lending, and “frequently” require personal guarantees from trustees.
It also pointed to the likelihood of borrowing to concentrate the asset mix of the fund, therefore reducing its diversification and increasing its risk exposure.
“Further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system,” the report stated.
“Borrowing, even with LRBAs, magnifies the gains and losses from fluctuations in the prices of assets held in funds and increases the probability of large losses within a fund.
“In a scenario where there has been a significant reduction in the valuation of an asset that was purchased using a loan, trustees are likely to sell other assets of the fund to repay a lender, particularly if a personal guarantee is involved.
“As a result, LRBAs are generally unlikely to be effective in limiting losses on one asset from flowing through to other assets, either inside or outside the fund.”
If implemented, Murray’s recommendation has serious implications for Australia’s third-party channel, given the widespread distribution of SMSF loans by mortgage brokers.
The MFAA is currently running an SMSF course for its members in an attempt to help brokers capture opportunities in the growing sector.
Speaking to Mortgage Business last week, Super Fund Pro director Peter Dunworth, who runs the SMSF course on behalf of the MFAA, did not expect the FSI to make changes to SMSF borrowing arrangements.
“I just don’t think the FSI is even on brokers' radars given that SMSF lending doesn’t even account for 10 per cent of the market yet,” Mr Dunworth said.
“The lenders have not lost any money on an LRBA transaction,” he said.
“The lending is actually very conservative.
“I’ll be curious to see what Murray’s research says because if he actually digs deeper and looks at the credit policy of SMSF lending versus traditional residential or commercial lending, he will find that SMSF lending is far more conservative, it has lower LVRs, higher serviceability standards and higher interest rates.”