Tag: The Budget

The planned $6.2 billion bank levy was a good idea on budget night, and two weeks later it looks like an even better one.

That’s because of a decision by ratings agency S&P Global to downgrade the outlook for Australian banks.

In its latest ‘banking industry country risk analysis’, S&P changed its assessment of Australia’s economic imbalances from ‘high risk’ to ‘very high risk’, due to “strong growth in private sector debt and residential property prices in the past four years”.

The move will cause an increase in the cost of longer-term funding for smaller banks and credit unions, but does not affect the big four banks or Macquarie Bank – the corporations in the frame to pay the bank levy.

For the smaller banks and credit unions, such as Teachers Mutual Bank, Police Bank, Credit Union Australia, Bank Australia and ME Bank, longer-term funding costs are expected to increase by 10 to 20 basis points.

One senior market economist told me on Tuesday that was a “fairly hefty hike”, which will manifest as either lower profits for those banks or higher interest rates charged to their customers.

A skewed market

The smaller banks and other ‘authorised deposit-taking institutions’ have long complained that the big-four banks have an uncompetitive advantage.

That’s because of the ‘four pillars’ policy, which Paul Keating set up in 1990s to keep at least some semblance of competition in the banking market, has left us with a handful of banks that are ‘too big to fail’.

The government is therefore in a position where it must bail out any of the majors during a crisis.

That means that when fund managers or other large investors buy bank bonds from the majors, they don’t demand as high a rate of return because there is effectively no risk.

Conversely, when they buy the bonds issued by the likes of Bendigo & Adelaide Bank, or Bank of Queensland, the small banks have to pay more for the privilege.

Banking writer and former RBA economist Chris Joye recently calculated the majors are saving about $5 billion a year thanks to the implicit guarantee offered by the government.

And that’s before you take into account the way negative gearing and the capital gains tax discount have acted to artificially expand their mortgage portfolios in recent years.

Ironically, the government-backed oligopoly is seen by some as a ‘free market’ not to be messed with.

One property adviser recently complained, for instance, that “I do feel like we’re living a communist society with the rules that are being imposed on a free market”.

Quite the opposite is true, in fact.

As long as government maintains the current settings, it’s the big banks that resemble the protected government-sponsored enterprises seen in communist China.

The national interest

It is true, as critics argue, that the money raised by the bank levy won’t come out of thin air.

The banks will either pass the cost onto borrowers or take a hit to profits, and therefore have to reduce shareholder dividends.

But there are two reasons why that argument runs against the interests of everyday Australians – even if they are shareholders or mortgage holders.

The first is that by protecting the big banks, the government gives the oligopoly its strong pricing power.

Their tight grip on the market means their profits constantly exceed reasonable returns on the capital they deploy – a fancy way of saying they cream off massive profits because they can.

Shareholders have been doing well for years at the expense of mortgage holders.

Secondly, if the big banks calmly pass on all the levy to borrowers, there will be an increased incentive for mortgage holders to seek a better deal from a smaller banks.

The bank levy is a way of returning some market power to the smaller players, to boost competition.

And as those smaller banks have just received yet another blow via the S&P downgrade, now is the perfect time to do it.

The real debate, if the politicians were brave enough to have it, is not whether the levy is needed – but whether it should be larger.

The ‘bank levy’ that is causing such a political storm in Canberra may not be great policy in itself, but it will still be overwhelmingly good for Australia.

To understand why, it’s first necessary to ignore the silver-tongued protests of former Queensland premier Anna Bligh, now head of the Australian Bankers’ Association, and former Treasury secretary Ken Henry, now chairman of National Australia Bank.

They are using years of expertise developed on the public payroll to defend bank shareholders.

And don’t give much credence to CBA boss Ian Narev’s simplistic claim that “basically all Australians” are bank shareholders.

More than a fifth of the big four banks’ shareholders are foreign investors, and many middle- and lower-income Australians have superannuation holdings too puny to make them significant shareholders of anything.

A $100,000 super account, for instance, would likely have about $6000 in bank shares. The dividend earnings on those shares before tax would be about $300. And those earnings would, according to Treasury estimates, be reduced by 4 or 5 per cent – well under $20 a year.

Bloated banks

In Australia, banks have grown to a ridiculous size and make profits many times those of our biggest employers, Wesfarmers and Woolworths.

But it is not ‘market forces’ that have made them that way. They have grown much more than other sectors of the economy thanks to two levels of support from the federal government.

The first is the implicit guarantee provided by the government for the banks’ liabilities.

That guarantee swung into action during the GFC and became explicit, but it is always there – and the banks, and the institutions that lend to them, know it.

That means the big banks can borrow more cheaply. Even with the bank levy in place, they’ll still only be paying back a third of the benefit they receive from that guarantee.

Tax distortion

The second reason banks are so profitable is a simple matter of scale.

If property investors were not offered such generous tax concessions via negative gearing and the capital gains tax discount, they would not be able to borrow as much money to bid up property prices.

If they were unable to bid up prices, owner-occupiers would not have to borrow such large sums either – there would be fewer dollars chasing each available property.

And if those twin tax breaks were reduced, the banks’ mortgage books, and therefore profits, would be smaller.

Mr Henry himself argued to reform the housing tax breaks back in 2010 – but then he was employed by taxpayers, not a bank.

A political bind

The problem for Treasurer Scott Morrison is that the tax lurks that drive this bloated system disproportionately advantage voters in Liberal-held electorates, as a report released by the Australia Institute on Tuesday shows.

The think tank’s league table, showing the annual CGT refund averaged across all taxpayers in an electorate, is dominated by top Liberal seats.

Nationwide, the average claimed by taxpayers in Nationals seats is just $146, in Labor seats $297 and Liberal seats $672.

And therein lies the problem. The obvious and most effective way to reduce the credit bubble and bring banks back to the relative size and profitability seen in other developed countries is to reduce those concessions.

But as the Coalition can’t do that for political reasons, it is instead reclaiming some of the banks’ huge profits to shore up the federal budget.

It’s second-best policy, but it will at least help counteract the effect of not considering the first-best policy.

That said, the levy on the five biggest banks will collect $6.2 billion over four years – pretty small beer considering the government also plans to phase their corporate tax rate down from 30 per cent to 25 per cent over the next few years.

The question then will be whether people like Ms Bligh and Mr Henry complain with equal vehemence that banks again have it too easy.