02/07/2009 - 00:00

Banks: innovation or regulation?

02/07/2009 - 00:00


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Our banks’ performance shows that the market gets it right most of the time.

LAST week's editorial on the banks sparked some heated responses from readers who objected to my perspective on the industry.

In short, I was asserting the value of having a healthy banking system, which is widely seen as one of the pillars of a strong economy.

I was also reminding readers that Australian taxpayers have not had to bail out our banks, as many other countries have done, though the federal government has put in place a guarantee on foreign borrowings.

A couple of surveys released last week by research group East & Partners and the Small Business Development Corporation showed that most people do not share my perspective.

The surveys revealed frustration at the banks' lack of support for their customers, particularly business customers.

It seems clear that Australia's major banks are putting a premium on prudence and caution.

That is the main reason Australia's four big banks - the ANZ, Commonwealth, National and Westpac - are among just eight AA-rated banks in the world.

Before the financial crisis engulfed the world there were 20 AA-banks.

A report released this week by the Bank for International Settlements, usually dubbed the bank for central banks, shed some useful light on this topic.

It ranked the performance of major banks in 13 industrial countries, and found that Australia's four major banks were among the most profitable in each of the past three years.

Their pre-tax profits have slumped over the past three years, to 0.95 per cent of total average assets in 2008, but that still put them above the major banks in all other countries except Spain.

This outcome reflects the Australian banks above-average performance on three key metrics - their net interest margin (1.66 per cent of assets) was relatively high but not the highest, while the loan loss provisions (0.26 per cent) and operating costs (1.51 per cent) were relatively low but not the lowest.

The BIS report showed that countries with thin interest margins had low operating costs while countries with fat interest margins carried high operating costs.

In other words, customers pay one way or the other, via low interest margins or having to use banks with lean operating structures.

One of the great ironies of this situation is that Australia's big banks, just like big companies in most industry sectors, have long claimed they are too small to be serious players in the global market.

The big banks have asserted that the 'four pillars' policy, which blocks mergers among them, was hindering their ability to compete and grow their business.

If the policy was a hindrance, that may be a good thing, because it surely helped to discourage the crazed, and ultimately very costly, competition that characterised banks in many other jurisdictions around the world.

By the same token, banks will do a disservice to themselves - and their customers and the economy at large - if they are overly cautious.

I remember the last time the banks pushed up interest margins to strengthen their balance sheets.

It was in the mid 1990s, when they were recovering from the 1987 stock market crash, the 1989 property market collapse and the "recession we had to have".

The banks enjoyed a couple of years of strong profit growth and ignored the complaints from their customers.

The result was the arrival of 'Aussie' John Symonds and scores of other mortgage originators and non-bank lenders.

The big banks didn't think these upstart competitors would have any lasting impact, yet they quickly snared a big chunk of the housing loans market and forced the banks to slash their fat interest margins.

That's an example of markets self-correcting.

Markets aren't always perfect but they tend to get things right most of the time

And the alternative is much worse.

Government and regulatory interference in markets can be far more damaging, often because it stifles the price signals that encourage new entrants and change consumer behaviour.


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