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Reining in the banks

By Milind Sathye - posted Monday, 8 November 2010


Australian families pay interest rates higher than pre-crisis levels on all loan types. For example, the standard variable interest rate on credit cards, which was 17.80 per cent pre-crisis is now 19.40 per cent. A fixed-term personal loan was available at 12.35 per cent pre-crisis; the rate is now 15.05 per cent. Although home loan interest rates are below pre-crisis levels, the mark-up over the Reserve Bank cash rate, which was 1.80 per cent for decades, jumped to 2.90 per cent - raising the standard variable mortgage rate to as high as 7.40 per cent - in September 2010.

Despite all this, the banks continue to blame rising funding costs for higher lending rates. When I debunked the banks' argument in an opinion piece in the Age in April, the Australian Bankers' Association accused me of misleading Australians. But earlier this month the Reserve Bank also debunked the banks' funding cost argument. According to the RBA board minutes, "Members noted staff estimates that banks' funding costs had been relatively flat over recent months. While the spread between lending rates and funding costs was below its peak in 2009, it remained well above its pre-crisis level."

Let's compare this with Canada, which was also relatively unaffected by the crisis. There, the mark-up for mortgage loans is 1.95 per cent. Canadian banks borrow from the same international market as Australian banks, so why do Australian banks need a mark-up of 2.90 per cent? Credit card rates in Canada, it's true, are comparable to those in Australia.

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My estimate is that, by using the taxpayer-funded guarantee, the banks (and particularly the majors) made a cool profit of $1.34 billion during the financial crisis. Joe Hockey's stance against the banks is thus well founded. So what should we do to rein in the banks? Should the government use its powers under the Banking Act 1959 as Mr Hockey has proposed?

Using punitive measures and prescribing interest rates would go against the grain of a market economy. To make banks behave we need to reduce their market power by other means. Several options are available.

Consumer action: If customers of the majors switch en masse to smaller banks or credit unions and building societies, the majors would be on their knees. This is unlikely to happen and the banks know that.

Australia Post: How about using the Australia Post network to provide competition, as some have suggested? New Zealand's KiwiBank is a post office bank. Australia Post would need to be authorised under the Banking Act and would then have to follow the prudential requirements of APRA. It is not as easy a solution as it might first appear.

Community oversight: Another solution, which I support, is community oversight of banks, which can take many forms. Community representatives, or representatives of different categories of borrower, could be nominated to bank boards, for example, by amending the Banking Act. As taxpayers underwrote bank funding during the crisis, a right of oversight makes sense. Alternatively, the Reserve Bank or APRA could nominate an official to bank boards to ensure that the community is not short-changed.

Break up banks: A solution proposed by Alan Greenspan in the United States is to break up large banks. Here, the government could consider a demerger of Westpac and St George and of Commonwealth and BankWest. Again, there would be political ramifications.

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We want our banks to be profitable, of course, and every country wants a stable banking system. But Australian banks sought taxpayers' help during crisis and then took advantage of that help. It's time to remind banks that it is the community that has given them the licence to carry on business and if they act to the detriment of the community, it has the right to impose sanctions. But are the banks listening?

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This article was first published on Inside Story on October 28, 2010.



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About the Author

Milind Sathye is professor of banking and finance at the University of Canberra and a former central banker.

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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