A royal commission into banks is not the answer.

Banks need a clean up, not a clean out

Tuesday, 23 August, 2016 - 12:19

The desire to bash the banks is understandable when some of their past behaviour is considered; but before the bashing goes too far, it is important critics know what it would mean to damage an important part of the Australian economy at a delicate point in the global economic cycle.

Calls for a royal commission come just as banks and their cousins, the insurance industry, are forced to grapple with the full effect of ultra-low interest rates and sluggish demand for their products.

A simpler and probably more efficient way of tackling bad bankers would be for the staff of multiple government regulating bodies to actually do the jobs they’re already well paid to do, but seem incapable of doing in a way that forces the banks to behave better.

The fact that a US bounty hunter has launched an attack on Australian banks for their alleged role in rigging key market interest rates is a comment on how slow Australian government regulators have been in cleaning up the banks.

The claim in a US court from Florida-based commodities trader Richard Dennis for unspecified damages from a group of Australian banks is undoubtedly a fishing expedition that could last for years. But what’s interesting about the case is that it’s based on evidence gathered by Australian regulators, including taped conversations between bank employees.

There is, of course, a wide gap between what bank employees say to each other when trading exotic products such as the bank bill swap rate and proving that a bank-sanctioned conspiracy has been uncovered.

However, even if that’s a hard case to prove, it raises the question of whether anyone at bank director level knew what the staff were saying, and possibly doing, in the name of the bank, or whether the taped calls came as a surprise, which is more a case of incompetence and laziness than criminal intent.

The latest failure of the banks to pass on the full reduction in government interest rates is also seen as some sort of conspiracy among bankers to cheat their customers; whereas a more likely reason is that the banks are starting to feel the pressure on their interest rate margins, the primary way they make profits.

There is no easy answer to the problem of compression on bank interest margins because that’s an issue caused by the worldwide slide into an era of ultra-low interest rates, and even negative interest rates.

Insurance companies are in the same boat when it comes to managing interest rate compression – a phenomena that could eventually lead to a crisis across the finance sector as profits become harder to earn and everyone is forced into taking greater risks to generate a reasonable return on the funds they invest.

Managing risk is the big issue when it comes to the challenge of low interest rates, as everyone who relies on interest income is discovering, and that includes banks, insurance companies, pensioners, people planning to retire, and private investors.

The easiest way of considering the problem is to imagine someone used to earning $30,000 a year in interest from their retirement savings. A few years ago, when you could get 5 per cent on a fixed-term bank deposit you only needed a retirement nest egg $600,000. Today you need $1 million.

Retirees are being forced to make painful adjustments to their lifestyle or they are taking greater risks with their savings by investing in the stock market.

Insurance companies and banks are doing exactly the same thing; and while riskier investment decisions can prove damaging to individuals, they can do far more damage at a business level as managers switch from high-quality assets to lower-quality investments in the hunt for yield.

It is not an exaggeration to say that ultra-low and even negative interest rates are starting to inflict severe damage on the global financial system as everyone scrambles to find a way to survive under a set of radically different conditions.

Bank and insurance company failures have happened in the past and will happen again if current conditions persist – and potentially be accelerated if too much political pressure is applied.

The problem of low rates is so widespread that everyone is actually in the same boat, even if they don’t yet recognise it, as shown in this check list:

• retirees are being pushed to the limit of their savings and shifting funds into riskier asset classes;

• insurance companies are being forced to raise premiums because they can no longer generate reasonable returns on their investments, which once represented half their income;

• pension funds face the prospect of lower returns, which means smaller pensions for their members when they retire; and

• banks are being squeezed by falling interest rates and the threat of increased government scrutiny and private legal actions for sins committed in better times.

No-one will shed a tear for the banks as they are forced to live with circumstances that are partly of their making; but it would be far better to see the banks cleaned up than cleaned out by a politically inspired royal commission.

Bankers might be hard to live with, but it would be even harder to live without them.