Wayne and Joe's much ado about banking

Wayne Swan said something bizarre in a speech in Sydney yesterday that failed to generate much comment, challenging Joe Hockey to rule out scrapping the 'Four Pillars' policy on bank mergers.

While Hockey did so immediately, pointing out that the policy had remained intact for more than a decade under the Coalition during a period when the system was less concentrated than it is today, why did Swan even raise an issue that was dead and deeply buried the moment the global financial crisis broke out in 2008, and in reality well before that?

The comments by Swan were presumably a bit of political scaremongering. His challenge was ostensibly generated by Hockey’s plan to have a 'son of Wallis' inquiry into the financial system should the Coalition win government in September.

Swan questioned the motives of those (a reference to Hockey) calling for a financial system inquiry.

‘’Do they carry the baton of those who in 2008 urged me to weaken stability and competition by abolishing the four pillars policy?’’ he asked.

‘’I wonder.’’

Well, given Hockey’s prompt response, he can stop wondering.

It is true that ahead of the GFC, and as late as September 2008, there were still bankers (including then ANZ executive and now senior Westpac banker Brian Hartzer) questioning the four pillars policy and arguing that local banks would be rendered insignificant by the massive bout of consolidation and expansion occurring offshore by the likes of, ahem, RBS and HBOS.

No one, it had to be said, took those comments seriously. It has been an article of faith among regulators and all but a few senior banking executives with ambition for most of the time since Paul Keating first formulated his 'six pillars' policy in 1990 that the four major banks should never be allowed to merge.

To the extent there was even the tiniest bit of residual doubt about the worthiness of that policy it was eradicated by the GFC, the acquisitions of St George by Westpac and BankWest by Commonwealth and the shrinking of the once-thriving non-bank sector.

The GFC produced a stark lesson that banks that are too big to fail have to be bailed out by taxpayers. The four pillars between them have about $2.8 trillion of assets – any combination of two of them would have close to $1.5 trillion of assets or more than 100 per cent of Australia’s GDP.

In the wake of what happened in the US and is still happening in Europe no treasurer or regulatory authority would countenance the creation of a mega-bank of that size in this economy.

If one of the four majors got into trouble the system and economy could probably, albeit with some stresses, deal with them.

If there were a bank double the size of the current majors and it was failing, the implications for taxpayers and the economy would be as unpleasant as those being experienced in Ireland, Spain, Cyprus and elsewhere, including the UK (where the UK taxpayer owns big slabs of RBS and Lloyds, which acquired the failing HBOS).

Even without the four pillars policy, of course, it is almost inconceivable that the Australian Competition and Consumer Commission would countenance a major banks merger – it blocked NAB’s proposed takeover of AXA Asia Pacific (one of the original six pillars) on the basis of its concerns about investment platforms for "retail investors with complex needs"!

Where Swan may have a point is his questioning of the need for an inquiry. Hockey first raised that a while ago during a contest with Swan to see who could bash the banks hardest for not passing on Reserve Bank interest rate cuts to home loan borrowers in their entirety.

The GFC did, as Swan said, stress-test the banking system and it emerged as one of the strongest and best-regulated on the globe.

There is an issue of a reduction in the number of competitors but it is arguable that the non-banks that provided the most competition for the majors (ACCC analysis has shown the regionals were price followers, not leaders) did so on the back of the unsustainably cheap access to credit from securitisation markets that helped create the crisis.

It is also the case that despite the supposed reduction in competition the net interest margins of the majors today are at the same level as they were just before the crisis, when competition was supposedly most intense.

As the market for securitised mortgages has improved and the majors’ ability to sensibly fund balance sheet growth has been constrained, there has been increased activity from the surviving non-banks and Macquarie has also been making a significant, albeit low profile, push into mortgage lending both through mortgage brokers and via a partnership with Mark Bouris’ Yellow Brick Road.

It is also the case that there are, thanks to the St George and BankWest acquisitions and ANZ’s push into Asia, quite significant differences in the strategies and balance sheets of the majors and therefore different competitive strengths and weaknesses, which generally aids competition.

Hockey will have his inquiry if the Coalition wins the election. Given the demonstrated resilience of the Australian banks, however, it would be a brave/foolish committee of inquiry, or treasurer, that recommended any substantial changes to the system. In which case why bother?