BIS says Australian banks are too big

David Uren at The Australian this morning picks up on BIS comments about Australia’s enormous banks:

The performance of Australia’s banking sector is seen by world investors and our own authorities as one of the great sources of our economic strength since the global financial crisis.

However, research by the Bank for International Settlements suggests the dominance of Australia’s finance industry contains the seeds of economic vulnerability.

Finance has grown too big around the world and cross-border lending too large, according to BIS chief economist Stephen Cecchetti.

“Experience shows that a growing financial system is great for a while — until it isn’t,” he told the BIS annual conference in Switzerland, arguing there is an optimal size beyond which the financial industry drags down the rest of the economy.

Australia’s finance sector is larger than BIS recommends on the metrics it has developed.

Its studies, based on analysis of the banking systems of 22 countries, including Australia, over a 30-year period, show the finance sector starts subtracting from growth when it accounts for more than 6.5 per cent of value added and more than 3.2 per cent of employment.

In Australia, the finance sector accounts for 11.5 per cent of all industry value added, having doubled its share of the economy since the mid-1980s.

This compares with the 2008 peak of 7.7 per cent in the US and 10.4 per cent in Ireland.

Australia’s finance sector employs 3.7 per cent of the national workforce, which is less than the 4.1 per cent in the US but more than Britain’s 3.5 per cent.

Cecchetti contends that excessive growth in the finance sector leads to disruptive indebtedness, delivering poor economic returns — he cites the three-car garage — and drains resources from more productive sectors of the economy. “Finance’s large rewards attract the best and the brightest,” he says.


Houses and Holes
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  1. Ha-ha-ha!!! How many crisis we need to realize that finance are not a productive industry, but a tool for redistribution and consolidation of wealth? Any other industry producing basic goods can survive with some difficulties for distribution, but financial industry without the real economy is 0, useless and dead.

    • The banks need us and we need the banks. Simple love hate relationship. But before I get too deep on this it’s bonus time in bank land. Need to figure what to spend next….

    • Exactly, Lori. I have been saying this for years, to anyone who will listen. Finance should be “handmaiden to industry”.
      Wealth is created by 1) utilising resources 2) utilising resources more intelligently; TO provide products and services for which there is a demand. Anything else is consumption and transfers.

      The finance sector does NOT “create wealth”, and capital gains on anything are NOT “created wealth”, they are a wealth transfer, generally from the productive sector whose costs are increased by the gain made in the non-productive sector.

      The exception is where the capital gain is BECAUSE the productive sector has increased its income; for example, as cities grow, centrally located land can expect to gain in value as the total income in the city economy grows.

      The finance sector is an “enabler” of wealth creation (by financing the acquisition of machinery and so on) but even then its fees are a “cost” to the productive sector.

      I am interested that the BIS has identified a “proportion of the economy” beyond which the finance sector is likely to be REDUCING productivity. This makes sense, because it is a sign that there is more “rentier” and “wealth transfer” going on in comparison to the “wealth creation enabling” role that finance should restrict itself to.

      I also think it is a danger sign that the Australian finance sector is dispoportionately larger in VALUE than in numbers of employees; this is even more prima facie evidence that its income is related more to a straight out unproductive bubble in values of assets (hint: urban land) than it is to providing actual services, which would take “staff numbers”.

      • I read a lot of their research and it looks sound. I don’t sub to the Australian, but I wonder if they gave a true picture of the housing risk, and mining “mostly” economy.

        • They warned of the GFC in advance. Warned of derivatives in advance. William White was and remains a legend. Phil Lowe did his best work on housing bubbles there.

          The BIS gives hope that we’re not doomed as a species. It also shows just how political national central banks really are.

          • Houses,I would think that the majority of derivatives traded have added to the efficiency of markets, and that only a very small proportion in some OTC derivatives have not. Would you agree?

          • Well, you have to be more specific. The derivatives used by real commercial interests to hedge pricing are useful. But not so in the hands of speculators, which creates a lot of volatility.

            The derivatives used by our big banks to control interest rate and currency risk have been terrific – except they also helped create an enormous housing bubble.

            I’m not against derivatives per se but there are a lot of examples of naked and unreserved positions actually amplifying risk.

