At last, some sensible commentary on bank levy

By Leith van Onselen

Amid the ongoing widespread bleating over the $6.2 billion bank levy (Budget measure explained below), two young commentators have risen to the top to explain why the levy is such good policy.

First, The Australian’s Adam Creighton has been quick to highlight why Australia’s banks are effectively quango organisations that operate with public support that affords them the ability to make oversized profits. Viewed in this light, the bank levy merely redistributes some of these profits back to taxpayers:

…the structure of the banking system in advanced countries such as Australia has very little to do with a free market…

For a start, government limits the number of banks by law, which boosts their profits. Banking licences are literally licences to create money (as banks simultaneously enter a loan and a deposit on their balance sheet).

The government also specifies how and what banks can sell…

On top of that the Reserve Bank provides them loans at very cheap rates and the federal government guarantees pretty much all their liabilities — a remarkable boon for banks.

To think banks can exist independently of government is a libertarian fantasy…

“When losses are borne by taxpayers, the incentives of stockholders and depositors to discipline bankers are much weaker … Australia’s banks have followed this trend, with liabilities about 20 times the value of their equity…

“Banks” are legal entities with unique government-sanctioned rights… This close relationship with government creates enormous rents or “super profits”, which aren’t eroded by competition…

The Coali­tion’s bank levy is the beginning of the end of the comfortable ­contract between the Australian government and bankers that has lasted a generation. The levy is a sign that the negotiated division of spoils among bankers, shareholders and taxpayers is going to be gradually rewritten.

Fairfax’s Jessica Irvine has made similar arguments:

…it is a nice thing, indeed, to see a policy proposal which is not only outrageously popular, but also makes good economic sense.

…the major bank’s borrowings are essentially guaranteed by taxpayers…

During the global financial crisis, the government stepped in to guarantee the deposits and new borrowings of all banks, in return for a fee. All those debts have now expired. But the banks continue to benefit from the knowledge that the government will step in again, if things go bad.

The more credit worthy they are perceived as being, the cheaper they can borrow.

And taxpayers carry the can when it all goes wrong…

It’s hard to estimate the size of the discount banks enjoy on their borrowing by virtue of the taxpayers effectively going guarantor on their loans. In all likelihood, it is much higher than 0.06 percentage points – which is all the levy seeks to recoup.

In a sense, the levy is similar to lenders mortgage insurance, which home borrowers pay when they have a deposit of less than 20 per cent.

If anyone should get this, it should be the banks which have been charging home borrowers this insurance for decades.

The bank levy is a form of protection for taxpayers in case the banks get into trouble and need their support to keep going.

Both Creighton and Irvine are spot on. The bank levy helps internalise some of the cost of the extraordinary public support that the big banks receive from taxpayers via the Budget’s implicit guarantee (which provides a two-notch improvement in the banks’ credit ratings), the RBA’s Committed Liquidity Facility, the implementation of deposit insurance, and the ability to issue covered bonds. All of these supports have helped significantly lower the banks’ cost of funding and given them the ability to derive super profits.

As noted by Chris Joye on Friday, the 0.06% bank levy is also very ‘cheap’, since it would only recover around one-third of the funding advantage that the big banks receive via taxpayer support:

If the two notch government support assumption is removed from these bonds, their cost would jump by 0.17 per cent annually to 1.11 per cent above cash based on the current pricing of identical securities. So the majors are actually only paying 35 per cent of the true cost of their too-big-to-fail subsidy…

Requiring banks to pay a price for the implicit too-big-to-fail subsidy is universally regarded as best practice because it minimises the significant moral hazards of having government-backed private sector institutions that can leverage off their artificially low cost of capital to engage in imprudent risk-taking behaviour.

Again, what better way to internalise some of the cost of the government’s support than extract a modest return to taxpayers via the 6 basis point levy on big bank liabilities?

The Turnbull Government’s unexpected bank levy announcement is the single best thing to come out of the 2017-18 Budget. It deserves widespread support from the community and parliament.

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  1. Add Ian Verrender to that list:

    Ever since Tuesday’s budget, various free market think tanks have been on the attack, arguing the Government has abandoned free market principles with the new impost and that this is a step towards nationalisation.

