Tag: The Budget

Stepping back, we can see that there really should have been no surprise that the budget grabbed a $6 billion prize from the banks.

Apart from the fact that the financial sector is so big – half of all company dividends in Australia come from the financial sector – there have been  moves around the world to tax banks in various ways.

The only debate is whether the funds raised go towards general taxation, or to a specific fund to insulate banks for later potential failures.

Clearly in last night’s announcement, it was all about plugging a hole in the budget, and we expect the charge to remain at least for the next 10 years. And as banks liabilities grow so does the money to Treasury, so there is a natural hedge down the track. In any case, this is really an indirect tax on consumers.

But it is worth looking at what has been happening else where.

In the UK an 8% higher company tax rate was applied to banks last year.

In the European Economic Community there are active proposals to impose a Financial Transaction Tax, which would be on trading transactions between banks. According to early plans, the tax would impact financial transactions between financial institutions charging 0.1% against the exchange of shares and bonds and 0.01% across derivative contracts,The tax that could raise 57 billion Euros per year if implemented across the entire EU.

The IMF had proposed several approaches to a Bank Levy, but it was initially targetted at helping to recoup the costs of bank failures and bail-outs in 2007.

The IMF’s report suggested a levy on all major financial institutions balance sheets. They said it could be imposed at a flat rate initially but could be refined later depending on the risk profile of the particular institution.

This is akin to the Financial Crisis Responsibility Fee which President Obama’s proposed  after the GFC and would raise US$90 billion over 10 years from US banks with assets of more than US$50 billion. Except the revenue was to flow into general funds.

Another approach is a Financial Activities Tax (FAT) which could be charged on bank profits, banker’s remuneration, or both. Again this could flow to general revenue, or to a fund to assist with a future bank crisis.

Given the large sums involved it is no surprise that the banks are targets, despite the fact this distorts the free market. When a government is short of cash this can appear a nice target – especially if the sector is already on the nose.

But is does set a worrying precedent – it says if you are a profitable business (especially in a sector which makes excess profits) then you are a target. In the Australian context, there are other sectors which would fit that description just as well.

By the way, some have called this a “Tobin Tax”. James Tobin a Nobel Prize winner, suggested a tax be added to all spot conversions of one currency into another to curtail short-term financial round-trip excursions into another currency.

But now, the Tobin tax is wrongly used to describe all forms of short term transaction taxation, whether across currencies or no.

Despite the rumors yesterday, the imposition of the liability levy in the budget last night was something of a surprise. It will hit the big four, and one other, only at this stage. They need liabilities of more than $100 billion to be captured.

On one hand you could argue that it is a simple, if rather lazy revenue raising measure, which plays to the gallery in terms of banks universally being poorly perceived and is a vote of no confidence in the bank driven processes of cultural reform.

Or you can argue it is an appropriate response to the recent aggressive repricing of the mortgage books and growing profits, despite margin compression.

The Government conveniently linked it to the FSI “unquestionably strong” mantra, which is clever, but it is not necessarily directly connected.

Which ever way you run the argument, it is worth looking in more detail at the numbers involved and how the banks may react. First, the budget papers said the big four banks had liabilities of $3.3 trillion, more than the national GDP. This is true. This number comes from the APRA Banks Performance data for December 2016.

Within the mix, more than $1 billion are on call deposits, and another $700m on term deposits.

Now, liabilities within the $250k consumer deposit protection scheme are excluded, as are those related specifically to capital ratios.  It is not easy to separate this out from public data.

“Ordinary bank deposits and other deposits protected by the Financial Claims Scheme – including those held by everyday Australians – will be excluded from the levy base. It will not be levied on mortgages”.

Individual banks have different liability structures. Looking at APRA data to March 2017, by bank, we see CBA has the largest volume of call deposits. This has been the case for many years, and reflects the heritage of the bank.  Banks have been powering their deposits higher, especially term deposits, as part of the required net stable funding ratio, which is a mechanism to reduce their reliance on more risky overseas funding (the big banks still rely partly on US commercial paper to fund some of their book).

Presumably the fifth bank is Macquarie, as the other bank using the IRB capital approach. Other regionals are pursuing this route, which in theory should reduce their costs of capital, but in practice, as the Basel rules morph, the gap between standard and IRB is reducing (and perhaps to the point where there is little benefit in switching?). If they were to get bigger they might fall in the levy zone.

