Are there any institutions more hated than banks? Right now, the answer is "no". Financial institutions, and banks in particular, have probably never enjoyed broad popular support. But at the moment they’re more on the nose than ever. Not only have the big four raised their variable mortgage rates, despite the Reserve Bank holding the national reference rate steady, but ANZ has also announced it will retrench 1000 workers as part of a cost-cutting drive.
Predictably, the response by politicians and many in the community has been furious. Some financial commentators continue to maintain that the rate hikes and job cuts are driven by pressures on bank margins, owing to rising costs of funding but most in the general community see only huge institutions making massive profits.
So are banks merely responding to rising funding costs? Or are they greedy corporations arrogantly abusing their power and size?
It’s a little of column A, a little column B. While there is no doubt that making money as a big bank is getting harder, the broad public anger at banks is justifiable. Australia’s big four banks enjoy an implicit public guarantee from Australian taxpayers. By acting in the interests of their shareholders, they are abusing that privilege.
Let’s start with the public’s grievances.
For most citizens, the key issue with their bank is the size of their mortgage repayment every month. As Leith van Onselen pointed out on the ABC’s The Business last week, the reason interest rates are such a trigger point in Australian politics is because of the vast private debt levels racked up by our householders. "It’s a fact of life that there’s a lot of people out there with huge amounts of debt," van Onselen pointed out, "and the 25 basis point cut makes a big difference to them. It shouldn’t, but that’s the way it is." No wonder voters in the mortgage belt are furious when the banks not only fail to pass on interest rate cuts, but actually raise rates when the Reserve Bank hasn’t.
But interest rate margins are just the tip of the iceberg when it comes to public dissatisfaction with the financial sector. You can’t have a GFC without an "F" for financial, and big financial institutions are widely — and correctly — blamed for causing the US sub-prime mortgage crisis and the global financial crisis that followed.
It is true that in Australia, banks were far more prudent in their lending standards, which meant we largely avoided the financial excesses of the US, Ireland, Iceland, Britain, and the rest. That hasn’t meant Australia has been free of financial misconduct.
In 2004 the National Australia Bank uncovered a rogue trading ring responsible for $360 million in unreported losses. In 2008, ANZ got caught up in the collapse of brokerage Opes Prime, which had racked up $630 million of losses. ANZ eventually got most of its money, while clients lost everything.
More recently, we’ve seen Sonray Investments collapse, after its boss Scott Murray started to transfer money out of client accounts in a doomed effort to cover up catastrophic trading losses. The Sonray losses were a comparatively small $47 million. Demonstrating that financial malfeasance is no stranger to Australian shores, the NAB rogue traders, the Opes Prime directors and the Sonray fraudster all went to jail.
Even leaving aside corporate crime, Australian banks have shown no compunction in using their influence in dubious ways. Remember the "cash for comment" scandal? This was the scandal involving prominent Sydney radio hosts John laws and Alan Jones, who took money from the Australian Bankers Association in order to make positive comments about the big banks on their radio shows. The scandal involved no criminality, but it certainly showed that the industry was prepared to mislead listeners and customers.
Then there is the issue of bank fees, currently the subject of a multi-billion dollar lawsuit by litigators IMF. IMF’s lawyers have signed up tens of thousands of ordinary Australians (including, I should declare, yours truly) to a class action against the big banks. They allege that billions of dollars worth of so-called "exception fees" were unlawfully levied for things like overdrawing an account, paying a credit card payment late, or exceeding a credit card limit. The banks had long justified their gouging on the grounds that they reflected the cost of processing, a ludicrous claim in an era of sophisticated IT systems and overseas data centres. Stung by the negative publicity, many of the banks have already reduced these penalty fees on their own initiative, acknowledging in this way that they were getting away with over-charging.
So you can see why ordinary citizens are hostile to bankers. But there is some truth to the bankers’ rejoinder that they are simply responding to market forces. In fact, both attitudes are substantially correct. Banks are being greedy: their giant profits mean they don’t have to raise interest rates or cut jobs straight away. On the other hand, that’s the whole point of being a for-profit bank. As corporations, they are legally obliged to maximise shareholder gain.
