Today Treasurer Wayne Swan announced a series of reforms to promote a “Competitive and Sustainable Banking System” following an intense debate initiated by the Shadow Treasurer, Joe Hockey. (I am happy to be quoted on any of this.)
The package has significant strengths and weaknesses, and is somewhat undermined by much superficial padding (eg, allowing building societies to change their name, getting taxpayers to fund lenders’ marketing campaigns, and claiming private sector initiatives as government policy).
The government has explicitly accepted three of Joe Hockey’s “nine points” on: (a) new price signaling powers for the ACCC; (b) measures to enhance the liquidity of the residential mortgage-backed securities market relied upon by smaller lenders; and (c) the introduction of covered bonds, which is an historical first for Australia.
Curiously, the government made no efforts whatsoever to open up Australia Post’s latent 3,800 branches for use by smaller lenders, which is an initiative supported by the former CEO of CBA, David Murray, and many industry minnows.
And the government persists in peddling the popular myth that competition will reduce interest rates. As the RBA has belaboured of late, the central bank sets prevailing lending rates, not the banks. If rates are too high, the RBA will cut the cash rate until it gets the lending rate it wants.
The two things that the government can do to reduce interest rates are: (1) make further cuts to the fiscal stimulus, which the Governor of the RBA recently acknowledged has resulted in rates rising faster than they had to; and (2) minimising price pressures by fostering a flexible labour market and investments in the supply-side of the economy.
A 12 year veteran of the RBA, Paul Bloxham, who recently left to become chief economist of HSBC, put it this way: “[B]y choosing not to tighten fiscal policy sooner, the government has implicitly chosen higher interest rates than might otherwise have been the case.”
Perhaps the package’s single biggest deficiency is the complete absence of any acknowledgement or discussion of the two major policy issues that are front-and-centre in all banking debates raging around the world today: moral hazard and too-big-to-fail. These are also the principal policy focuses for the global Basel Committee on Banking Supervision, the global Financial Stability Board, and the G20.
Joe Hockey has also relentlessly raised these issues in his own advocacy. But for some reason the government has been missing in action from the global debate. Indeed, they have apparently negotiated an exemption for Australia’s four major banks from new higher capitalisation standards that will be applied to the world’s 25 most systematically important banks, even though three of the four majors rank, by market capitalization, in the top 25. The basis of this exemption is understood to be the assumption that the major banks will stay domestically focused in the prosecution of their business models. But what ensures that this will indeed be the case?
The crux of post-GFC policy challenge is getting a better understanding of the crucial role banks play in the community, and the risks that they should be permitted to take given the presence of explicit taxpayer guarantees. The CFO of NAB recently described this tension best: “The [taxpayer] guarantee has underlined the privileged position that banks have in the economy and that at the end of the day the state will step in to support them. It has shined the light on the obligations on banks not only to act in their own self-interest but to keep in the front of their mind they have obligations to all stakeholders.”
Yet in his reform package the Treasurer has not told us:
1) Whether banks will be asked to pay for taxpayers insuring nearly $1 trillion worth of customer deposits, which he today confirmed will become a permanent feature of Australia’s financial system following their unveiling for the first time during the crisis (ie, will this continue to be provided by taxpayers for free?);
2) Whether taxpayer guarantees of the bank’s wholesale liabilities, which peaked at just under $200 billion, will be made available in future crises, as the banks themselves have said they expect to be the case (in conflict with the Governor of the RBA’s stated preferences in recent parliamentary testimony—see here);
3) What policy measures the government proposes to put in place to mitigate the “huge moral hazard” risks that the RBA Governor identified have now been embedded in the financial system following the shift to explicit taxpayer guarantees.
The Treasurer’s policy proposals do possess some important strengths:
1) The government has appointed former RBA Governor, and current Chairman of Members Equity Bank, Bernie Fraser, to examine the bottlenecks to moving to a financial system that has full account portability, which is not currently the case. This is a very welcome development.
2) The government has seemingly embraced a radical idea that I have outlined on several occasions in the past, which I termed a “National Electronic Credit Register” (NECR), which would provide the architecture necessary to establish electronic linkages between all lenders and deposit-takers throughout Australia. NECR would, I believe, revolutionise the ability of the RBA and APRA to manage financial stability risks, and furnish the connections that would permit seamless account portability. I explained how this would work in detail a while ago here, or if you cannot access that, here).
