If even some of the various reports today about the measures Wayne Swan is planning to create his “fifth pillar” to discipline the major banks are correct, the argument for a proper inquiry into competition in the financial system has become even stronger.
What we are seeing from the political parties of all hues is a series of proposals for ad hoc interventions in what has been a very stable and well-performed system, with the potential (if they were ever implemented) for all sorts of unintended distortions and consequences.
According to the reports, Swan is supposedly planning to re-introduce, with some limitations, the government guarantee of funding for credit unions, building societies and regional banks. He is also, it is said, planning to increase the government’s intervention in the mortgage-backed securities market. He might extend the guarantee on deposits in the non-banks beyond its expiry date next year. And he is, apparently, considering whether to let the mutual authorised deposit-taking institutions pass on the benefit of currently unusable franking credits to their depositors.
Swan has promised to reveal his package of reforms to create his “fifth pillar” this month, despite the fact that there has been no proper investigation of whether they are actually needed, what the implications of introducing changes to the system might be or how significant an impact the mutuals might have on competition if the playing field were tilted towards them by more government/taxpayer assistance.
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It is worth noting that the Reserve Bank of Australia submission to the Senate committee on banking competition effectively demolished the myth that the banks have been using their post-crisis increased dominance of the local system to gouge their customers.
It is also worth noting that the major banks’ share of housing lending has recently been falling, not rising, which is an indication that there is non-bank or regional bank competition.
Given that the fixation of Swan and other politicians appears to be home lending, it is also worth considering whether it is in the national interest for the government (presumably using taxpayer funds) to try to lower the cost of home loans at a time when the RBA is trying to use monetary policy to dampen consumer spending and control the inflationary pressures it believes will flow from the income shock generated by the record terms of trade.
There are some who might also question whether it is prudent to do anything to further inflate the housing market given what has occurred offshore.
Swan’s fifth pillar needs to be seen in perspective. The four major banks have total assets of about $2.5 trillion, with the banking sector as a whole having around $2 trillion of domestic assets. The credit union and building societies have combined total assets of about $76 billion.
While not wanting to understate their potential to provide some competitive discipline, they aren’t really a pillar and, whatever the government does to assist them, without access to external capital they are unlikely to become a fifth pillar for a very long time to come, if ever.
It is also worth noting that the Australian Competition and Consumer Commission has declared that the last “fifth pillar” – St George, before it was acquired by Westpac – didn’t provide price competition for the majors. St George had nearly $70 billion of assets when it was acquired.
The danger in rushing out “reforms” without exhaustive analysis and debate – without a fully-fledged inquiry — in an area as important and sensitive as the financial system is the risk of unintended consequences.
Guarantees, whether limited or not, do distort markets and generate moral hazard. We already have four banks deemed “too big to fail.” What are the implications of adding another 120 or so institutions that are “too small to fail?”
There has been an argument that taxing the mutuals tilts the playing field because they can’t use their franking credits, although the corporatised institutions, of course, don’t give the benefit of their franking credits to depositors but distribute them to shareholders so that, just like the mutuals, their profits are only taxed once.
Giving some form of tax break to mutuals – allowing them to offer some form of tax-preferred deposit – would probably just bid up the cost of deposits generally at a time when the banks have already bid them up in an attempt to reduce their reliance on offshore wholesale funding. Is that necessarily desirable and why wouldn’t the majors pass on any further increase in the cost of their deposits to their borrowers?
Some limited intervention in the market for securitised mortgages is the most obvious and most controllable way of helping the credit unions and building societies increase their access to funding.
Even that, however, needs to be done carefully. One of the problems with the way politicians look at competition in the financial system is that they appear to regard the period immediately prior to the crisis – when there was an endless supply of very cheap credit to almost any commercial borrower, with extremely compressed risk premia – as the norm, rather than the aberration that it was.
There is nothing in the system at present that suggests competition is the most pressing issue – margins are broadly at their pre-crisis levels, when there was intense competition, and banks’ fee income has fallen significantly. As the impact of the global regulatory response to the crisis – more capital and liquidity – is fully absorbed by the banks and, presumably, passed on to some degree to their customers, there will inevitably be an enhanced ability for non-banks to profitably compete.
The really important question is how to reduce the major banks’ reliance on offshore debt markets, which the crisis demonstrated was a threat to the stability of our system and economy.
If Swan, who as Treasurer has a responsibility for the stability of the system, was less concerned about the Opposition’s opportunistic seizing of the leadership in the bank-bashing stakes and more concerned about the system’s fundamentals, he’d take the heat out of the debate by referring issues of funding and competition to a proper expert committee who could spend a year or so considering the state of the system and coming up with recommendations for reform, if indeed any were deemed necessary.
This article first appeared on Business Spectator.