Sorting the good bank levies from bad

The naked self interest in the call by building societies and credit unions for a “modest and conservative’’ annual levy of between $1 billion and $2 billion on the four major banks is obvious. The national interest isn’t quite as clear cut.

The Customer Owned Banking Association urged the Federal Government to impose the levy in this year’s federal budget, using the familiar argument that the four majors enjoy financial and competitive benefits from their “too big to fail” status and the implicit government guarantee that generates.

COBA is in good company, given that the Greens have agitated for their own levy on the majors, although their proposal would, they said last year, raise $11 billion over four years and as much as $30 billion in 2016-17! COBA’s proposal is differentiated from the Greens’ by being “far more moderate.”

Last year, of course, in the dying days of the second Rudd Government when it was scrambling for revenue in the lead-up to the federal election, then Treasurer Chris Bowen announced a proposed “Financial Stability Fund” through a levy on deposits that was supposed to raise $1 billion over three years, starting in 2015-16. The fund was supposed to strengthen the government’s ability to respond to a financial crisis.

Joe Hockey has put that levy on hold pending the outcomes of the Financial System Inquiry he commissioned and which former Commonwealth Bank chief executive David Murray will chair. It would be absurd, given that the inquiry has been asked to provide its findings and recommendations by November this year, if the government acted pre-emptively and imposed COBA’s proposed levy in the budget.

Inevitably, however, proposals for levies and the like on the four majors will surface within the inquiry. There are those who simply resent their dominance and profitability but others who see super profit taxes and levies as a way of tilting the competitive playing field.

In fact that playing field is already tilting. Very late last year the Australian Prudential Regulation Authority released the framework for its treatment of “domestic systemically important banks,” or D-SIBS. The D-SIBS are, of course, ANZ Bank, Commonwealth Bank, National Australia Bank and Westpac.

From 2016 the majors – alone of the deposit-taking institutions APRA supervises -- will face a capital surcharge of an extra 1 per cent of their common equity tier one capital. While COBA says that only Canada and China have introduced a surcharge as low as that, the Australian and Canadian systems and their regulators emerged from the financial crisis with their credibility intact.

The majors are probably also the only institutions affected by the Reserve Bank’s “committed liquidity facility,” designed to give the banks access to liquidity in an emergency. It was necessary because there aren’t other sufficient high-quality sources of liquidity available for the banks to meet the new Basel Committee liquidity requirements.

The banks will pay an annual 15 basis point fee on the full amount of the facility they negotiate with the RBA, regardless of whether or not they use it – and a 25 basis point premium over the RBA’s cash rate if they do call on it.

It also tends to be overlooked that in the event of a failure of an authorised deposit-taking institution, the industry (which effectively means the majors) has to make up any shortfall in deposit funds after a wind-up of the failed institution. In effect there is an industry-funded deposit insurance scheme in place.

That after-the-event scheme could be replaced through the creation of a Financial Stability Fund which would build up bailout reserves over time through a levy on ADIs.

There are examples of deposit-insurance schemes elsewhere and the Basel Committee has advocated their introduction to reduce the moral hazard created by implied guarantees.

Given that in this system, however, depositors are ranked ahead of unsecured creditors in the event of an insolvency, there is an element of moral hazard already baked into the industry structure – and a massive buffer against depositor loss even before the industry support for depositors or a stability fund could be called on.

To be effective and equitable, and to avoid distortions and unintended consequences – and moral hazard – within the system, however, it would need to apply to all ADIs and not be used to cloak an attempt to manipulate the competitive relativities within the system.

The capital surcharge (which APRA could, if it wanted to, increase) is quite explicitly the price the majors and their shareholders pay for their being classed as D-SIBS and too big to fail. Singling them out for further impositions not faced by their competitors would be an attempt to artificially engineer a new industry structure, with unpredictable consequences.

The Greens and COBA indeed see the levy as a way to handicap the majors because both ADIs and other non-banks that compete with them wouldn’t have to pay it.

Competition from the players exempt from the levy would, they argue, prevent the majors from passing the cost back to depositors (where it arguably belongs). It would be major bank profitability and major bank shareholders that would absorb the cost.

That’s not necessarily the case. Despite Wayne Swan’s “reforms” that were designed to facilitate and encourage “switching” the majors’ dominance hasn’t been dented. Customer inertia – or their comfort in dealing with the majors – means it is conceivable that at least some of the cost of a levy would be passed on to depositors and/or borrowers without meaningfully impacting their businesses.

Discussions about the ‘’too big to fail’ status of the majors and their dominance of the domestic system also need to take into the account that the majors don’t just compete with domestic ADIs – they compete with foreign institutions both within the domestic markets and internationally.

The financial system inquiry is the appropriate forum for a complex discussion of system stability and competitiveness. It will inevitably have to consider what might be done to improve the potential for increased competition and reduce the potential risks to taxpayers without materially and negatively impacting systemic stability, depositors’ security or the interests of the vast numbers of retail shareholders and super fund members exposed to the fortunes of the majors.