Last night, the Basel Committee on Banking Supervision circulated a draft document on what level of additional capital requirement Systemically Important Financial Institutions (SIFIs) will be required to hold. According to Bloomberg, it said it:
would subject banks to a sliding scale depending on their size and links to other lenders, said the people, who declined to be identified because the proposals aren’t public. Banks wouldn’t initially face the highest surcharge, which is intended as a deterrent to expansion, one person said. The largest banks may face a 3 percentage point levy at their current sizes, the person said.
These deliberations are a part of the Basel III process. Australian banks have so far been exempted from this discussion, although it remains a possibility that they will dragged in by their international peers. After all, if you’re a too-big-to-fail multinational bank and you know your gonna get whacked with higher captial charges, one way to remain competitive is to ensure anyone who competes with you is also charged. Nonetheless, at this stage, the big four are out of it.
But is that as it should be?
Last week, Greens Senator, Adam Bandt suggested that no, it should not. From Banking Day:
Greens MP Adam Bandt said his party’s banking bill, currently before the House of Representatives, was “just the start” of a number of changes the party hopes to make to the financial services industry.
The Greens see merit in imposing a levy of around 20 basis points on the big banks, in recognition of the benefit they receive from operating in a “government fostered” oligopoly.
They want to see the introduction of account portability, so customers can move their transaction accounts as easily as they move their mobile phone accounts.
The party is also investigating the merit of imposing a levy on private ATM operators and using the funds to put ATMs into remote areas.
And it would like to see changes to the Consumer and Competition Act so the Big Four banks are prevented from acquiring any more second-tier institutions.
… “There have been some adjustments from time to time, such as allowing increased participation of foreign banks, but, overall, there has been a reluctance to really allow anything to challenge the position of the Big Four.
“These policies stem from the desire of successive governments to maintain a strong banking sector with a low risk of failure. They correctly see many banking services as essential services and believe that a strong banking sector underpins a strong economy.
“Isn’t it time the beneficiaries of this policy should be asked to provide something in return?”
His idea for a 20 basis point levy on the big banks comes from the International Monetary Fund, which reported that the guarantees to the financial sectors of developed countries were worth around 20 basis points.
Well…yes, it is about time, as I’ve written consistently for some time. There has been near wholesale denial amongst the Australian intellectual class on the need to return risk to the banks (with the exception of the “six economists”). To me that silence has been particularly pointed on the intellectual Right in Australia. The bank-supporting jottings of supposedly market-oriented commentaters at The Australian is one example. This has always intrigued me given the Right should be up in arms not only about the Australian bank bailout in 2008 but the Federal Government’s steady steps toward a Swannie Mac system of permanent AOFM purchases of RMBS. The forebears of such a system are Freddie Mae and Freddie Mac, which are roundly blamed by the intellectual Right in America for the creation of the US mortgage bubble.
At last, however, there appears to be some support emerging amongst the Right for handing risk back to the banks. Earlier this week, Anthony Creighton of the conservative think tank, Centre for Independent Studies, penned the following in Crikey (h/t Crocodile Chuck):
The elephant in the trading room — that many banks are too big to fail — looks set to drift off the agenda. Yet it is the most fundamental problem with the existing financial system. And it is not only a foreign affliction. It is patently obvious that Australia’s four major banks are too big to fail, which means Australian taxpayers subsidise them, including their more risky proprietary-trading and speculative activities.
Publicly guaranteed private companies should not be part of a free market. As both Mervyn King, governor of the Bank of England, and Alan Greenspan, former chairman of the Federal Reserve Board in the United States, have suggested, if banks are too big to fail, then they are too big.
Ideally, the government’s promise not to rescue banks would be credible. Unfortunately, in a democracy, it never will be. The free-market solution is therefore to offset the benefits to private banks from their guarantee and try to curtail the perverse incentives created by it.
It is therefore ironic that Adam Bandt, a Greens MP, is calling for a “too big to fail” levy on Australia’s major banks. How any such a levy were designed would be crucial. But given Australia’s major banks do not even pay a fee for the government’s $1 million deposit guarantee, some scope exists for some type of compensation for taxpayers.
Bravo and indeed.
But to determine what the best shape of any SIFI charge we first have to frame the question properly and neither Bandt nor Creighton has done so.
Both appear to be operating within the bounds of Treasury’s current discussions on how to recalibrate deposit guarantees. Whilst this is fair enough, it’s kind of absurd to worry about the moral hazards of such for a number of reasons. First, depositors are further up the bankruptcy food chain than investors and are extremely unlikely to ever lose money anyway. Second, there is a far greater moral hazard in the system in the idled wholesale debt guarantee. The Federal Budget currently carries the marginal risk in the entire bank wholesale debt complex. This is a gigantic moral hazard that clearly distorts investor behaviour, threatens excessive bank borrowing, excessive bank lending, as well as huge damage to the tax-payer in the worst case scenario.
As the millenium housing boom in Australia showed, in terms of incentives for banks to goose profits by lending without limit, deposits hardly rank against borrowing swathes of offshore funds.
As well as ignoring the only moral hazard that really matters, this debate is taking on some other strange notions.
Adam Bandt’s proposals also ignore the current functional resolution regime for Australian banks that do go bust. Rather sensibly, like most of our international peers, we don’t do messy bank collapses. There are very good reasons for this. When a bank of any magnitude goes under, even a systemically unimportant bank, it raises questions about the health of all banks in the system, not to mention the regulators of the system itself. A troubled bank is therefore siezed and sold before it reaches the point of public dissolution. The banks’ doors open the next day and panic is prevented but the sale price is small enough to effectively wipe out shareholders, disgrace management and the board, and thus contains no moral hazard. Examples of this approach are rare but do exist, such as the sale of the State Bank of Victoria to CBA in 1990. Both banks were government owned at the time, however, the method remains the same. Such would be handled by APRA today.
During thre GFC, the big banks managed to absorb shaky mid-tier banks and non-banks without the direct assistance of regulators, beyond some leniency at the ACCC. As noted, they could do this because they were themselves bailed out on the liability side of their balance sheets.
Herein lies a second major problem. Adam Bandt’s desire to prevent big banks from absorbing any new small ones is a reflection of the current politics of banking. For the perfectly admirable reason of sustaining competition, it is now virtually impossible to waive through bank mergers. Perhaps, amidst a crisis, these political sensitivities would give way to practical reality but we don’t know do we? Moreover, if a mid tier bank was handed over to one of the big four, it would simply be becoming part of the larger too-big-to-fail system. And anyways, Mr Bandt wants to ban it altogether.
So, in sum, at the moment we have a set of four too-big-to-fail big banks, whose exposure to global capital markets demands an ongoing implicit government guarantee that nobody will touch, and we have an effective paralysis in the functional insolvency regime for mid-tier banks that regulators have relied upon for decades, making mid-tier banks too-political-to-fail as well, and a possible outlet that only makes the first problem worse.
So far as I can tell, our entire banking system is now stuck in a framework of perverse incentives with the tax payer is at risk for pretty much the lot.
The most sensible solution to this farce has previously been presented by Deep T. Boost capital reserve requirements to a point where banks can’t go bust, then let them compete.
In other words, embrace a SIFI charge for all banks.
