Defined Terms and Documents

Banks need reining in, but an act is not the way - SMH  -  October 22 2010  -  Milind Sathye

Community oversight is required if things are to improve.

Joe Hockey has suggested the use of punitive measures by Parliament against banks that do not keep their interest rates in line with the Reserve Bank cash rate. But can Parliament take punitive measures, and, if so, in what circumstances?

Parliament has already conferred powers on the government to control interest rates, under Section 50 of the Banking Act 1959. The section also provides for imposition of a financial penalty on banks that defy the directive.

These powers are, however, for use in exceptional circumstances. Even in the global financial crisis, countries such as the US and Britain have not used such powers. It would be against the grain of a market economy to do so.

How, then, do we rein in recalcitrant banks?

Recalcitrance arises out of the market power banks wield. For example, in June banking assets in Australia were 215 per cent of GDP. The proportion was 115 per cent, 87 per cent and 84 per cent for Britain, Canada and the US respectively.

Government policies during the GFC helped banks consolidate market power.

The Westpac-St George and CBA-Bankwest mergers; a bank wholesale funding guarantee at a fee that was the lowest in the developed world; a deposit guarantee of up to $1 million, which resulted in migration of funds from other institutions to banks; and favourable tax treatment have made Australia's banking system one of the most concentrated and profitable banking systems in the world.

But have ordinary Australians or small businesses been helped?

Small business's share in the pie of bank credit declined from 43 per cent (June 2003) to 30 per cent (June 2010). Banks favoured the big end of town while small businesses reeled under pressure of lower credit availability and higher costs. A small business variable overdraft rate that was 9.7 per cent (pre-crisis) now stands at 10.3 per cent while large businesses continue to pay lower on their credit outstanding (7.05 per cent pre-crisis and 6.45 per cent now).

A taxpayer-funded guarantee was provided to banks to enable unhindered credit supply to Australians. Obviously banks ignored social responsibility.

Australian families pay interest rates higher than pre-crisis levels on all loan types except housing loans. However, even for housing loans the mark-up over the Reserve Bank cash rate, which for decades was 1.8 per cent, has jumped to 2.9 per cent, raising the standard variable mortgage rate to as high as 7.4 per cent in September (2010).

Interestingly, the return on deposits, which provide half of bank funding, has not risen. The average rate on all term deposits (currently 4.4 per cent) is still below the pre-crisis level. Banks touted the high-funding-cost argument to raise lending rates, an argument this author debunked with evidence through opinion articles earlier this year. The Reserve Bank, too, has debunked it in its latest monetary policy.

If ordinary Australians and small businesses have not benefited from banks, who has benefited? The big end of town continues to get loans on favourable terms.

Second, bank officials fill their pockets. A Productivity Commission study found that while remuneration for chief executives in Australia averaged that in Europe (but was less than in the US), such remuneration in Australia's finance sector was closer to the US rate.

Bank shareholders are leading the world in shareholder returns. The average five-year total return in Australia was 9.2 per cent, ahead even of Canada, which stood at 8.9 per cent.

Australian families and small businesses have to submit meekly to the growing arrogance of our banks. The banks have become so powerful they virtually decide government policy. How else could major banks get wholesale funding guarantees at a fee that was the lowest in the developed world?

The only thing that may possibly rein in our banking behemoths is the threat to break them up.

US President Barack Obama's banking reforms have given such powers to the US government and the Bank of England governor recently advocated a similar course.

Banks need to be subjected to community oversight, perhaps through appointing a community representative to the board. Joe Hockey is right: we need to rein in the banks, but it has to be through more competition and community oversight and not by using powers under the Banking Act.

Milind Sathye is professor of banking and finance at the University of Canberra and previously worked for the Central Bank of India.