Great insights from Christopher Joye on how banking works in Australia - building societies not banks - ABC Lateline

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Great insights on ABC Lateline from Christopher Joye on how banking works in Australia. However, we don't share his optimism that banks will be incentivised to lend more to Australian businesses as:

(1) there is still a massive gap in terms of the amount of leverage banks can use with mortgages (50x) versus cashflow lending to business (13x); and

(2) in any event, banks do not have the enough skilled staff or tools to lend to businesses without mortgage backing.

See also Alan Kohler's brilliant article which explains that banks only want our houses.

 

This part of the interview nails the point about leverage:

CHRISTOPHER JOYE: Yeah. I think what we're going to see is a radical reshaping of competition in the banking sector through these capital changes.

It's very complicated but the short story is that the four major banks have been able to carry twice the leverage and generate twice the returns for every dollar of home loans they make than their competitors: that is, the regional banks.

And Murray is going to level that competitive playing field so everyone will carry roughly the same capital and roughly the same leverage and therefore generate roughly the same returns.

So I think you will see the majors' market share fall in home loan lending. They will be pushed into more business lending and that's good, because business probably need more capital and lower-cost capital. And you're going to see the regional banks rise as more prominent home loan lenders.

EMMA ALBERICI: Because up to now the banks have been able to have much more debt on their balance sheet and now they won't be able to?

CHRISTOPHER JOYE: Yeah, correct. I mean, the numbers are staggering: Westpac's home loan book according to its own numbers was leveraged some 77 times, which means it only held 1.3 per cent of capital, or $1.30 of capital for every $100 worth of loans it was making. And that advantage was unassailable and impossible to compete against if you're a Bendigo or a Bank of Queensland or a Suncorp. So we're going to see...

 

Emma Alberici speaks with Christopher Joye and David Uren for their take on the Government's response to the Murray financial systems inquiry. 

Full Transcript

EMMA ALBERICI, PRESENTER: Now for a more detailed look at the Government's response to the Murray inquiry, I'm joined by Christopher Joye here in Sydney, columnist for the Australian Financial Review and economist, and in our Canberra studio the economics editor of the Australian, David Uren.

Gentlemen, welcome.

CHRISTOPHER JOYE, COLUMNIST, AUSTRALIAN FINANCIAL REVIEW: Emma.

DAVID UREN, ECONOMICS EDITOR, THE AUSTRALIAN: Good evening.

EMMA ALBERICI: Now, the Government wants to crack down on merchants who charge excessive credit card surcharges. Christopher Joye, what's considered excessive?

CHRISTOPHER JOYE: Well, anything that's above the reasonable costs associated with a transaction, which is obviously going to be difficult to enforce because I don't think anyone really knows precisely what reasonable costs are.

EMMA ALBERICI: David Uren, Treasurer Scott Morrison said that credit card surcharges would have to pass the "fair dinkum" test. What does that even mean?

DAVID UREN (laughs): Well, I don't know. I mean, I think people obviously recent having to pay 1.5 per cent when they do just a store transaction, much as the same way as people will often recent having to pay a couple of bucks to use an ATM.

I think they'll probably struggle to find a method of legislating or regulating that pleases everybody, but I think they're clearly serving notice to the industry that fees will have to come down.

EMMA ALBERICI: Christopher Joye, as you just pointed out, enforcement will be nigh impossible, won't it, when you've got hundreds of thousands of businesses charging these surcharges?

CHRISTOPHER JOYE: Yeah, I think that's right. And as David said, I think evaluating what reasonable costs are is going to be an inherently difficult exercise. And then you've got small business highly fractured and decentralised. So that enforcement question is a big one.

EMMA ALBERICI: OK. Now, the banks will be required to hold more capital in reserves so they can better withstand financial shocks. Presumably it's the banks' customers who are going to have to pay for this, David Uren?

DAVID UREN: Well, Westpac has partly shown that it's prepared to put some of the cost onto customers. It's not entirely clear.

I mean, strictly speaking, if the banks are made safer by having more capital, well then, the cost for those banks of raising deposits should also fall. So it's not actually, you know, demonstrably true that raising more capital automatically pushes up their costs. The banks argue that it will.

I think it's interesting that so far the other three major banks that have raised capital to please APRA's capital demands have not increased interest rates - or, at least, not to the home borrowers. So, you know, I think Westpac did take a step away from the rest of the pack last week.

EMMA ALBERICI: But Westpac, Christopher Joye, did use this as the excuse for raising interest rates?

