A green attempt at banking basics

The Greens may be literate but in their relentless quest to impose a super tax on banks they continue to demonstrate the issues they have with financial literacy.

The Greens have seized on a couple of recent reports in the Fairfax papers to propose a 20 basis point levy on the four major banks that they say the Parliamentary Budget Office has calculated would raise $11 billion over four years and as much as $30 billion in 2016-17.

They argue that the levy is justified by the ultimate support provided by the federal government and taxpayers to banks deemed 'too big to fail'.

The issue has been boiling away in the background ever since the federal government guaranteed, for a price, the wholesale borrowings of the major banks when offshore debt markets seized up during the global financial crisis.

It has recently been given fresh legs because of several articles focusing on the Reserve Bank's ‘committed liquidity facility', or CLF, which would provide last-resort liquidity to banks should another episode of acute stress like the financial crisis occur.

The CLF is not ‘new news'. It was actually announced by the Reserve Bank back in 2010 and the central bank has issued several statements and papers on it since.

The reason the Reserve, the Australian Prudential Regulation Authority and Federal Treasury devised the CLF arrangements flows from the new global liquidity requirements developed by the Basel committee, which require that banks hold sufficient high-quality liquidity to withstand a 30-day acute liquidity crisis.

While the committee recently relaxed its definitions of what constitutes high-quality liquidity and the minimum amount of liquidity banks would be required to hold, and stretched the timetable for full compliance with the new standards from 2015 to 2019, the Australian banks have a peculiar problem.

Despite eurozone evidence to the contrary the primary source of high-quality liquidity is supposed to be holdings of government debt. Unlike the US and Europe, however, there simply isn't sufficient Australian government debt on issue to enable the major Australian banks to comply with the new regime.

So the Reserve Bank has agreed to provide, from 2015, the CLF. It isn't an open-ended or costless form of insurance for the banks, nor is it readily available.

The banks and RBA will agree in advance a specified amount of accessible liquidity, supported by repurchase arrangement for collateral (loans) that the banks would have to lodge with the Reserve if they draw on the facility.

Whether they actually tap the CLF or not they will pay an annual fee of 15 basis points on the full amount of the facility they have negotiated and if they do use it they will pay a 25 basis point premium over the Reserve Bank's cash rate.

The RBA has sole discretion as to whether a bank can draw on the CLF and it has said that access to the facility is contingent on the authorised deposit-taking institution (the program isn't confined to the major banks) having a positive net worth in the opinion of the RBA and APRA.

The CLF is a facility of absolute last resort and could only be accessed by a solvent bank, or other ADI, in exceptional circumstances.

It should be remembered that the only reason the AAA-rated Australian banks' borrowings were guaranteed (for a fee) by the government was because other governments (the Irish led the charge) with lesser-rated and insolvent banks wrapped their sovereign debt ratings around their banks during the worst of the GFC, elevating their perceived security above the Australian banks.

That demonstrated that there are circumstances where no matter how prudently they are managed they can be put at risk by external events.

The problem with the Greens' proposal, and the query over their financial literacy, is that at their core banks are simply intermediaries. They are the middlemen between savers and borrowers.

While the Australian Bankers' Association rushed to characterise the Greens' proposal as an attack on Australians' retirement savings because of its potential impact on bank shareholders, including superannuation funds, the more likely reality is that any impost on the banks would be largely, and probably completely, passed onto bank customers. Either borrowers would pay more, or depositors receive less or, more likely, both would share the cost.

The Greens, by restricting their proposal to banks with assets of more than $100 billion, are trying to confine it to the majors and would presumably argue that competition would prevent the majors from passing it through to customers. The dominance of the majors, however, means that they do have brand and scale advantages and pricing power.

They are also, contrary to what the Greens appear to believe, not exceptionally profitable. They make a profit of about 1 per cent on their assets – a 1 per cent movement in the value of their assets (loans) would completely wipe out their profits.

Their returns on funds, which are in the mid-teens, might appear high but these are highly leveraged institutions. Their simple leverage ratios within their banking operations would be above 20 times their capital bases. If they didn't have solid returns on equity (albeit well short of the best-in-class companies on the ASX) they'd be at significant risk and one only has to look at the UK, the US or Europe to see how devastating a loss-making bank sector can be for taxpayers and economies.

And, ultimately, their profits are large in dollar terms because they are big institutions – between them the four major banks have about $2.8 trillion of assets (not all of them in banking) and about $180 billion of shareholders' funds. According to KPMG the combined pre-tax profits of the four majors was $33 billion in 2012.

One could also, of course, argue that the banks, and the majors in particular, are already paying a super tax in the form of ever-increasing regulation and increased capital and liquidity requirement.

The Greens' banking super-profits tax would, by wiping out 20 per cent of their less-than-super profits – 20 basis points out of the one percentage point they generate on their assets – would, if it couldn't be passed through to customers, do a pretty effective job of undermining their credit ratings, their cost of capital and their stability, pushing them closer to drawing on the CLF.