The measure is 6 basis points on the net liabilities, and is expected to yield about $1.5 billion each year. So, the assumption is 70-80% of liabilities may be captured. This would equate to 4-5% of annual profit of the big four, but may not be equally distributed.

In addition, banks have the option of switching their funding from bonds and other financial instruments to retail deposits below 250k to avoid the charge. So we would expect even greater competition for consumer deposits in the months ahead. A change in treasury mix will take some time, but may improve financial stability down the road.

Banks in Australia are still relatively inefficient (no world class cost income ratios here), so in theory they could drive out costs harder. But this is hard.

They can also adjust their deposit pricing for larger deposits, to cover the costs, or lift their lending rates to cover the costs of the levy. Whilst the ACCC has been charged with looking at mortgage rates and how they move, given the many moving parts between changes to capital ratios, repricing to adjust volume flow (especially in investor and interest only loans), and competitive issues, it will be hard to unscramble the egg to identify repricing connected to the levy within the bank treasury function. The upcoming APRA discussion on revised capital ratios will just add to the confusion.

Banks could also reduce their payouts to shareholders a little, and there are a number of reasons why future returns may be lower, perhaps coming back to an average of circa 12-13%. This is more to do with the slowing residential mortgage sector, which has the main growth engine for the industry for years. The recent round of results showed that, trading income apart, home lending drove the results, despite lower net interest margins.

The impact on smaller banks will be interesting, as they are at a pricing disadvantage of 10-15 basis points, or more. So even if the full weight of the levy was applied to the mortgage book of the majors, regionals will still find it hard to compete. Indeed the pressure for deposits may become more intense adding extra margin pressure.

With so many moving parts, the true impact will be hard to track, but I think you can assume that consumers will end up paying, either with higher mortgage rates, lower deposit rates, or via lower dividends. The ABA has already said as much. So really this is not so much a levy on the banks as a second order tax on consumers and small business.

Might be smart politics, but the impost on the community may well get lost in translation!

Nice perspective from Christopher Joye in the AFR this morning.

The bank leverage tax is an interesting innovation that raises tremendous revenue ($6.2bn) and encourages the big 4 and Macquarie to use more equity and less debt (and when they do leverage, to chase sticky household deposits of less than $250k in value rather than issuing wholesale bonds). This will presumably reduce the supply of wholesale securities at the margin, which could in turn lower spreads and reduce the banks’ cost of capital. The majors and Macquarie have many levers they can use to defray this tax, including cutting their internal operating costs, which are massively overinflated, lifting loan rates and/or reducing wholesale deposit rates. The leverage tax is clearly negative for big bank shareholders and positive for creditors with our long-held position that the majors’ returns on equity will mean-revert back to 12%-13%, and converge with returns generated by smaller banks, looking more and more certain by the day;

We also expect APRA to surprise the big banks with tougher-than-expected equity capital targets in their mid-year report on the level of leverage that will ensure they remain “unquestionably strong” on a global basis. This should see their common equity tier one capital ratios move comfortably towards 10.5%-11.0% and their all-important non-risk-weighted leverage ratios lift up to around 6% on an APRA basis (and closer to 7% on an internationally harmonised basis, which is where the 75th percentile global peer currently sits). If ever there was a good time to boost equity buffers, it is right now—if only the banks had listened to our advice over the last few years to pre-emptively raise equity capital when it was much cheaper at higher prices;

There are loads of other commendable policy developments for the financial system that have Treasury’s thoughtful hands all over them, including: backing open customer data sharing between lenders (we’ve supported this for years); extending APRA’s reach to non-bank lenders for macroprudential purposes (we’ve argued for this); undertaking further independent reviews of competitive neutrality via the Productivity Commission and ACCC; allowing regulators to ping bank executives with hefty new fines; forcing bankers’ bonuses to vest over longer timeframes; expanding APRA’s powers to intervene with bank compensation policies; and much more;

The budget announced some measures to minimise tax avoidance by banks that issue hybrids out of their foreign branches, which ostensibly applies to the CBA Perls series though all outstanding securities have been granted transitional relief through to their call dates. This should not therefore impact any existing hybrids and had been long discussed with the industry (CBA will presumably now issue hybrids out of their Aussie business);