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# Why the Government wants to let smaller banks issue 50% more covered bonds
- URL: https://www.benchmarkanalytics.com.au/why-the-government-wants-to-let-smaller-banks-issue-50-more-covered-bonds/
- Published: 2026-10-29T20:00:00.000Z
- Updated: 2026-10-29T19:59:59.000Z
- Description: The Government wants banks to commit 50% more assets to covered-bond security pools. The reform could lower funding costs for mid-sized banks, but comes with risks for depositors.
- Author: Nick Hossack
- Tags: Covered Bonds, Bank Competition, #banking

Australia's smaller banks have long faced a competitive disadvantage: they generally pay more to raise funds than their larger rivals. A new Government proposal could help narrow that gap.

On 23 October, Treasurer Jim Chalmers announced draft regulations increasing the covered-bond limit from **8% to 12% of a bank's Australian assets** — a 50% increase.

The reform follows a recommendation from the Council of Financial Regulators' review of small and medium-sized banks.

### What is a covered bond?

Banks fund their lending through customer deposits, wholesale borrowing and other sources.

A covered bond is a form of wholesale borrowing secured against a designated pool of assets, usually residential mortgages.

Unlike ordinary unsecured bank bonds, covered bonds provide investors with two sources of repayment: a claim against the issuing bank and security over the underlying assets.

This additional protection generally allows banks to borrow more cheaply and for longer periods.

### Why is there a limit?

Covered bonds were introduced in Australia in 2011, subject to restrictions designed to protect depositors and financial stability.

Assets supporting covered bonds are effectively reserved for those investors if a bank fails. They are consequently less available to satisfy other creditors.

The current legislation limits the value of assets committed to covered-bond security pools to 8% of a bank's Australian assets.

The Government proposes increasing that limit to 12%.

Consider a bank with $50 billion in Australian assets.

Currently, it can place up to **$4 billion** of assets in covered-bond security pools. The proposal would increase that capacity to **$6 billion**.

That is an additional $2 billion of potential collateral, although the amount actually borrowed would be smaller because covered bonds require more security than their face value.

### Will smaller banks benefit?

Potentially, but not equally.

The major banks already enjoy economies of scale, strong credit ratings and well-established access to wholesale investors.

Medium-sized banks may gain disproportionately if additional covered-bond funding reduces their reliance on more expensive borrowing.

Very small banks, however, may lack the scale to establish economical covered-bond programs.

### What is the economic trade-off?

Greater covered-bond issuance could reduce funding costs and strengthen mortgage competition.

But it also increases *asset encumbrance*: the proportion of bank assets reserved for secured creditors.

This could weaken the position of depositors and other creditors if a bank fails.

The Council of Financial Regulators therefore supports a moderate increase rather than removing the restriction.

**The real test is whether cheaper funding translates into more competitive lending, without materially weakening depositor protection.**

Covered bonds: More funding capacity for smaller banks

Australian Government proposal | October 2026

| Current limit8%Australian assets in cover pools | Proposed limit12%50% increase in capacity |
| ----------------------------------------------- | ----------------------------------------- |

How a covered bond works

| **1\. ISSUING BANK**Borrows money and remains responsible for repaying bondholders.                 |
| --------------------------------------------------------------------------------------------------- |
| ↓ Designates eligible mortgages as collateral                                                       |
| **2\. COVERED-BOND SECURITY POOL**Mortgages and other permitted assets provide additional security. |
| ↕ Investor funding and repayment claims                                                             |
| **3\. BOND INVESTORS**Have claims against the issuing bank and the designated security pool.        |

Worked example: A $50 billion bank

Maximum value of assets committed to covered-bond cover pools

| Existing 8% limit  | $4bn |
| ------------------ | ---- |
| Proposed 12% limit | $6bn |

+$2 billion

Additional permitted cover-pool assets

Not the amount of additional bonds necessarily issued.

How much could cheaper funding save?

| Hypothetical bond funding           | $1 billion             |
| ----------------------------------- | ---------------------- |
| Hypothetical funding-rate reduction | 0.25 percentage points |
| Gross annual interest saving        | $2.5m                  |

Illustration only: assumes $1bn of borrowing is refinanced at a rate 0.25 percentage points below an alternative source. Excludes issuance, collateral and other costs. Not an observed market spread or forecast.

The policy trade-off

Cheaper wholesale funding could strengthen banking competition. But more assets would be reserved for covered-bond investors rather than being available to other creditors if a bank fails.

Sources: Treasury draft Banking Regulations 2026 (23 October 2026); Banking Act 1959; Council of Financial Regulators, Review into Small and Medium-sized Banks (2025). Draft reform is not yet in force.