CHRISTOPHER JOYE: Yeah. And to be clear: we have seen substantial increases in interest rates on investment loans by about 0.2 percentage points and Westpac's now applied that to owner/occupied loans.

I think the question is whether the banks feel they can get away with it. To date they have been able to. I don't think there's any doubt we're going to see further rate increases one way or the other. If the RBA cuts rates, they probably won't pass on the full extent of that cut.

And the banks want to have their cake and eat it. They want to pass on the cost to consumers and protect their shareholders and not dilute the returns to those shareholders.

But David is right: more capital and less leverage means they're safer and, in theory, the cost of their funding should be lower. And we've seen sometimes in the bond market over the last three to six months reductions in the cost of that funding for the banks on the back of perceptions that they will be safer concerns.

EMMA ALBERICI: What will this do to the banking system more generally, this capital requirement? Will it generally make it safer? Because most people would assume that in the event of some kind of crises, as we saw in 2008-2009, the Government steps in anyway, David Uren?

DAVID UREN: Well, I think a lot of the regulation that has taken place since the Global Financial Crisis has been designed precisely to reduce the likelihood that Government will be called.

It helps to have a larger safety margin when things turn nasty and losses mount, but it's probably also the case that if you look, say, at the US subprime crisis, there was probably no bank that failed during the US subprime crisis that would have been saved had another per cent or two of capital in its reserves.

I think when things go wrong in a financial institution, they tend to go wrong in a big way through very bad lending practices across the board. Fortunately we're not seeing that. It's a margin of insurance but, you know, it's probably not really a life and death matter.

EMMA ALBERICI: Christopher Joye?

CHRISTOPHER JOYE: Yeah. I think what we're going to see is a radical reshaping of competition in the banking sector through these capital changes.

It's very complicated but the short story is that the four major banks have been able to carry twice the leverage and generate twice the returns for every dollar of home loans they make than their competitors: that is, the regional banks.

And Murray is going to level that competitive playing field so everyone will carry roughly the same capital and roughly the same leverage and therefore generate roughly the same returns.

So I think you will see the majors' market share fall in home loan lending. They will be pushed into more business lending and that's good, because business probably need more capital and lower-cost capital. And you're going to see the regional banks rise as more prominent home loan lenders.

EMMA ALBERICI: Because up to now the banks have been able to have much more debt on their balance sheet and now they won't be able to?

CHRISTOPHER JOYE: Yeah, correct. I mean, the numbers are staggering: Westpac's home loan book according to its own numbers was leveraged some 77 times, which means it only held 1.3 per cent of capital, or $1.30 of capital for every $100 worth of loans it was making. And that advantage was unassailable and impossible to compete against if you're a Bendigo or a Bank of Queensland or a Suncorp. So we're going to see...

EMMA ALBERICI: Because there's a general assumption, I think, that if you have this much in deposits then that's how much you lend. But of course that's not the case.

CHRISTOPHER JOYE: Yeah, and that's not the case. And so we're going to see real convergence in returns and I think the Australian banking system in 10 to 15 years' time will look very different as a result of these changes.

EMMA ALBERICI: How significant is the change, do you think, David Uren?

DAVID UREN: Look, I mean, I think that to a certain extent the changes we've already seen - those that Christopher's talking about, which are designed to level the competitive landscape with the smaller banks - they will produce shifts in market share.

I think, though, that one of the things that's still an open question is how much more capital the banks will be required. And really, the Government's response to the Murray inquiry gives APRA a carte blanche to say, well, how much capital it does need.

And I think it's... really, it's the incremental capital that we might see APRA demanding as time goes by that, you know, will also be quite a significant factor in terms of the weight of capital that the banks have to carry.

EMMA ALBERICI: Chris, to the question I asked David earlier, I mean about the too big to fail issue: the governments of whichever persuasion, as the Rudd government did during the Financial Crisis: they're not going to let one of the big four collapse?

CHRISTOPHER JOYE: I mean, this is 100 per cent correct. I've spoken to regulators about this. Privately they say they will not let not just the big four fail but literally almost any bank fail.

But the financial system inquiry was fascinating on this point. They made the observation that, based on the capital the banks held in June last year, if we had had the sorts of movements in house prices and other asset prices that we saw in North America and Europe during the Global Financial Crisis, "the four major banks would have been insolvent".

So they are clearly short capital. My numbers are: they probably over the next three to four years need to raise another $20 billion to $33 billion worth of capital. It's actually not that much and it's a very manageable task. And we have now government-guaranteed deposits. They have access to emergency liquidity or loans from the RBA currently worth $250 billion. So these are explicitly government-backed institutions.

