Banks too clever by half

5th Nov 2010

The big banks have exploited their privileged position in society, but their arrogance might yet force them to account, writes John Hewson.

There should be two dimensions to the long overdue parliamentary inquiry into our banks: economic and social. While it is always essential to get the economics right, we are a society, not just an economy. Important trade-offs may be involved.

Much of what we seek in terms of economic efficiency is drawn from a conceptual framework of “perfect competition”. Much of what our banks do today is to exploit their increasingly oligopolistic position, that is, exploit the failing competitive model.

Although their exhaustive advertising would suggest otherwise, they seek to minimise real competition, except in terms of “service” which, with the increasing reality of centralised credit control and depersonalised banking, is in substance laughable.

Indeed, they seize every opportunity to increase market share, to annihilate competition from non-banks and the smaller banks, and to charge for their “diminishing service”, while seeking to become financial services giants, always seeking to move beyond traditional commercial banking to investment banking, equity capital, funds management and financial planning, stockbroking, even insurance and, of course, offshore.

Note how they exploited the global financial crisis, grabbing back control of the household mortgage market and equipment finance, as traditional finance companies and mortgage trusts failed – a trend accentuated by misguided government guarantees and other support.

They are now so big in market terms, and in terms of political influence and social significance, that they are seen by both politicians and central bankers/regulators, as “too big to fail”.

Yet, while the possibility of failure is the essence of true competition, banks also serve a fundamental public or social service. They are the foundation of our financial, money and payments system, which is in turn fundamental to the operation of our economy and broader society. In this sense they are essential “utilities”, like power and water, but are not regulated as such.

This is, in part, the thinking behind the “Volcker rule”, recently adopted by the United States in reregulating its banks, whereby a distinction is drawn between “traditional commercial banking”, borrowing and lending, and “casino banking”, investment banking and beyond.

The risks are very different. Society needs to be assured that its traditional banking is sound, although a bank’s “casino” activities can still compromise the whole house.

Our big four are in a particularly privileged position, both economically and socially. They enjoy a banking licence and – in response to the GFC – were given an explicit government guarantee on their deposits, able to borrow internationally with the government’s AAA credit rating and gained privileged access to the Future Fund, etc. They have exploited this privileged position, in pursuit or narrow economic objectives, essentially ignoring their social responsibilities.

True, they were in reasonably good shape going into the GFC, relative to others internationally. But just because they didn’t look like failing doesn’t mean that they were being well run. Indeed, the excesses were there. Pre-GFC, their lending practices were loose.

With the GFC, they were quick to recapitalise and rebuild their balance sheets, to reprice risk, meaning to increase base lending rates, widen margins restrict credit and increase charges.

But this is the rub between economics and social, even moral, responsibilities. Many whom the banks had earlier “pushed” into excessive borrowings, both individuals and small businesses, are now being repriced and rationed, and overcharged; and in some cases forced to fail – being too small to survive.

Clearly, this behaviour is beneficial to bank shareholders and to those who have bank shares in their super funds. But at what cost to the rest of our economy and society?

Indeed, the banks, in their even more privileged position, were working directly against the government’s post-GFC attempts to stimulate our economy and minimise the threat of business failure, unemployment and personal bankruptcy.

Unfortunately, much of this has been camouflaged in the broader data by the resources boom. Yet the public outrage may yet be heard. A populist bent to a parliamentary inquiry process may prove them to be too arrogant and smart by half.

John Hewson is a former leader of the Liberal Party.

Article Source : The Financial Review