It’s worth exploring the banks’ claim about cost pressures. Australian banks can’t satisfy all their funding requirements from domestic deposits — the term deposits and savings accounts of ordinary consumers — and so have to source much of their money from overseas credit markets. This means that only about half of the money the bank lends you to buy a house comes from domestic sources. The rest must be borrowed by the bank from other financial institutions, generally overseas. The difference in interest rates between the money the bank borrows for itself and the interest you pay the bank on your mortgage is called the bank’s margin. Bigger margins mean bigger profits. Smaller margins means smaller profits. And, as even the Reserve Bank acknowledges, margins have been shrinking.
Shrinking margins mean banks have to cut costs if they want to keep making profits. Banks that don’t make profits can quickly face serious pressure. If the losses are large enough, the liquidity of the bank can start to be questioned. This can lead fearful investors to dump even more stock. A downward spiral can set in, leading eventually to a run on the bank, as nervous deposit holders pull all their money out. While this has never happened to a big Australian bank, that doesn’t mean it isn’t possible. Once a bank begins to appear vulnerable, the end can be swift — as the shareholders and employees of Northern Rock discovered in 2008.
Even if bank profits simply fail to meet expectations, the consequences for those running them can be significant. Top bankers enjoy astronomical pay packets, but that doesn’t mean they don’t care about their next bonus. With many remuneration packages tied directly to bank share prices, falling profits means falling pay for CEOs. Eventually, boards will step in and fire top executives. Unsurprisingly, CEOs are more than willing to jack up interest rates and slash staff numbers to keep balance sheets healthy.
In a well-functioning market, companies will baulk at raising their prices, because they fear losing their customers. But banking in Australia is not a well-functioning market. In fact, with the big banks controlling nine-tenths of the mortgage market, Australia has a banking oligopoly. The Government might have recently made it easier for customers to exit mortgages, but the banks enjoy all sorts of natural advantages against normal competition.
For a start, changing banks is a massive hassle. Unlike telephone numbers, your bank account number is not portable. Changing your bank means telling your employer, and spending hours ringing around the various places where you have set up a direct deposit account. You’ll have to learn a new passcode, new internet and phone banking details, and get issued with new cards. You’re also going to need 100 points of identification at your new bank. All this sets up psychological barriers for the consumer. Banks profit from this inertia in the form of fees.
Then there is bank consolidation. The big banks have been allowed by corporate regulators to take over much of their own competition. You might think the Bank of Melbourne, St George and Westpac are three separate banks. But you’d be wrong: all of them are in effect the same institution, whatever the bunting on the branch. Likewise for BankWest and the Commonwealth. So a consumer can change banks and and still end up paying fees to the same shareholders.
But the biggest advantage banks enjoy is their taxpayer guarantee. Unlike most ordinary businesses, big banks are so important to the rest of the economy that they really are, as the saying goes, "too big to fail". It is almost inconceivable that an Australian government would ever let one of the big four go under, especially after Lehman Brothers, so it is quite clear that Australia’s biggest banks will always be rescued should they get into trouble. That’s a pretty clear example of what economists like to call "moral hazard".
The effect of this implicit guarantee makes Australia’s banks a kind of public-private partnership where the profits are privatised and risks are socialised. Investors and top executives enjoy the gains now in the form of dividends, salaries and bonuses. But as the citizens of the US, Ireland, Iceland and Britain have discovered, if one of these banks ever gets into trouble, it will be taxpayers who pick up the tab.
That’s why Wayne Swan’s bank-bashing is particularly hypocritical. The Rudd-Gillard administration has been at pains to protect and entrench the so-called "four pillars" policy. Too big to fail is, in Australia, essentially government policy. If he really wanted more competition in the banking sector, he would act to curb their power; perhaps even try to split them up.
But that, of course, is almost unthinkable. That’s the problem with giant oligopolies. No matter how much you might hate them, they’re almost impossible to reform. Like the rest of us, Wayne Swan is stuck with the big four banks.