Strength before competition

Wayne Swan's willingness to approve the Westpac-St George merger highlights the government's desire to bolster Australia's banking system, even at the expense of diversity within the sector.

There are few surprises in Wayne Swan’s decision to approve Westpac’s merger with St George, even though he attached a list of largely meaningless conditions. The language of the approval, however, given the volatile context in which the merger is occurring, was interesting.

After the Australian Competition and Consumer Commission cleared the merger on competition policy grounds, it wasn’t inconceivable that Swan would block it, but it was very, very unlikely.

If the disappearance of the "fifth pillar" isn’t going to result in a substantial lessening of competition, Swan would have needed to find some other national interest argument to veto the deal. In fact he looked to the credit crisis to find reasons for why the merger was positively in the national interest.

The treasurer’s statement yesterday said the merged entity would have a larger balance sheet and capital base and broader access to funding markets, making it better placed to withstand systemic shocks. St George’s brand would also benefit from Westpac’s lower funding costs.

In other words, the credit crisis provides a core reason for why the merger is in the national interest.

St George has demonstrated that, despite its inferior credit rating relative to the four major Australian banks, it has been able to raise term funding offshore, albeit at a premium to their funding costs. It is well capitalised and highly liquid. The credit crisis might squeeze its margins and profitability relatively to what they would otherwise have been, but its low cost-to-income ratio means that its stability shouldn’t have been an issue.

To the extent there was a risk of depositor or lender concern, the government’s guarantee of bank deposits and term funding would dispel it. The decision to extend those guarantees meant that Swan could have, had he wished, rejected the merger and argued that preserving competition had supplanted any reservations about system stability as the post-guarantees policy priority.

Nevertheless, Swan did cite system stability, prudential requirements and economic efficiency as arguments for approving the merger.

The same arguments would apply in spades to Commonwealth Bank’s acquisition of Bank West from HBOS, or any major bank acquisition of Suncorp’s banking business.

The government appears to be quite comfortable, keen even, to allow significant diminution in the depth and diversity of competition within the banking system in return for some structural buttressing of its stability.

Despite its guarantees of the deposits of authorised deposit-taking institutions and of their term funding requirements, the government would be very nervous about the demonstrably brittle state of confidence within the system.

Even though the flight from non-banks to the perceived safety of the majors had started well before the guarantees were announced – some wealth managers say that there were droves of customers who opened multiple bank accounts in expectation of a $20,000 cap on the level of guarantee and there was clearly a massive diversion of funds from the non-bank sector to the banks ahead of the announcement – the government and its authorities appear unsettled by the significant impetus the announcement has given that process.

While there are mortgage trusts, and cash trusts, and foreign bank branches that are blaming the guarantee for large-scale withdrawals of funds, the longer the crisis continued, and the more foreign banks and non-banks that were bailed out by their governments, the bigger the flow of funds away from them and into the four majors would have become, with or without the guarantee. (Perpetual, in announcing the freezing of redemptions of $2 billion in two of its income and mortgage funds today, blamed the guarantees).

As the domestic economy slowed, and the property industry began showing cracks, the outflows of funds from mortgage trusts (some of which have already been frozen for months) would have accelerated.

It doesn’t matter whether the government introduces an "insurance premium" for large deposits (although it ought to be easy enough to split large deposits among banks and avoid or reduce that impost), in an environment as volatile and fear-laden as this, there was always going to be a continuing scramble for the perceived safest havens – the major banks. (Run on the non-banks, 22 October)

The guarantees simply formalised what was implicit. The dislocation occurring within the non-bank part of the system was inevitable and unavoidable if the crisis continued and its impacts on the real economy started surfacing. The crisis is continuing and its impacts on real economies are emerging.

The government’s responsibility is to protect the core of the system, which it is doing.

In the parts of the system that aren’t regulated by the Australian Prudential Regulatory Authority and where investors have exposed themselves to greater risk in pursuit of greater return, it is, and ought to be, caveat emptor.

Allowing some reduction in competitive intensity in order to strengthen the core can be justified. The St George/Westpac merger should strengthen both banks, and has certainly provided a useful underwriting of St George through the worst of the crisis.

While there are some distortions created by the guarantees that impact the core system that may have to be addressed, the government will, however, have to resist the inevitably considerable pressures to extend, whether directly or indirectly, taxpayer support and moral hazard – as is happening elsewhere – beyond that core.