            In that respect OTC may well be the problem…

          • I’m not sure that speculators are the major cause of volatility particularly in Europe. I think it is convenient for Governments to blame the speculators but the cause is really loose and unsustainable fiscal policy. The bond market, derivative market and speculators are simply the messenger.

          • I agree with you Bob, but the major problem is putting derivatives over what is a consumer item, not a commodity.

            Home loans should be risky – the direct hedge for them should be prudent lending and capital constraints, not being able to foist off the risk to some other poor sucker or government.

          • Derivatives are fine as long as these derivative trades are NOT underwritten by bank depositors and taxpayers.

            JPM’s CIO derivative trade fiasco is a good example of both moral hazards!!

          • Prince has a point in the credit derivative markets for sure, where banks make ugly loans and flick them off the books into Superannuation companies.

          • Houses and Holes; you are right. The BIS has an excellent track record of accurate but ignored predictions.

            I partly agree with you on derivatives. “Insurance” would be a systemic risk too if it consistently under-priced risk due to misapprehensions in the industry. It was gross under-pricing of risk in derivatives that was the problem, not derivatives per se.

            The big damage to national economies and the global economy, is not done by the money lost by speculators in paper instruments, but by the equity in urban land that is wiped out when the bubble bursts. This is one of the biggest gaps in mainstream economic understanding today. Even the Great Depression of the 1930’s was as severe as it was, primarily because of what happened in land markets. Analysts have all been looking elsewhere for explanations “because the light is better there”.

            Speculators in paper instruments speculate VOLUNTARILY with their own money or money that other speculators (including finance companies) are prepared to lend to them. But a bubble in the prices of urban land, affects EVERYBODY in the economy and they have NO CHOICE in the matter. The numbers of people literally “participating” in the bubble, and indeed the sums of money involved, are far greater than what happens in the markets for speculators in paper instruments.

            A bubble in the prices of paper instruments, and an increase in the value of speculative holdings in those instruments, does not increase the costs to the productive sector of the economy, undermine productivity, and TRANSFER WEALTH out of the honest incomes of large numbers of “Joe and Jane public”, like a bubble in the value of urban land does.

        • and all rises in prices are not bubbles, but an essential mechanism for eliciting a supply response in a capitalist economy.

          • BobT; where there is a risk of a bubble occurring, is when the “SUPPLY RESPONSE” to the increased demand, is absent either due to genuine scarcity, or regulatory interference. Hint: bubbles in urban land values only happen where supply has been interfered with by regulators and/or monopolists.

  2. Were Switzerland’s figures released as part of this study ? Would be interesting to see how they compare.

  3. Phil… No doubt it has, but fortunately we have only recently artificially boosted incomes with loose fiscal policy, which really is the key ingredient for the bubble. The first home buyers grant was simply a gift to the banks by acting as a tier of protection against default.

    • The “key ingredient” for house price bubbles is restrictions on supply. Everything else is “fuel” of one kind or another, but bear in mind that South Korea has such tough credit conditions that young people mostly save most of the purchase price of a house. And when South Korea copied the UK’s urban planning system, back in the 1970’s, house prices started going up faster than young people could save money, and topped out at median multiples of around 15 in Seoul. Without ANY “credit expansion” or demand-side subsidies at all.

      Household formation rates and birth rates collapsed, and national SAVINGS increased impressively as young people saved desperately towards a rising target that remained just ahead of the ability of most of them to save. This makes sense when you think about it.

      If there is “credit” and demand-side subsidies, the prices will rise faster than a significant cohort of young people can “save a deposit and get credit”. The “lucky” ones who can save a deposit and get credit will be in mortgage slavery for the rest of their lives.

      This is fiscal child abuse and it is an indictment of our civilisation that one generation could do this to its own immediately following one.

  4. So, if any of the Big 4 Oz banks need a bailout in the land bust, they get split in half. If the citizens make this a condition of any government rescue UPFRONT, their behavior would change today.

    • AMEN, David Collyer, and Jack. I reckon if the banks knew this was what was going to happen, we would be sure that we would NEVER get confronted with a “fait accompli” that a “bailout” is required to avert “systemic risk” in the first place.

      I suggest a threat not only of dismissal of the bank executives involved, but that they be barred from holding finance industry positions ever again, for life.

  5. Its interesting re how these guys operate. Their is lobbying occuring to reduce super tax concessions further.
    I suspect the real motive is ensure that negative gearing is the only real option for high income earners.