Reality intrudes on banks' fairy-tale run

  • By Pat McConnell

In the upcoming final session of the Hayne royal commission, the redoubtable counsel assisting, Rowena Orr QC, will, like Dorothy in the movie, rip open the curtain cloaking the banking system to find that the ‘most powerful’ Wizard(s) of OZ, are really just ordinary men, with huge megaphones, and buckets full of excuses for their mistreatment of the Australian public.

But how come did these heartless Tin Men, who threw some of their customers out of their homes, came to be considered so exceptional?

A submission to the royal commission, by the Commonwealth Treasury gives a clue referring to a statement in the Murray Financial Service Inquiry of 2014, which has become accepted wisdom.

“Although Australia was not immune to the effects of the GFC, the financial system and institutional framework held up well compared with many financial systems elsewhere in the world. In particular, Australia ’s regulatory frameworks proved robust during this period.”

This assertion has often been translated (erroneously) as – the banks and banking regulators saved Australia from the global financial meltdown.

Over the past decade, the assumption that somehow Australian banks, especially the four pillars, are exceptional, compared to the rest of the world, and that the regulators (ARA and ASIC) are also world class, has given rise to many examples of the arrogance and complacency uncovered by Justice Hayne.

First, are Australian banks exceptional? 

They may be, but only if you cherry-pick the competition, usually the countries that suffered most in the GFC, such as the USA, UK, Ireland and Iceland. 

But if one chooses banks that are roughly the same size as the big four, such as in Canada, Sweden, France, and Japan, Australian banks are firmly in the middle of the pack. However, the banks in those countries, while not angels, have not been found to indulge in the range of misconduct unearthed in the royal commission.

At home, are the largest banks remarkable?

In a separate inquiry into the Australian financial system, the Productivity Commission concluded that “the balance of power [from advantages of scale, scope and branding] gives the major banks the ability to pass on cost increases and set prices that maintain high levels of profitability — without losing market share”. This means that the largest banks are indeed exceptional, but only because they are a government supported oligopoly, that is able and eager to generate excess profits, whenever the opportunity arises.

Regulator mistake

The Productivity Commission found that such high profitability is sometimes a direct result of regulatory intervention, such as, in 2017, when, panicked by the housing market, APRA clamped down on new interest-only loans.  As a result, large banks increased their mortgage rates not only for new interest-only borrowers but for all new borrowers.

These actions generated windfall profits that smaller banks could not compete with (as they were also covered by the same regulations).  The Commission concluded that this profit-taking behaviour should have been anticipated and was an unnecessary “additional cost to the community”.

The prudential regulator obviously missed the fact that their rule changes could be used by the biggest banks to generate extra profits for doing nothing exceptional, except to jump on the bandwagon. But APRA did nothing to rectify their mistake, as it would sully their reputation.

However, as evidence to the Royal Commission has uncovered, Australian banking regulators have been bamboozled by the banks they are supposed to regulate, time and time again.

In its submission to the royal commission, the Treasury repeated the claim that Australia is leading the world with its Twin Peaks regulation.  Indeed, Australia was one of the first to adopt the concept of Twin Peaks, which was invented by Michael Taylor (a Pommie), and a few jurisdictions have adopted a similar model, most notably the UK in the wake of the GFC.

However, no jurisdiction has adopted the Australian model where ASIC is both the banking and corporate regulator.  As the Commissioner has observed, ASIC’s remit is possibly so wide that it is not able to carry out any of its roles well.  The Commissioner will no doubt canvass how this situation can be resolved before the final report is due next year.

Banking is not cricket, and there is no need to insist that Australian banks and regulators should somehow be ‘exceptional’ world beaters. The banking system is a critical part of the plumbing of any economy and as such it should be expected that banks and other financial institutions, should be efficient, fair and honest, as is, in fact, required by the banks’ Australian Credit Licence.

It is no bad thing that the royal commission will strip away many of the pretensions of the ‘wizards’ that occupy Martin Place and Collins Street and remind them that their role is to support the Australian economy not to bask in the glow of some bogus fairy tale about they single-handedly saved Australia a decade ago. Humility not hubris, is the order of the day going forward.