Tough day for banks

Banking Day today has a string of interesting articles that dramatically underline the increasingly dour future for the major banks, not to mention the broader services deconomy. First up, the possibility that the banks will, after all, be dragged into the new international measures demanding extra capital for systemically important financial institutions:

Global financial regulators are considering creating several classes of systemically important financial institutions (SIFIs) in a rule change that could impose higher capital requirements on Australia’s Big Four banks.

On Friday, German business newspaper Handelsblatt reported that officials were considering creating “two to five” levels of systemic importance. One or more of these levels could include Australia’s Big Four.

The reported proposal for multiple levels of SIFI is part of a complex behind-the-scenes global regulatory battle over how SIFIs will be defined and regulated.

Under Financial Stability Board rules agreed last November, tougher rules are to be imposed on a small group of SIFIs. In late 2010, this group was being referred to as “G-SIFIs” – that is, “globally systemically important financial institutions”.

It was expected to contain only global giants such as UBS, Citi, Credit Suisse, Deutsche Bank and BNP Paribas, which are a major presence in many key global markets. These giants could be required to hold equity equal to three percentage points above the basic 10.5 per cent capital-to-assets ratio required under Basel III.

Large domestic players such as the Chinese and Australasian banks were not in this group because their businesses were mainly concentrated in their home markets. They were referred to as “local SIFIs”.

But, since November, a debate has emerged over whether, and how, to impose tougher rules on a wider group of SIFIs that could include some  “local SIFIs”.

Last week, Australian officials confirmed they were concerned that at its widest this group could include Australia’s Big Four.

Reports now suggest that depending on the outcome of this debate the Big Four could be required to hold capital equal to an additional one per cent of assets under the SIFI rules.

The debate is believed to be taking place within the GHOs, the group of central bank Governors and Heads of Supervision that governs global prudential regulator the Basel Committee.

Given Deep T.’s assessment of risk-weighted capital across the major’s mortgage books, the more capital the better so far as I’m concerned. Whether that happens or not, however, the regulatory risks remain for the banks. That is local, as well as global, as Banking Day also reports that the spectre of a “Son of Wallis” inquiry is back:

A new inquiry into the Australian financial system remains possible after a spokesman for the Treasurer, Wayne Swan, refused to rule it out on Friday.

The spokesman was reacting to the Federal Treasury’s Friday release of material from its 2010 “Red Book” of post-election advice to the Government.

The material advised the government that the inquiry should start “once markets have stabilised and G20 outcomes have become clear”.

Media reports quoted a spokesman for the Treasurer as saying that “neither of these have occurred yet”.

The newly released material shows Treasury strongly urged a full-scale inquiry into banking and finance.

Treasury lists four key reasons for the post-crisis review:

• The GFC “highlighted the vulnerability of Australian borrowers and some retail and wholesale investors”.

• The GFC “showed systemic risk originating from outside the prudentially regulated sector”.

• Competition concerns “have been exacerbated through consolidation and the exit of key market participants” – such as, presumably, St George, BankWest and a number of mortgage managers.

• New global regulations are being developed and implemented in Australia and other nations in response to the GFC.

Not surprisingly, these pressures are leading to downgraded growth expectations at the banks themselves. Banking Day also illustrates a shift in NAB’s profit growth guidance:

National Australia Bank hinted at the persistence of a lower target for bank profits in an interview with Business Spectator.

Michael Ullmer, the bank’s deputy chief executive, said NAB will operate in a profit ranging from 16 per cent to 18 per cent and measured by return on equity.

In the interview, Ullmer said: “What a lot of people are saying is that…  an aspiration of a 20 per cent return on equity may be… [too] ambitious.”

“If you go to the UK, for example, where we’ve obviously got a greater exposure than others, people are talking about whether ROEs are now going to be in the range of 12 to 15 per cent.

“My guess, in Australia, is that we should stick to an aspiration target of an 18 per cent return on equity… So, you’ll see banks operating more in that sort of 16 to 18 per cent range, because we have always got to balance the expectations of our shareholders, so that we can tap capital markets when we need to… [That is what you] have to do on the customer front in order to remain relevant to your customers and grow market share.”

Five months ago, Mark Joiner, NAB’s executive director of finance, told a conference that banks would “seek to work their way back to 18 per cent to 20 per cent.” Joiner was speaking at an Australian Centre for Financial Studies event.

Ullmer’s top target bumps into Joiner’s target, but the targets do not overlap.

And is it any wonder? As Banking Day also points out, the long-awaited pick-up in business lending was nowhere to be found in the December quarter:

Banks are, or were, overwhelmingly dependent on the household sector for new business in the December 2010 quarter, the National Financial Accounts show.

For every dollar advanced by banks, on a net basis, to business over the quarter, banks lent $7.70 to households.

Banks lent A$27.7 billion net to households over the quarter.

Business borrowed only $3.6 billion from banks over the same period.

One reason business borrowed so little from banks over the quarter was that business readily found loan capital in offshore markets.

Non-financial corporations earned a net $7 billion from the rest of the world over the quarter, the Australian Bureau of Statistics said. At the same time, business repaid $13.5 billion in loans to banks over the quarter.

With business borrowing abroad so easily, the banks were in a position to repay some of their own foreign borrowings over the period, repaying a net $13.1 billion to the rest of the world in the last quarter of last year.

Local governments, mainly the Federal Government, borrowed $9.9 billion offshore during the quarter.

None of this will be news to regular readers, but the convergence of stories suggests an ongoing awakening in the broader discussion around the banks. Sell on News today highlighted a growing awareness in the broker community that retail is in for a rough ride because of the negative wealth effects around housing. Expect more analysts to downgrade the finance, realty and retail complex in the months ahead.

Houses and Holes


  1. Interesting how it takes the mainstream almost a year to work it out hey?

    These potential measures (plus other things analysed and worked out by the Macro bloggers) will directly impact on the banks share market valuations.

    Higher retained capital and reduced lending = reduced ROE and ROIC = less dividend payout = market behaviour changes to that of a bond-like, not growth share-like (i.e PE goes down to 10-11, not 13-16) = bank share prices will come down

    And that’s without any “tapering of dwelling values”

    • This would return banks to their traditional role of being “widows and orphans” shares, ie shares suitable for those groups – reliable dividend, growth at about the same rate as GDP. Long term, this is all that they can possibly do. The era of big profit growth for banks was driven initially by computerisation and related productivity increases, later by getting into financial services/fund management, latterly by ballooning credit growth. None of these have any significant potential left. The only possibility would be the destructive path followed by the US banks, spinning up a great tower (or should it be inverted pyramid?) of derivatives with no real underpinnings.

    • I’m all for that Alex.

      In a robust world, banks should operate like utilities, and have a 6-10% ROE, all the time.

      However, we don’t live in such a world – and the banks will try to return to their pre-GFC 15% plus ROE days, and use whatever methods they can to do so – even if that means reinflating the property bubble or even the share market (an area they do have some control over due to the SGC inflows and big funds managers they own)

      I don’t give them much luck however.