    Nothing could be further from the truth. The banks abandoned the free market in 2008 when they begged for taxpayer assistance and in the intervening years have trampled over the interests of their own customers and the community.

    Since then they have adopted the old agrarian socialist mantra: capitalise your profits and socialise your losses.

    If there was one failing in last week’s budget by Prime Minister Malcolm Turnbull and the Treasurer, it was to allow the banking sector to portray the new levy as some kind of unexpected impost, a shocking intrusion into the free market, rather than what it really is: a commercial fee for services rendered.

    • KeenEyeKenMEMBER

      These think tanks need to drop the pretence of being ‘free’ market advocates.
      Stuck in the 1950’s mantra of campaigning against government monopolies, they fervently champion the exact same (private sector) monopolies owned by their aristocratic backers – embodying the very ideals they claim to oppose.

  2. As noted earlier – there is nothing wrong with charging a levy by reference to the size of the big 5 bank liabilities.

    But we should not lose sight of exactly what those liabilities are, as otherwise we may make the mistake of assuming that because more liabilities will generate a larger big bank levy we should encourage the banks to expand their liabilities.

    Big bank liabilities that consist of unproductive capital inflows that are used by the banks to offer super cheap mortgage rates to speculators/investors in existing property are damaging whether or not the taxpayer is being cut a slice via the bank levy.

    Sure the big banks will kick and scream about the levy as no levy is better than a levy but once they stop kicking and screaming they will probably realise what all peddlers of crud understand. If you make the taxpayer a partner in your nasty enterprise you will have state protection for the common profits.

    Whatever happens to the bank levy it remains critical that the criterion of productive v unproductive is adopted to all activities of our banking sector especially when it comes to capital inflows as unproductive inflows pump up the exchange rate and kill Australian jobs and shrivel Australian business competitiveness with foreign competitors.

    That means no more capital inflows being used to deliver cheap mortgage rates for asset price speculation or the mere acquisition of title to local assets.

    Capital inflows that clearly and directly demonstrate that they will contribute significantly to the expansion of the productive capacity of the economy are a different kettle of fish but unfortunately our kettles have seen far too few fish of that type recently.

      • Sool,

        Capital is not debt.

        But yes there is a difference productive and unproductive applications of capital (and debt for that matter) and if you don’t know that you don’t know much.

  3. Jeremy Bentham

    Banks just accept a new tax ? Then another, then increases on them, then more.

    Nope – no way, no how. These guys most passionate core principals lie in limited government. The bankers are bolted on anti-government. Give them an inch they will burn your house down types.

    They will fight it – and raise rates. GUARANTEED.

    So what will happen ?

    The government will get more revenue, the banks will raise rates – and the punter will wear the cost – as always.

    Good policy would be to legislate on the banks ability to set rates. THAT is good policy. Set the tax and ban them from passing it on.

    But no – they have NOT done this.

    So they are slugging the poor and middle class while protecting themselves and the banks.

    Classic LNP. Classic media for not seeing it. Classic myopia in the face of cognitive bias.


    • What’s wrong with passing the cost on. At the moment, borrowers get an advantage from it because bank costs are artificially low.

    • This need never have been an issue if (seriously overrated) Paul Keating hadn’t sold off the Commonwealth Bank. A government owned institution could have set the margins between the rates of borrowing and lending and the rest of the banks would have had to follow or lose out. We’ve been increasingly ripped off by the banking cartel ever since Keating’s poor decision.

      • You’re dreaming if you think that CBA wouldnt’ have been sold off at some stage.

    • Even StevenMEMBER

      @ Jeremy

      If banks pass on the 12-15 bps (estimated) in full to customers, then the big banks will quickly find themselves uncompetitive with their smaller banking brethren that are not subject to the levy.

      Most likely outcome is the cost of levy will be shared amongst shareholders, customers and employees (through cost cutting / layoffs). Probably in that order.

    • Nope. Just drop the guarantee. It was introduced during the GFC. Not needed now. The fuckers can then wear the increased funding costs, and the property speculators can wear the increased mortgage costs.

  4. If the tax payer, via the government, ever has to chip in, or guarantee the banks, the government has to demand EQUITY ownership as a condition. The citizens have to take any upside, then sell down at some future stage.