If ratings agencies take fright over proposals to limit bank profitability, we will all pay the piper, writes Stewart Oldfield.
BACK in 1991 the then federal government of Bob Hawke had a very different relationship with the country's banks.
Then treasurer John Kerin wished the management and staff of the soon-to-be-listed Commonwealth Bank of Australia every success in the future.
"On behalf of the Commonwealth government I would like to express my best wishes to CBA as it becomes a publicly listed company."
Of course, he hastened to add, he would not normally be involved in the commercial policies of the bank. (How entirely reasonable of him, you might think).
Fast forward a couple of decades and the environment could not be more different.
Without state-owned assets to sell to finance election promises, politicians see the banks as the most useful of whipping boys.
The public is never going to complain if you sink the boot in about rising interest rates or executive salaries and each side of politics knows it.
This is not to say that we don't need rigorous regulation of banks for the betterment of the
country.
But the public debate needs to rise above mere exasperation over the aggregate value of banking sector profits.
For whatever reason, the banks have failed to explain that since the onset of the global financial crisis they have issued more than $40 billion in new shares in anticipation of tougher regulatory requirements and fund acquisitions (that government agencies sanctioned, mind you). So, of course, they are making bigger profits. They have to as they are larger companies with more needy shareholders to serve. On measures taking into account their bigger balance sheets, such as return on equity or return on assets, they are still short of pre-GFC levels. On consensus numbers, only one of the major banks is expected to produce double-digit earnings-per-share growth over the next three to five years, compared with expectations of greater than 30 per cent growth among the big miners.
So why the frenzy against the banks now?
Of course, if some people had their way, the banks would be nationalised just as prime minister Ben Chifley advocated in the 1940s. And wouldn't that be good for the economy.
The Australia Institute, which does some good work, has estimated the banks are making $20 billion in excess pre-tax profits, which implies they are only entitled to make a maximum pre-tax return on shareholders' equity of about 11 per cent.
The problem is that if this was the highest return banks could generate across a cycle, shareholders in droves would withdraw their capital from such a heavily leveraged and cyclical industry. And as the RBA has acknowledged, one of the most important factors that got the Australian economy through the GFC was the banks' ability to raise capital when banks everywhere else couldn't.
With fresh capital from those needy shareholders, the Australian banks were able to nurse tottering corporates and households through a global crisis and then we
were all able to go off to the Melbourne Cup as if nothing ever happened.
But this is no time for complacency. Lehman Brothers collapsed just two years ago, shutting down global wholesale capital markets for months.
There is a reason why global banking reform is being phased in over a decade. The global banking system remains incredibly fragile.
So Australia desperately needs its major banks to keep their AA ratings. Without such ratings, they would not be able to finance our current account deficit as easily as they do. If the government wants to take substantive measures to foster savings by Australians so that we are not so reliant on the big banks to find money offshore, this would be a positive reform for our economy, correcting what NAB CEO Cameron Clyne has referred to as an Achilles heel.
But don't for a moment think that right now our friends at the credit ratings agencies aren't watching this simpletons' debate about the need to legislate away bank profitability with some horror, wondering if they should put the banks on negative credit watch.
If they do, the results will be catastrophic. Ken Henry knows it Wayne Swan knows it, Malcolm Turnbull knows it. Maybe Joe Hockey, Bob Katter and Barnaby Joyce don't know it, but that's another story.
In short, if the ratings agencies take fright and mark the major banks down a notch or two, the banks will struggle to raise funds offshore as easily as they do, the cost of borrowing here will rise substantially for those who are lucky enough to get it, and for those who can't well, rising unemployment will just be the start of it.
It's called economic reality.
So, sure, introduce legislation that improves the ease of switching accounts between banks or further empowers the competition regulator to look for collusion.
But legislate fixed interest margins for mortgages as the Greens are advocating and we will be endangering our very economic prosperity.
The Americans have been stupid enough to blow up their finance industry with idiotic policy settings and have ended up with 9 per cent plus unemployment.
Could we about to do the same?
Frequently Asked Questions about this Article…
Why are Australian politicians focusing criticism on bank profits right now?
Politicians often target bank profits because the public gets angry about things like rising mortgage rates and high executive pay. With fewer state assets to sell, banks have become convenient whipping boys during election cycles. The article notes this political pressure can lead to calls for tougher regulation or even limits on bank profitability.
Have Australian banks actually grown, and does that explain higher profits?
Yes. Since the global financial crisis banks have issued more than $40 billion in new shares to meet tougher regulatory rules and fund acquisitions, making them larger with bigger balance sheets. On measures that account for size, like return on equity or return on assets, the majors are still below pre‑GFC levels despite larger absolute profits.
What risks would come from legislating limits on bank profit margins?
The article warns that legislating fixed interest margins or caps on profitability could alarm credit rating agencies. If ratings are cut, banks would struggle to raise funds offshore, borrowing costs would rise, and that could flow through to the wider economy as higher unemployment and reduced access to credit.
Why are strong credit ratings (like AA) important for Australia’s major banks?
AA ratings make it easier and cheaper for major banks to borrow money offshore. The article explains that without strong ratings, banks would find it harder to finance Australia’s current account deficit and the cost of borrowing for households and businesses would likely increase.
How did Australian banks help during the global financial crisis (GFC)?
According to the article, Australian banks were able to raise fresh capital when banks elsewhere couldn’t. That capital allowed them to support struggling companies and households, which helped the Australian economy get through the GFC more smoothly than many other countries.
Some groups say banks are making 'excess' profits — is that supported?
The article cites an estimate from the Australia Institute that banks may be making about $20 billion in excess pre‑tax profits, implying a maximum pre‑tax return on equity of roughly 11%. The article also argues that if 11% were the best long‑run return, shareholders might withdraw capital, which would weaken the banks over the cycle.
What kinds of bank reforms does the article support versus oppose?
The article supports practical reforms that boost competition — for example, making it easier to switch accounts between banks or giving regulators more power to investigate collusion. It opposes measures like legislating fixed interest margins for mortgages, which it says would risk economic damage and higher unemployment.
How might credit rating agencies respond to public debate about limiting bank profitability?
The article suggests rating agencies are watching the debate closely and could place banks on negative credit watch if proposals to limit profitability appear likely. Such a move could trigger downgrades with serious consequences for banks’ funding costs and the broader economy.
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