Interesting take on the Bank Levy from Christopher Joye in the AFR.
For the first time big Aussie banks can point to the fact that they now pay a specific levy in lieu of their too-big-to-fail status, which should in theory further reduce their cost of debt and equity.
Previously this particular government guarantee was implicit: from July 1 it becomes explicit. This directly reduces the probability of default and loss on the banks’ deposits and bonds, which should shrink the interest they are required to pay. Equally the banks’ cost of equity should decline given they now have materially lower risks. The explicit too-big-to-fail government guarantee actually gives the banks grounds to go back to depositors and bondholders and demand that they pay less, not more, interest, precisely because their perpetual nature has now been written into law.
It is entirely possible that this reduction in the banks’ weighted-average cost of capital could completely offset the (modest) 0.06 per cent levy. Any residual cost can easily be shared with customers via slightly higher product costs. The banks are about to receive another excuse to jack-up loan rates when by “mid-year” the Australian Prudential Regulation Authority releases its new equity capital targets to ensure these too-big-to-fail-institutions remain “unquestionably strong”.
Since we are explicitly guaranteeing their longevity, setting unambiguously world-class, first-loss equity buffers has never been more important. And the policy solution we have arrived at, which involves taxing the subsidy while requiring banks to have bullet-proof balance-sheets, is superior to that originally proposed by the financial system inquiry, which left the subsidy in limbo. But I must admit surprise at the Australian Bankers Association’s rabid opposition to the levy given the vast bulk of its members (by number) enthusiastically support it, as the likes of Bank of Queensland and Bendigo & Adelaide Bank have made clear. Perhaps those deposit-takers sitting outside the oligopoly would be better served establishing their own independent organisation.
The final crucial point is that the tactical rationale for the government introducing this levy is to save Australia’s AAA rating, threatened by the $13 billion of zombie savings the Senate failed to pass. The loss of the AAA rating would likely have no direct effect on the government’s interest repayments. But it would lower the four major banks credit ratings from AA- to A+, which our research suggests would increase their borrowing costs by about 0.10 per cent annually (notably more than the levy). This point has been missed in the debate: much of the motive for balancing the budget and maintaining a credible 2020-21 surplus is keeping the rating agencies at bay on behalf of the banks, not the public sector. In this manner, Scott Morrison’s explanation that the levy will help with “deficit repair” is absolutely spot-on