DAVID UREN: Just to sort of follow on Christopher's point: that during the heart of the Global Financial Crisis, many hours of Cabinet time, of treasurer's time and of Treasury secretary's time was spent trying to work out ways to ensure that Members Equity Bank, the smallest bank, I think, in Australia, didn't get into trouble because securitisation markets had folded. And I think Ken Henry made the point after that crisis that, in the thick of the drama, there's almost no bank that is too small to be allowed to fail.

CHRISTOPHER JOYE: Yeah, that's right.

EMMA ALBERICI: OK. So on superannuation, the Murray inquiry had recommended that super funds shouldn't be allowed to borrow money to invest. Curiously, the Turnbull Government has disagreed with that recommendation.

CHRISTOPHER JOYE: Yeah.

EMMA ALBERICI: And if making the system safer was the objective, this seems like an anomaly, doesn't it?

CHRISTOPHER JOYE: It's a really, really interesting subject because within the $700 billion of self-managed super, lots of people have bank stocks and the banks are leveraged 24 times currently. So that's actually a leveraged equity investment that has no recourse to the borrower. If the bank defaults on the debt, they don't claim your self-managed super money, right?

EMMA ALBERICI: It just makes - and to translate what you've just said: that makes super more risky? (Laughs)

CHRISTOPHER JOYE: Correct. And so the notion of having further leverage inside SMSFs was obviously rejected by Murray, but that recommendation hasn't been accepted by the Government. I think the important consequence of that...

EMMA ALBERICI: I think his recommendation was across the superannuation industry that no super fund should be allowed to borrow to invest?

CHRISTOPHER JOYE: Well that's right and that is the general principle and there was an exception for non-recourse loans.

But I think this is very important because of the $700 billion in SMSFs, only five per cent or thereabouts is currently invested in residential properties and associated mortgages. And that is a tremendous growth opportunity for the banking sector.

So if the home loan market in owner/occupied sectors and investment sectors starts to slow down, they can potentially drive tremendous credit creation through providing non-recourse loans - they must be non-recourse - to SMSFs.

And the problem with a non-recourse loan is: it sounds very similar to a subprime loan in the US, which used to be called "jingle mail" because the lender had no recourse to the borrower beyond the asset itself, so they could just leave the keys in the house and walk away.

EMMA ALBERICI: David Uren, the final report said, "Direct borrowing by super funds could impose risks if allowed to grow at higher rates." Why you think the Government has ignored the recommendation that that should stop?

DAVID UREN: Well, I think that there would be a large number of Liberal Party voters who would have self-managed super funds. So, you know, I think the self-managed super fund industry has developed over a relatively short space of time quite a deal of political clout. So I have no doubt that that's a factor.

But I think also they probably... Well, you know, there's a tension there. The Reserve Bank has clearly been calling for regulation on borrowing and self-managed super funds. The Reserve Bank has been quite concerned about it. But clearly the Government has taken an alternate view that, as yet, the magnitude of borrowing is not that large in the overall scheme of the SMSF assets.

EMMA ALBERICI: OK. We're almost out of time, but just finally: the Government is now shaping legislation that will define the purpose of superannuation. Is there any doubt what it's for? Isn't it for retirement savings, Christopher Joye?

CHRISTOPHER JOYE: Absolutely. I mean, the purpose of super is to provide for adequate retirement incomes. But I think the concern is that, under the remit of super, product manufacturers have been able to develop products that may not serve necessarily the interest of retirees. And so they want to get greater definition around the role of super funds and their trustees and the sorts of investments they should be making.

One of the key criticisms of public offer or large super funds in Australia has been that they're very exposed to risky asset classes. On average, about 77 per cent of all super fund money within public offer funds is invested in equities, which is the most volatile asset class.

And with an ageing population, you know, folks want to question that decision-making process. So I don't think that's an unreasonable ambition.

EMMA ALBERICI: David Uren?

DAVID UREN: Well, I think a criticism was made, has been made of the super industry that it is there for retirement, it's not there for estate planning. And I think that in an appendix of the Murray inquiry there's discussion about distortions in the tax system bearing upon superannuation.

And I think that some of that focus around being really sharp about what the actual purpose of super is: once you clarify that, it then becomes more possible to look at some of the tax implications which thus far, of course, the Government has been a little bit reluctant to approach.

EMMA ALBERICI: We're out of time, thank you both so much.

DAVID UREN: A pleasure.

CHRISTOPHER JOYE: Thank you.