3) The government has endorsed Joe Hockey’s proposal to empower the ACCC to prevent anti-collusive price signaling by institutions, which seems like a sensible idea (they also suggest some mitigants to quell industry concerns).
4) The government has announced that it will make the deposit guarantees permanent, which was likely to happen in any event. It has not, however, disclosed whether institutions will be required to a pay premium for this taxpayer-supplied insurance service, as would ordinarily be the case.
5) The government has extended by $4 billion its existing $16 billion commitment to the RMBS market, which is an idea that Joshua Gans and I first came up in March 2008 that does not increase net government debt and which has generated positive cash-flows for taxpayers.
It has to be said that this is a fairly trivial additional and represents just 8 per cent of the annual volume of RMBS securitisations prior to the crisis. More disappointingly, the government has not announced any pro quo for the taxpayer quid. There is no new licencing regime for securitisation, which I have advocated. That is, lenders benefit from this taxpayer injection of cash at zero cost.
Recall that securitisation in Australia remains completely unregulated. You would have thought that governments had learnt the lessons of the last crisis (ie, self-regulation does not work), yet Australia seems distinguished by its ability to be blinded by hubris. Obvious policy reforms here include establishing a common set of securitisation standards for all participants, and a formal licencing regime overseen by APRA.
6) The government has accepted Joe Hockey’s suggestion to permit banks to issue covered bonds, which I understand is not something that regulators support. This will help diversify the ADIs’ funding sources, and brings Australia in line with other developed countries. But it is not clear that this will do anything to support competition. In fact, one smaller bank executive has argued the majors would likely be the biggest beneficiaries of this innovation.
7) Finally, the government will establish a centralised exchange for the trading of government debt securities. It claims that this will in turn help improve the liquidity of the corporate bond market. While this may prove true, the first beneficiary will be the government itself, since it will effectively be seeking to raise funds directly from the retail market. As I have noted on countless occasions before, mums and dads are massively underweight fixed-income investments (and overweight equities) in their superannuation portfolios. If a listed exchange increases the probability of self-managed superannuants, individuals and even institutions investing in AAA-rated government debt, then that is probably a good thing. And insofar as it allows more transparent pricing of corporate debt securities, it could help to boost liquidity in this underdeveloped market, which I consider to be a worthy policy aim.
Regrettably, there is also considerable fluff in the government’s package:
1) Banning exit fees is a terrible idea that is likely to most adversely affect smaller lenders, and actually undermine their ability to compete. Smaller lenders, which operate on wafer thin margins that are substantially lower than the major banks (see this analysis here) need to charge exit fees to mitigate early repayment risks and recover their costs. This proposal has been widely opposed by smaller lenders and I am surprised to see it get off the ground.
2) The idea of a ‘mandatory fact sheet’ for all new loans is already required by the existing NCCP laws. All lenders have to detail in plain English upfront all of the fees and charges associated with a new loan in standardised, industry-wide formats.
3) The government is going to allow building societies and mutuals that already meet APRA’s banking capitalisation guidelines to call themselves a ‘bank’. This is hardly revolutionary policy that will lead to a ‘fifth pillar’ in banking, but rather just offering the option to these institutions to change their name. Given the stigma associated with the word ‘bank’, it will be interesting to see how many actually take it up. The one benefit of calling yourself a bank is the perception of safety and security. Yet the government’s decision to make taxpayer guarantees of deposits permanent addresses this issue.
4) The government appears to be asking taxpayers to underwrite a marketing (or ‘awareness’) campaign for smaller banks, mutuals and building societies, which looks like a waste of public money.
5) The government will establish a ‘taskforce’ with the RBA, which is the payments system regulator, to see whether there are any further ways to improve ATM competition. Since this is already the RBA’s regulatory responsibility, and the central bank has recently completed substantial reforms to the sector, it is hard to see what more will be achieved.
6) The government claims it will work to develop a ‘bullet-bond’ structure for the RMBS market. Yet this is, in truth, a private sector initiative that has little to do with the government. The package states, for example, that “The AOFM recently announced its support for the issuance of a new RMBS transaction by Bendigo and Adelaide Bank, which includes a significant bullet tranche.” That is, an Australian bank has already successfully launched this innovation.
