Ralph Norris goes all in on moral hazard

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For much of this year, I have argued that the big four banks are being protected by regulatory authorities and the government, which have deployed a smoke screen around the liability side of bank balance sheets. I call this fog Invisopower! One of the reasons I have argued that this is not such a good idea is because of the moral hazard that this approach to rescuing the banks has created.

In today’s AFR, an op-ed by retired CEO of the Commonwealth Bank Ralph Norris attacks APRA’s endeavor to impose Basel III measures and gives us the bitter flavour of how extreme that moral hazard has become:

Australia fared relatively well during the global financial crisis because of swift and decisive action by the government and regulators, a strong financial system and export sector, and, no doubt, a fair measure of good fortune. There is an ill wind blowing again, largely from Europe, and fortune may not necessarily smile on us a second time. Is this the time to be leading the world in making major changes in the financial sector?

The objective of the Basel III reforms is to raise the quality, quantity and consistency of capital and liquidity for internationally active banks. The Basel rules were developed under the direction of the G20 leaders as part of the package of global responses to the financial crisis, and were released in December last year.

Although the G20/Basel objective is supported by developed Western nations, many are arguing adoption will have a substantial impact. Banks around the world will need to raise trillions of dollars in additional capital and additional short- and long-term funding. Estimates of the impact on the global economy vary widely, but it is clear that requiring banks to hold more capital and liquid assets will lead to a drop in gross domestic product in many countries.

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Yes, and? Is it better to let the banks run wild then crash and require bailout amid giant recessions that over time are much more likely to result in slow growth? Back:

Australia is moving to implement Basel III, in some respects much faster than is required under the rules, and with specific national restrictions on qualifying capital. And we are out of step with the rest of the world – they are not racing to the finish line. The Europeans have issued draft capital rules, but these differ significantly from Basel III. US regulators are considering their position in relation to the domestic Dodd-Frank package (shades of Basel II, which the US did not implement). In fact, according to Basel’s latest implementation report, only one country, Saudi Arabia, has actually published its final version of Basel III.

So far as I can tell, this argument is “everyone else is wrong so we should be too”. Back:

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Of course there are benefits in having a strong and stable financial sector, as was demonstrated during the financial crisis, but Australia’s stable banking sector withstood the GFC because it is already well capitalised and well regulated.

Oh, come on. The Australian banking system survived the GFC because of an unprecedented stimulus package in the vicinity of $50 billion, as well as the full power of the RBA and Federal balance sheets was deployed to save it. On the fiscal side, the measures included: FHBG stimulus, massive building programs aimed at jobs, government guarantees to deposits and wholesale debt, mass immigration and mass RMBS purchases. On the monetary side, the measures included huge rate cuts and throwing out the rule book on repurchase agreements.

Many of these measures were so far outside of the financial architecture that was initiated after the Wallis Inquiry that they cannot be considered as anything other than a gargantuan bailout. Back:

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Raising the bar again may lead to a marginal increase in stability but, it must be asked, at what cost? It is difficult to be precise about stability benefits at the margin versus cost, but it is clear that higher or increased capital levels did not necessarily correlate with increased stability and resilience during the crisis. It is also true that financial crises can originate outside the financial system, and increased stability within the system may not avert such crises.

Orwell would be proud of this. Yes, if your vulnerability is caused by an enormous dependence upon offshore wholesale funding, then no, more capital won’t help you when those external markets freeze because your so extraordinarily insolvent. Australian ADIs borrow almost $700 billion offshore but that doesn’t matter because its somehow outside the system? In an extraordinary kick in the nuts for regulators, Norris is redeploying the Invisopower! that has absolved banks of responsibility for the liability side of their balance sheets as an argument against increasing capital, which does help protect the bank balance sheet on the asset side, but also slows lending. Breathtaking. Back:

Some have argued that tougher standards in Australia put Australian banks at a competitive advantage, for example, in the wholesale funding markets. But it can also be argued that it puts them at a disadvantage if the increased regulation puts pressure on the interest cost for Australian businesses and consumers, and the reality is that banks are being asked to raise capital in a world where capital is becoming increasingly scarce, and more expensive. The cost of getting it wrong, because of flawed assumptions or models, could be very great, and would have a direct impact on the price and availability of credit for Australian customers. The costs of implementing Basel III come at a time of greatly heightened uncertainty in the international money markets.

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So, it’s not the banks profligate borrowing in international markets and inflation of their assets that’s causing the rise in the price of capital, it’s regulators attempts to stabilise the system. I guess that’s why ratings agencies reckon the banks credit ratings are raised two notches by regulatory support. No, wait, its:

Germany, one of the strongest economies in the world and clearly a mainstay of the European Union, has recently failed in a €6 billion debt offering by €2.4 billion, some 40 per cent short.

If a sovereign of this strength finds difficulty in attracting investors, the risk to the rest of the world in seeking capital and funding is high indeed.

The chief executive of Standard Chartered, Peter Sands, captured the essence of the dilemma, noting: “There is an acute danger that the pursuit of financial stability imposes too great a cost on economic growth and job creation at a fragile time for the world economy.”

This is simply a false analogy. Last time I looked Germany is in Europe, the epicentre of the crisis.

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Last week, ANZ Chairman John Morschel opined about why Australians see their bankers as out of touch. If he does not wish to see that gulf widen, I suggest he ask Ralph Norris to zip it.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.