Mark Bouris and I published this op-ed in the AFR today...
AUSTRALIAN FINANCIAL REVIEW
Scrap the big four’s ‘protected species’ status
PUBLISHED: 13 Feb 2012 PRINT EDITION: 13 Feb 2012
Mark Bouris and Christopher Joye
With four banks worth about $250 billion that control 80-90 per cent of all Australian financial transactions, and dominate the planning and funds management industries, it’s understandable they attract attention.
But don’t blame the bankers. By choosing to pass on their costs to the five million families that have home loans, and to millions of small business borrowers, rather than absorbing them, they are simply doing what all good oligopolists do: exploiting market power. They are seeking to preserve world-beating, double-digit returns on equity for the benefit of themselves and their shareholders. That’s rational.
The answer to Australia’s banking problems lies not with bank executives, who have but one sensible objective—profit maximisation. The answer rests with policymakers, who need to urgently revisit the industry’s dangerous and inequitable incentives, which are increasingly exposing all Australians to greater moral hazards and sub-optimal financial services.
Banking is a simple business: those with the lowest funding costs generally win. The Australian banking system encourages extreme size, since the bigger you are the lower your costs will typically be. The majors are so large these days they are explicitly treated by investors as “too-big-to-fail”. In particular, they benefit from a two notch rating upgrade, which none of their smaller rivals receive, because Standard & Poor’s assumes that they alone will get “extraordinary government support”.
This is why Australia’s banking sector has turned the ineluctable risk-return trade-off on its head. Ordinarily, as risk grows, expected returns rise in lock-step. Yet Australia’s smallest and riskiest banks deliver the lowest returns. In contrast, our safest banks, with their prized AA- credit ratings, produce the best returns. That is, super low-risk entities extract super-normal returns.
Unfortunately, the banking debate is characterized by confusion cleaved between two camps. There are those who pretend banks are just like normal private companies, and should not be interfered with. These folks like to claim that the banks did need not receive much taxpayer assistance during the crisis.
In the other camp we have those who understand that banks are public-private utilities performing a vital social function—transforming short-term savings into long-term loans—that gives rise to ‘asset-liability mismatches’ that inevitably require public backing.
ANZ’s chairman, John Morschel, underscored this disconnect last week, remarking, “I wish politicians would get their facts straight…There was no capital provided to any Australian bank by the government and the only thing they did was guarantee wholesale funding, for which they…earned a hell of a lot of money.”
This is incorrect. In addition to guaranteeing over $100 billion of wholesale bank debts for the first time ever (at sub-market fees), taxpayers also guaranteed the banks’ biggest source of funding—retail deposits—for free. Without the latter, Treasury feared there may have been bank runs, which could have triggered domino effects across larger institutions.
And who were the biggest users of the wholesale guarantees? The majors, of course. The likes of Bendigo & Adelaide Bank couldn’t afford to rely on them because the guarantee was (perversely) priced on the banks’ credit ratings, which made them mechanically cheapest for bigger entities to use.
The ACCC also set-aside competition concerns during the GFC, green-lighting a swathe of major bank purchases, including St. George, BankWest, RAMs, one-third of Aussie, indirectly Wizard, and Challenger’s lending business. Today the ACCC’s new boss, Rod Sims, worries: “[E]ven though there are four of them, there is a lack of full and effective competition…I think [they] feel…protected from others entering the market and that makes for arrangements that are too cosy for consumers."
Finally, our taxpayer-owned bank, the RBA, which describes itself as a ‘lender of last resort’ to private banks, supplied billions of dollars of cheap money to the banks when nobody else was willing to do so.
Once in a while bankers acknowledge that their solvency is vouchsafed by us all. NAB’s Mark Joiner concedes, "The guarantee underlined the privileged position that banks have in the economy and that…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."
We believe the real trouble with Australia’s banking system is that it’s based on a flawed paradigm: a purported conflict between ‘stability’ and ‘competition’, which the major banks highlight when justifying their margin expansion.
We believe these two objectives are, in fact, complementary. Specifically, Australia’s financial system would be safer if we had ten smaller, $25 billion banks, which were not individually big enough to threaten the system’s viability compared with the four too-big-to-fail behemoths, worth around $250 billion, that we have left today.
In a similar vein, Bendigo & Adelaide Bank’s Chairman argues, “We went into the crisis with no bank too-big-to-fail…Coming out of it, I don't think that's the case...We’ve ended up with an industry structure that's far more rigid, and…more vulnerable to the next shock.”
Policymakers should accept that government guarantees of banks are a sine qua non for safe ‘maturity transformation’. But this taxpayer insurance has to be properly priced, or you encourage a US-style situation whereby a handful of implicitly government-backed lenders dominate financial intermediation to the detriment of competition and stability.
When extending liquidity and insurance to banks, we don't believe that Treasury or the RBA should rely on rating agencies. APRA ultimately monitors and controls every Australian bank’s risk, and the cost of taxpayer support should be APRA’s intrusive regulation, and thus priced the same for all institutions.
We also believe that in preference to guaranteeing nebulous ‘institutions’, taxpayers should focus on insuring safer ‘assets’. If the Commonwealth offered a credit-wrap of mortgage loss insurance like the Canadians do, it would formally price an implicit guarantee that already exists (generating significant revenue) while leveling the competitive playing field. This would allow all banks to raise capital on similar terms and help eliminate the too-big-to-fail advantages the majors currently have. It’s also something ASIC’s Chairman, Greg Medcraft, supports.
Finally, why not require all banks to publish a regular index of their funding costs and net interest margins to end the asinine monthly RBA rate debate. We’re surprised the majors haven’t offered to do so!
