Let the bank bashing begin

Property Observer

Yesterday we read Paul Sheehan in the Sydney Morning Herald arguing that Australia's major banks "look like ports in a storm”, and were prudent in hesitating to pass on the RBA's cuts.

Sheehan claims that, "reflexive calls for our banks to pass on the Reserve Bank's interest rate cuts, in full, are now double-edged… A healthy bank is far preferable than a stressed bank. They may need their fat for harder times.”

In case you missed it, his op-ed's title conveyed the message even more crisply: "Our banks aren't so greedy after all.”

Sheehan was accompanied by a second SMH piece, ironically produced by an economic consultant to the banks, which posited that we should, in fact, only ever expect the banks to pass on 80 per cent of any RBA move. Again, the article's pithy title told you all you needed to know: "No need for banks to pass the cut.”

Sheehan's insinuation that we should prioritise major bank profitability over competitive considerations is not novel. He is merely trotting out the very standard RBA and Australian Bankers' Association line on the purported trade-off between 'financial stability' and 'competition'. The two are supposedly mutually exclusive, which necessitates a more concentrated financial system. Privately, serious policy thinkers know that both the RBA and APRA would prefer fewer banks to regulate rather than more.

To this line of logic, more competition means lower margins, which means less profitable and hence less 'stable' institutions. It's that crude. And it's wrong.

Sheehan would have almost certainly been worded up by someone in the RBA-Treasury-ABA-major bank network to present the 'other side' of the bank bashing story.

Oh, and rest assured, this is an insiders' network, much like the 'financial oligarchy' that MIT's Simon Johnson famously identified as the source of so many problems in the US.

A former head of Treasury and director of the RBA, Ted Evans, is chairman of Westpac. His successor as head of Treasury and a director of the RBA, Ken Henry, has just been appointed to NAB's board.

The governor of the RBA between 1996 and 2007, Ian MacFarlane, joined ANZ's board once his term at the RBA expired.

David Morgan, a long-time Treasury official who rose to become 2iC, left to join Westpac, which he led as CEO during the 1990s and 2000s.

Another former RBA official, Andrew Mohl, was until recently chief executive of AMP.

And I fully expect the outgoing deputy governor of the RBA, who was well-known as a defender of the banking oligopoly, to end up on some bank board.

If during your career as a (relatively) lowly paid regulator or public servant you have one eye on a lucrative banking job to secure your retirement nest egg, it's hard to believe that this does not in some way contaminate your ability to exercise independence.

The Washington-Wall Street-like crossover between Australian banks and the bureaucracy may be one reason why domestic regulators have been so keen to protect the majors from the reforms their peers overseas are being subject to following the GFC.

After all, according to the local oligarchy's narrative, luck had little role to play in Australia's success in skirting the crisis. It had nothing to do with our leverage to Asia, extraordinary endowments of resources, high population growth, 20 years of rising real GDP, or the fact that our banks had not expanded overseas due to their focus on servicing the high growth domestic economy.

In Sheehan's words, "we can thank good government policy and good banking.” No sight of providence in this play!

This may explain why the RBA has been pushing hard to have the major banks exempted from the extra capital charge that the world's 30 largest banks will be hit with under BASEL III, even though the majors rank among this list.

The argument goes that Australia's banks don't have significant overseas exposures. But is it not the explicit corporate strategy of the CEOs of two of the four majors to expand into foreign territories? Of course it is. We've even had the newly appointed CEO of the Bank of Queensland claim that Australian banks should use their (taxpayer-underwritten) pricing power to buy cheap assets overseas.

The dysfunctional regulatory-banking nexus is also possibly one reason why our banks have been exempted from holding the standard 'liquid assets' that all other global banks will be required to keep. The official explanation was Australia has little government debt to satisfy this requirement.

Yet Australia's unique solution involved the RBA offering all banks a so-called 'Committed Liquidity Facility', which for a cost of just 0.15 per cent per annum will give banks an immediate line of credit whenever they face funding stress. That is, they can swap illiquid assets with the RBA for cash and thus directly cauterise their solvency concerns.

One of the reasons I have argued consistently for better pay in the public sector is so that officials feel less need to leave and seek lucrative private sector gigs. (And officials do use this explanation when asked why they are taking on such jobs.)

The financial stability/competition trade-off that guides so much banking policy thinking in Australia is actually a sham. To demonstrate why, I put to you this idea.

The four major banks' combined market capitalisation is an extraordinary $250 billion (that's about 20 per cent of the national GDP).

Imagine, for a moment, if we could replace the majors with, say, a larger number of smaller institutions. That is, if we took this quarter of a trillion dollars and spread it across, say, 10 smaller, safer banks – with no offshore expansion plans, with no 'non-core' banking activities – worth, say, $20 billion to 30 billion each. Think of 10 different versions of Bendigo and Adelaide Bank.

Our financial system would no longer have four 'too-big-to-fail' legs, and all of the long-term moral hazard problems that these government-guaranteed institutions engender. Instead, it would have 10 smaller pins across which to apportion the economy's risk. This is just smart diversification.

How might one achieve this? You could begin by introducing a financial transactions tax that became much more punitive as an institution's size – measured by its assets as a share of the system's total assets – rose beyond a certain, unacceptably high threshold.

You would basically be signalling that if you want to become a mega, too-big-to-fail bank, you are going to have to pay taxpayers a hefty price for the explicit and implicit catastrophe insurance.

And if you think I am being melodramatic about taxpayers bailing out banks, I would encourage you to refer to Standard and Poor's independent perspective. In assessing the creditworthiness of the major banks this month, Standard and Poor's commented that their funding costs were substantially lower because of the assumption of taxpayer support. Specifically:

"Our counterparty credit rating on CBA is two notches higher than the [stand-alone credit rating], reflecting our view of a high likelihood of extraordinary government support in a crisis. This reflects our view of CBA's high systemic importance in Australia, and our assessment of the Australian government as highly supportive of institutions core to the national economy."

And if you want a lighter take on everything I have argued today, have a glance at this online cartoon skit between two of the big banks CEOs.

Christopher Joye is a leading financial economist and a director of Rismark International and Yellow Brick Road Funds Management. The above article is not investment advice.

This article first appeared Property Observer on December 13. Republished with permission.