Risky bank business will end badly

It became clear at the weekend that the current flood of global liquidity being engineered by central banks in the US, China, Japan and Europe is going to have an unhappy ending.

And because the ending is now almost certain to be painful the central bankers are likely to keep pumping money into their economies for longer than is generally expected.

But the longer they keep it up the more painful tapering could become because banks and institutions are taking more and more risk. In the US, for example, high risk taking in some areas is now exceeding pre-GFC levels. 

Normally commentaries of this sort start with China or US but this time I am going to start with what is happening here because it is possible that we may be starting to head down the US-China path.

During the week myself and my colleague Alan Kohler were separately told by business accountants that a number of banks, led by the ANZ, had altered their lending criteria so for the accountants’ business clients  who wanted more borrowing, ANZ was making it easier.

The accountants believed that the ANZ, at least, seemed to be gaining market share.

So it was no surprise to Alan and I when, last Thursday, National Australia Bank chief executive Cameron Clyne warned that at least one competitor, whom he did not name, was weakening its credit standards.

Accordingly on Sunday’s Inside Business interview with ANZ’s  Mike Smith, Kohler started by telling the ANZ chief that people in the small business sector say “if you want a loan at the moment, you go to the ANZ, that they are – ANZ is the most aggressive lender for business”.  Kohler then asked: “Is that right?”

Mike Smith replied he did not think the ANZ was the most aggressive but then made the tell-tale qualification: “We have improved in the terms of the way that we're…  the whole relationship model…  and certainly we have given much better tools in terms of technical tools to our relationship managers and I think that's probably having an effect”.

That’s ‘bank speak’ for saying we now believe we know more about our clients so we can lend them more money on better terms without taking a bigger banking risk. But of course you are taking a bigger risk – it’s just that you believe it can be justified.

On its own that ANZ decision will not make Australia more vulnerable but the other banks will be forced to match, so we are going to have a period of greater risk taking in business bank lending.

And later Mike Smith underlined some of the forces in Australia that would lead to greater bank risk taking by   pointing out that the new capital requirements being    imposed on the Australian banks will force our banks to take greater risks to maintain their profits.

I would add that at the same time in the home lending area, Macquarie is lowering the margins via Yellow Brick Road and other retailers to gain market share.

All four big bank chief executives may disagree with me but I came away from the Kohler-Smith exchange believing that, if we are not very careful, to maintain their incredible level of profits our banks will be tempted to increase their risk taking and that might come just as global liquidity is withdrawn via US tapering.

Mike Smith warns that when the US starts tapering its massive liquidity injection it will start a change in interest rate structure, “which is going to be pretty significant… a little bit more significant, than people realise”. But Smith does not think the tapering will happen until “well into next year”.

Whereas Australia is just starting down the high-risk path, in China banks have been taking enormous risks and incurring large bad debts for some years.

And in the US, former Morgan Stanley investment strategist Gerard Minack explains that the Americans are currently issuing twice as much in junk bonds as they did at the peak of the last cycle, attracted by the current low interest rates on junk bonds. The Federal Reserve has learned nothing from history, according to Minack.

And of course European banks are punting on bonds in doubtful governments.

Suddenly you can see the looming danger – banks and investment institutions have responded to the excess global liquidity created by the central banks to lift their risk taking and that will have an unhappy ending.

Australia has not done that  – yet.  But it looks like we may be starting.