Swan vs the banks

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The Cupboard today has an interesting discussion on the increasingly high-pitched debate between Treasurer Swan and the big banks:

Mr Swan said the banks had a much higher return on equity than most of their global peers and accused them of trying “to maintain forever huge profitability”. National Australia Bank chairman Michael Chaney hit back, warning that it would only backfire if the banks absorbed higher funding costs as this would reduce their profits and returns on equity.

…”What he’s proposing is very dangerous,” Mr Chaney told The Australian. “A reduction in their profitability would threaten their credit ratings. That would lead to higher borrowing costs, even lower profitability, further credit rating threats and so on, in the downward spiral we’ve seen with foreign banks.”
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Far be it for me to sympathise with the banks but this is true. If the banks can’t retrieve lost margins then they will only lend where it is profitable to do so. It’s hard to say where they’d draw back from but mortgages would be at risk. The banks have been borrowing wholesale debt at 6%+ and discounted mortgages rates are around 6.5%, leaving very little margin.

But Chaney is not giving the full story, either. The banks are caught in an earnings vice no matter which way they turn. If they do hold back rate cuts and expand their margins then their asset quality is likely to decline as consumer confidence in debt sinks even lower. That will also hit their profitability via declines on the asset side of the balance sheet, as well as the shrinkage in the balance sheet itself. Basically it’s the system that’s under stress and the players within it are all just voicing their interest. The debate goes on:

Mr Swan said yesterday consumers had every right to be angered if their bank decided to hang on to part of a cut in the official cash rate of 4.25 per cent to boost their profits.

…But Mr Chaney said that it was precisely because other international banks had low returns on equity that they could not tap capital to meet prudential requirements, so they were forced to reduce lending, “as we are seeing in Australia today with the withdrawal of foreign lenders”. “We live in a very fragile financial world and our political leaders should be exhorting banks to ensure they maintain their profitability in the face of funding cost pressures,” Mr Chaney said.

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True enough, but the bank’s ROE’s are, must, and will shrink anyway over time. That’s just the new normal. Banks are going to become Keynesian utilities once more. Sorry.

On the other hand the banks are making perfect sense on deposits:

Suncorp Bank chief executive David Foster, Westpac deputy chairman John Curtis and ANZ chairman John Morschel also weighed into the debate yesterday, saying tax incentives to encourage deposits would help banks further reduce their reliance on volatile offshore markets, while HSBC Bank Australia chairman Graham Bradley said political pressure should not centre on returns for struggling foreign lenders.

…Mr Morschel noted other countries had different treatments for interest earned on bank deposits and that the issue was worth government considering, if it was concerned about “the cost of living and the cost that the average family and business incurs in terms of interest cost”.

“The government needs to look at all the available instruments that they have at their disposal and . . . consider what they feel is the best treatment for the various investment alternatives,” he said.

Mr Curtis noted that while investments in property attracted negative gearing, and investors in equity receiving a franked dividend also received a tax credit for tax paid by the company, there were no such treatment for bank deposits. “We should be encouraging people to save,” he said.

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Damn right. But doing something sensible like this doesn’t fit too well with the Treasurer’s recent rhetoric about our “confidence problem” does 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.