over the two years since the passage of enabling legislation, covered bonds have proven to be a useful source of funding for Australian banks.

over the two years since the passage of enabling legislation, covered bonds have proven to be a useful source of funding for Australian banks. About 57$ billion has been raised, predominantly in offshore market. This represent just over one-quarter of the banks "long-term debt issuance over this period, although the pattern of issuance has evolved with financial market conditions. In particular covered bond has proven useful as a wholesale funding source that is less sensitive to global risk events than traditional unsecured funding. this was evident in the banks issuance of predominantly covered bond in early 2012 as condition in funding market deteriorated becuase of sovereign debt concerns, particularly in Europe.

Around that time, the Reserve bank noted that the delineation between secured and unsecured funding for the banking system was perhaps not as stark as market condition implied. As it turned out, conditions in global unsecured markets improve from mid 2012, and Australian banks returned to what might be considered more typical pattern of issuance - raising the majority of their wholesale funding via unsecured bonds.4

Importantly covered bond have enabled banks to diversity their investor base and reduce their funding risk. Australian covered bond have consistently been rated AAA, which has allowed the bank to attract new funding from investor with AAA mandates. This may also have assisted those bank repurchasing their government-guaranteed debt, as the bank were able to offer investors an alternative AAA asset to invest in.

There is also some evidence of a broadening in banks investor base along the geographical dimension with regional central banks among the buyers of Australian banks covered bonds. European investors has also provided demand for these instrument, reflecting their familiarity with the asset class. This has contributed to the banks issuing wholesale debt across the broader range of currencies in the past two years, compared with their issuance patterns prior to the introduction of covered bonds.

Covered bond have also enable the banks to increase their tenor of thier issuance, which has helped to smooth the maturity profile of their outstanding debt. The banks have typically issued covered bonds at tenor of 5 to 10 years, compare with a norm of 3 to 5 years for their unsecured issuance. More strikingly, the banks has issued covered bonds at very long tenors, sometime exceeding 15 years

Discussion points

• what is a covered bond ? explain the structure of covered bond and why banks may issue this type of debt security
• within the context of Australian banks issuance of paper for wholesale funding, discuss why the issuance of covered bond versus the issuance of unsecured debt has varied as market conditions changed.
• Notes in the discussion paper that covered bond have enabled bank to diversify further their investor base and extend the tenor of their issuance. What does this mean and why might it be important for the banks?