Assets 'tax' could hit banks hard

GREENS MP Adam Bandt's proposal that the big four Australian banks be required to pay an annual levy of 20 basis points, or 0.2 per cent, on the value of their assets above $100 billion to swing $11 billion to the government in the next four years is more dangerous for the big banks than earlier calls by the Greens and others for some kind of "super-profits" banking tax.

Banking super-profits tax proposals struggle because the big four's profits aren't actually that super. They are certainly big: cost-benefit analysis of the levy proposal undertaken by the Parliamentary Budget Office estimated that the big four banks earned total profits of $33 billion and paid tax of $9.6 billion in 2011-2012.

They earned about $10 billion less between them in 2008, and since June 30, 2007, their assets have roughly doubled to $2.1 trillion as competitors fell away and their lending market share boomed: about eight out of 10 loans and nine out of 10 home loans now come from the big four.

A super-profits tax should really aim at super profitability, however, and on that score the banks can argue back.

Since the crisis erupted, they have been forced by regulators to significantly increase the amount of capital that supports their businesses. This is part of worldwide moves to make the banks safer, and it is a weight on the key measure of any company's profitability, the return on equity.

The average return on equity for the big four peaked at 20.6 per cent in 2007, according to KPMG's annual banking survey. It fell to 18 per cent in 2008, fell further to 13.7 per cent in 2009 as the market crisis became an economic slump, recovered to 15.9 per cent in 2010 and 16.7 per cent in 2011, and then eased back last year to 16 per cent.

The most profitable bank is CBA, which achieved a return on equity of of 18.1 per cent in the December half: but while it is the second biggest listed company here, 22 other companies in the ASX top 100 posted superior returns on equity last year.

The difference between what banks pay for funds and what they charge borrowers is the net interest margin, and for the big four banks it actually fell by 7 basis points in 2012, to 2.17 per cent.

As former Reserve Bank governor Bernie Fraser recently pointed out, by defending their net interest margin the banks have been making a choice between themselves and their customers. They have been holding on to margin and propping earnings and dividends by not completely passing on Reserve Bank cash rate cuts to their variable mortgage rates.

Their net interest margin has not surged, however. "I hate to be a party pooper," the current central bank governor, Glenn Stevens, told the House of Representatives economics committee on February 22 when asked when people borrowing from the big banks could expect a better deal. "Margins fluctuate a bit from quarter to quarter and year to year, but they have been in a reasonably narrow range for quite some years now. That is what has happened."

Bandt's proposal is a bigger threat to the banks, firstly because instead of being tagged to so-called super profits, it is tied to the fact that the big banks are too big to fail.

It's a threat secondly because the levy is big. The Parliamentary Budget Office calculated that it was equal to 25 per cent of the tax the banks already pay. It noted that, in fact, this was a potential problem: the hit is so large that it would probably trigger a "behavioural response", such as restructuring aimed at avoiding the levy.

The levy idea is also a threat because it has been floated in an election year, when the government and for that matter the opposition are making promises they can't afford: $11 billion from the politically unpopular banking sector might be tempting.

It has always been assumed that the government stood behind Australia's banking sector as a lender of last resort, and the Commonwealth government stepped in during the crisis to guarantee bank borrowings (for a fee).

Heightened global liquidity requirements in the wake of the financial crisis are also going to be satisfied in this country by the creation of a "committed liquidity facility" of up to $380 billion by the Reserve Bank. In effect, it will be an unused line of credit that banks will be able to tap if, in some future crisis, their cash reserves are running out.

Credit agencies recognise that the government and the Reserve Bank will prevent a bank failure if banks themselves are unable to take over distressed institutions. This occurred during the crisis with CBA's acquisition of Bankwest, for example, and as occurred in 1990, when CBA took over the State Bank of Victoria.

They would rate the banks less highly if they thought the banks might be allowed to fail, and the banks would pay more for the funds they raise if that happened. Bandt's argument is that the big banks should pay a levy for that ratings uplift, and the funding advantage it delivers.

There are some problems with the proposal. Bandt and the Greens argue that the big four banks would not pass on the levy through higher lending rates and higher charges, because it make them less competitive, particularly compared with smaller banks that did not pay the levy. The levy would affect 80 per cent of the market, however, and the big banks would probably find ways to pass it on.

The planned Reserve Bank committed liquidity facility will also not come free. The banks will pay the Reserve 15 basis points on the line of credit even when it is not being used, and 40 basis points on drawn funds. They will also sell mortgage securities into the Reserve as collateral, at a discount.

If the liquidity facility is indeed the ultimate "too big to fail" facility in other words, it is one that will cost the banks. The levy the Greens are proposing would be an additional, large impost - and if it resulted in the banks being downgraded, their borrowing costs and their lending rates would rise.

This is an election year, however. The banks are about as popular as a shark in a swimming pool and the government is searching for ways to meet spending commitments without blowing the budget apart.

Anything is possible: the banks will be watching very closely to see if the Greens get traction.

mmaiden@fairfaxmedia.com.au