The Australian Centre for Financial Studies (ACFS) has released a new report, which argues that the Australian banking sector receives excessive taxpayer support, stunting the development of alternative funding channels, such as the bond market and securitisation.
The report analyses the supply of finance to the Australian business sector and is part of the Centre’s Funding Australia’s Future (FAF) project, which was launched in December 2012 and seeks to develop a better understand the role of the financial system in facilitating long term economic growth in the Australian economy.
The report is particularly scathing of the level of taxpayer support afforded to the banking sector in the wake of the GFC – including deposit insurance, the ability to issue covered bonds, and access to the RBA’s committed liquidity facility – which have not come with commensurate obligations from the banks:
Government support for commercial banks since September 2008 has fortified the Australian banking system during an ongoing global financial crisis, but it has not been fully matched by greater obligations on Australian banks. The Federal Government’s favoured treatment of banks over other capital channels may damage the future financing of Australian business by inhibiting the natural development of non-bank channels; especially the corporate bond channel and the securitisation channel…
Support for Australia’s banks has been large and support of the four major banks has been especially large.
Too much support for one channel ultimately will be detrimental to the financing of Australian business. Excessive support for the banking channel will eventually distort the allocation of capital and risk and also inhibit the growth of other channels that have a very important role to play – the bond channel and securitisation.
It also urges policy makers not to make further concessions to the banking sector – possibly a shot across the bow of the current Financial System Inquiry, which is headed by former banker David Murray:
Policymakers should be very careful not to continually make more and more policy concessions to Australia’s largest banks, because that unreciprocated support will damage the development of other capital channels…
The ACFS paper also examines the potential impact on small business lending as central bank quantitative easing stimulus programs are unwound, claiming that Australia’s banks are particularly vulnerable to a large fall in house prices:
Disruption of the supply of capital, and liquidity, is a danger faced by the business sector at all times. However, severe disruption of capital markets will be more likely than normal during the slow unwinding of quantitative easing (QE).
The Australian business sector suffered refinancing difficulties in 2008/9 when the bond market closed and banks tightened their lending conditions. A return to those conditions during the unwinding of QE is a live danger. A second danger is that a fall in asset prices – especially real estate prices — reduces the security that borrowers can provide to lenders. Real estate is the collateral used in most bank lending to Australian small businesses. If the withdrawal of QE is accompanied by a precipitous fall in property prices in Australia, then Australian banks will be forced to either reduce the provision of credit to small businesses or raise loan margins or both.
Policy makers should plan for how credit to small businesses will be maintained in the event of large falls in real estate prices that are caused by the unwinding of QE.
The ACFS also argues that Australia’s infrastructure sector is suffering from a “structural liquidity problem”, whereby long-term cash flows of up to 40 years are being funded by 1-5 year banks debt, creating liquidity risks:
Australia’s infrastructure sector owns assets with very low asset liquidity that have cash flows stretching out 40 years or more… But most of the debt is 1-5 year bank debt. Moreover, a considerable part of the equity financing of infrastructure is through channels that are open ended: Investors who provide equity funding for infrastructure through defined contribution superannuation funds can withdraw their equity at short notice. The infrastructure sector in Australia therefore has a structural liquidity problem.
As a solution, the ACFS recommends that infrastructure funds be forced to list in public markets, thereby enabling them to attract more self-managed superannuation funds as investors:
A better policy would be insistence that Australian superannuation funds only hold equity in listed infrastructure funds.
Listing of currently unlisted infrastructure funds would have an added benefit in relation to self managed super funds (SMSFs). If there were more listed infrastructure investment options then there would be more investment in infrastructure by SMSFs. That would help connect the largest new source of capital (SMSFs) to the fastest growing demand for capital.
Finally, the ACFS claims that tax policy is not an effective mechanism for influencing financing, and argues for no changes to the equities dividend imputation system or the reduction of taxation on interest income:
[A] comprehensive approach would consider the major capital channels of business funding as a whole; with the competing channels as its parts.
Requests for rebalancing of the amount of capital that flows through the competing channels by tax remedies have little merit. In particular, proposals for the reduction of taxation on interest income to ‘level the playing field’ for debt channels relative to the equity channel should be rejected…
Australia’s public equity market functions well in efficiently allocating capital to Australian firms and risk to savers. The dividend imputation system is central to that role and should be preserved in its current form…
Because of dividend imputation Australian firms have to subject their investment plans to more objective scrutiny by outside investors than firms in many other countries. This arrangement is very healthy in terms of efficient allocation of capital and risk.
Dividend imputation is not perfect but the problems it causes are small compared to its benefits. It does not need a substantial policy overall.
Full report here. Let’s hope somebody reads it.