An energy menace to bank balance sheets

The outlook for the medium term is positive, according to Commonwealth Bank chief Ian Narev, but he worries that an energy-sparked dollar shift could expose Australian business and bank balance sheets.

In his KGB interview, Commonwealth Bank chief executive Ian Narev showed that he is bullish about the Australian economy, particularly for 2014 – after the federal election.

But as he looks down the track – three, four or five years – there is a global and local cloud that is worrying him.

We are seeing an unprecedented flood of money in global markets, which is reviving economic activity but down the track might increase global inflation.

Indeed, nobody knows exactly what the effects of such a money flood will be longer term. Part of the Commonwealth Bank scenario planning which Narev described is to examine the theoretical global risks and possible outcomes.

But there is a particular problem that Australian is in danger of facing. We are seeing, currently, a strong rise in the Australian dollar. Narev, like many others, is fearful that not enough Australian companies have really made fundamental change to the their productivity in the light of this rising currency. All too often, they have simply cut costs by retrenching people but not really changed the way they operate. Alternatively, they've gone offshore for more of their supplies (CBA sources a home-grown hope, December 20).

If there was a big fall in the Australian dollar it would then translate into much higher corporate costs because the underlying productivity forces have not been changed.

And if Australian costs and prices increase, so does inflation and so do interest rates. If Australian banks have attracted a customer base that requires low interest rates to sustain loan repayments, higher interest rates would be a very dangerous scenario.

In terms of how the Australian dollar might fall, there are many scenarios. But the one that concerns the Commonwealth Bank, and others, is the growth of energy supplies in the US and the Middle East. If that energy momentum is developed and the increased prosperity in the US pushes up the American dollar, then Australia's terms of trade could fall.

In particular, our LNG and thermal coal exports might generate less revenue, which would compound the pressure on the Australian dollar.

Narev emphasises that these are not forecasts but that it is the job of the bank to plot possible scenarios and to have a strategy available to handle those scenarios.

And when you see a danger you will make adjustments in today's world to lessen your exposure to that danger.

All this is made possible when a bank is in a very strong position. Commonwealth Bank's strength partly reflects the enormous investment that was made in technology back in the days of former CEOs Ralph Norris and David Murray.

The job of the current management is to use that technology not only to grow the bank but to make sure that if anything goes wrong in the future it is well able to handle it.