Growth in SMSF borrowing will "increase risk in the financial system"

Last December, the Financial Services Inquiry’s final report recommended a ban on borrowing to invest in property through self-managed superannuation.

Among its 44 recommendations the FSI report, advised government that to minimise risk to the financial system it should stop self-managed superannuation funds (SMSFs) using limited recourse borrowing arrangements (LBRAs) to acquire property and other assets.

Superannuation rules were changed in 2007 to allow SMSFs to borrow using LBRAs. The value of the loans rose from $497 million in June 2009 to $8.7 billion in June 2014.

“Further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system,” the FSI report noted.

The inquiry pointed out that while a lender only had recourse to the asset over which the LBRA was held, trustees would likely sell other fund assets to repay the debt if the asset’s value fell.

“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,” it warned.

It also raised concerns that borrowing reduced diversification and concentrated risk in superannuation funds, and allowed SMSF members to circumvent contribution caps, which restrict the amount members can add to their funds.

Self-Managed Superannuation Professionals’ Association of Australia director of technical and professional standards Graeme Colley said there was “scant evidence of abuse of LBRAs to date”.

“But [SPAA] can appreciate the FSI’s position if leverage in superannuation did grow to a level where it could be a threat to people’s retirement savings,” he added.

Separate from the review, regulators have been cracking down on unlicensed property spruikers who have been luring investors into setting up SMSFs to buy residential property, often using borrowed money.

In November, the Australian Securities and Investments Commission commenced proceedings in the Supreme Court of New South Wales against property investment promoter, Park Trent Properties Group. ASIC alleges Park Trent advised at least 500 members of the public to establish an SMSF and then use the fund to buy investment properties that were owned or promoted by Park Trent companies.

If the FSI’s proposed ban on borrowing goes ahead, funds with existing LBRAs would not be affected, although those disposing of assets bought with an LBRA would have to extinguish the associated debt at the same time. No date was set for the proposed regulations to begin.