Tuesday, December 14, 2010

Christopher Joye on the banks

P-L-A-I-N E-N-G-L-I-S-H Bank Speak

Boy, I got bored with this banking debate a while ago. The word ‘debate’ does not do it justice, however, since the different stakeholders are talking at cross-purposes. I thought I might try, one last time, to break this down so folks can avoid some common mistakes.

1. The RBA is NOT the ACCC, and does not give a rat’s bum about competition

First, as I have pointed out for years, the RBA has no regulatory responsibility for ‘competition’ in the banking sector. In fact, its one regulatory objective—financial system stability—directly conflicts with any notion of enhancing competition. That is, the RBA sees an explicit trade-off between more competition and maintaining system stability. This is why in the middle of the GFC the RBA (a) initially opposed efforts by the government to support the securitisation sector relied upon by smaller lenders, and (b) relentlessly defended the competitive characteristics of the system despite an obviously enormous increase in its concentration (as the non-conflicted Treasury submission to the Senate Inquiry acknowledges).

It is, therefore, quite silly--disingenuous even--to think that you are going to get any objective or worthwhile statements from the RBA supporting higher levels of competition in the banking system. There is just no upside for the central bank advocating this stuff (it would be like asking the ACCC to champion reduced competition). Furthermore, the RBA knows that there are a vast number of participants out there--including politicians--that can do the vocal heavy lifting on the industry’s behalf.

The RBA’s only interest is in ensuring that any increase in competition does not undermine the stability of the financial system, which, in effect, means the stability and market power of the major banks.

2. The ‘competition’ debate is about risk and return, not interest rates

As I explained yesterday, the RBA ultimately sets the level of interest rates, not the banks. If, for example, better competition ends up contributing to lower lending rates, the RBA will increase its cash rate to force banks to lift rates back up again. It is not quite that simple, and there is no doubt that the advent of bank ‘top-ups’ to the RBA's cash rate changes has made monetary policy more complex to set in the near-term. The Governor conceded as much in recent parliamentary testimony, remarking that (a) the RBA does not know exactly what banks will do (contrary to some claims in the media), and (b) to the extent that the banks do more than the RBA anticipates, that will have an effect on future monetary policy decisions, which may need to reverse-out the banks' actions.

Having said that, the RBA was clearly frustrated by the major banks jawboning on funding costs and net interest margins earlier in the year on the basis that they did not really need to further increase RoEs, which is why in the October minutes it made the otherwise unnecessary observation that NIMs were “well above” pre-crisis levels. Politicians latched on to this point, which the RBA also made in other publications. I suspect the central bank got a little spooked about the public furor their statements caused, and the manner in which the RBA had been dragged into the debate. This probably explains the recent RBA back-tracking and reversion-to-type, which has puzzled some journos.

To be clear, the debate about ‘out-of-cycle’ rate hikes is not about getting rates lower. It is about the question of whether we are seeing oligopolistic profiteering or margin expansion by the majors. It is about the acceptable trade-off between the returns generated by explicitly taxpayer-backed institutions, which cannot be compared to other private sector industries, and the risks they take. This is the nub of the debate raging globally. This is also precisely the issue that the Chairman of Bendigo & Adelaide Bank is talking about when he states (as reported by AAP):

“Return on equity (ROE) was a measure of profitability and the Australian banks delivered ROE of 20 per cent or more prior to the global financial crisis, he said. A return to that level was still anticipated by bank analysts, but historically such returns were "unusually high and beyond what one would expect of a privileged, government guaranteed utility", Mr Johanson said”

NAB’s Cameron Clyne also gets it when he told the Senate Inquiry yesterday, “What we are is a solid, dividend-paying stock. Not everything has to be a high ROE if you are able to pay a strong dividend.”

To his credit, this is the heavy-duty policy matter that the Shadow Treasurer has been concentrating on for some time now.

Of course, the two things that the government can do to reduce the level of interest rates paid by borrowers in the community are: (1) make further cuts to the fiscal stimulus, which the Governor of the RBA recently acknowledged has resulted in rates rising faster than they had to; and (2) minimise inflation pressures by fostering a flexible labour market and investments in the supply-side of the economy. As the 12 year veteran of the RBA, Paul Bloxham, argued in the AFR the other day: “[B]y choosing not to tighten fiscal policy sooner, the government has implicitly chosen higher interest rates than might otherwise have been the case.”

3. Swannie's policy package does have some bite

The Treasurer’s package does contain several important reforms, including: (1) making the taxpayer guarantees of deposits permanent (but what price will banks pay for this service?); (2) undertaking a Bernie Fraser-led inquiry into establishing my idea of a national electronic credit register, which could facilitate true account portability; (3) creating a listed exchange for the trading of government debt, which will help retail investors access these AAA-rated securities and foster liquidity in the thinly traded corporate debt market; (4) giving the ACCC new price signalling powers, which, interestingly, Graeme Samuel argued last night on Sky News was a tool required by the regulator, citing a specific example of local bank price signalling last year; and (5) the advent of covered bonds, although this will almost certainly benefit the major banks most, as evidenced by their share price action following the announcement.

As I discussed in my analysis yesterday, there is also, unsurprisingly, a lot of fluff, and some bad ideas, like banning exit fees.

4. But the meaty policy issues are too-big-to-fail and moral hazard, not competition

On the policy front, the really big issues are how the taxpayer guarantees of the financial system have fundamentally reduced the risk profile of banks, the policy measures one needs to now put in place to minimise the probability that this will, in the future, induce moral hazards similar to those that propagated problems in the US, and what, from a regulatory perspective, it means for us to have a significant number of too-big-to-fail institutions. Unfortunately, Swannie’s package does not even acknowledge these concerns.

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