In June 1991, the American investment banker Albert Wojnilower participated in a Reserve Bank conference on financial deregulation. Concurrently, a major Parliamentary Inquiry into the Australian banking system was under way. The Martin Inquiry was forced on the Labor Government by public disgust with a banking sector serially incompetent and marginally corrupt that had evolved from the wholesale deregulation ensuing from the 1981 Campbell Report.
Wojnilower posited an instructive generalisation. National financial systems inevitably serve a public purpose but are largely constituted by profit-oriented institutions. Thus sectoral regulation is inevitable. But there is no natural equilibrium; the system is innately unstable because the pursuit of profit (in tandem with innovation) gradually undermines extant regulatory structures and regulation has to be perennially refashioned to ensure that the public interest continues to be served. Said Wojnilower: "the mere abolition of constraints will not automatically give birth to desirable new structures."
The Martin Parliamentary Inquiry produced a report in November that was fat but hollow. Wojnilower's insight fell on barren ground then and since. The public interest will be served at the finance sector's discretion.
The Big Four banks have been the major beneficiaries of the imbalance. Financial 'regulation' is effectively now primarily oriented to ensure their health. It goes beyond the catchphrase of 'too big to fail'. The situation could more accurately be labeled 'too powerful to be controlled'. That power has been appropriated and delegated to it by successive governments and regulators. Fierce lobbying has reinforced political lassitude, all rooted in an unthinking commitment to a flawed regulatory model.
How did we get here from there? By a series of separate but mutually reinforcing events. The political reaction to the early 1990s crisis is instructive. The crisis was facilitated by comprehensive financial deregulation, spawned by banking sector incompetence and crowned by monetary policy ineptitude. Minor adjustments were made (bank bad debts were now to be monitored on a quarterly basis), but no systemic reconsideration was contemplated of banking practices, banking culture and the regulatory apparatus. A foretaste of the recent crisis.
The banks' fostering of the foreign currency loan debacle, quintessential sign of dysfunctionality, was trivialised and ignored. In 1992, the Government amended the Tax Laws to allow banks to gain tax deductions for discretionary partial bad debt write-offs. Prime Minister Keating claimed that the change would benefit bank customers, but it has benefited only the banks. The concession remains intact, and the Tax Office has never examined the scheme (indeed, banking sector tax payments in general) for potential rorting.
Regarding banking numbers, the competition regulator has consistently legitimised banking consolidation, contrary to its own charter, that has underpinned the current dominance of the Big Four. The predation of the second tier reached its height in 2008 in the regulator's scandalous tolerance of the Westpac takeover of the rising St. George, immediately accompanied by the handing of BankWest to the Commonwealth Bank.
As of January 2011, within the banking sector, the Big 4 accounted for 82% of household deposits, 87% of housing loans to households and 83% of total gross loans and advances. Having their origins in narrowly focused trading banks, the banks are now allfinanz institutions. The Big 4 possess, know they possess, and seek to exercise their market power. If funding costs rises, they have the power to readily pass these costs on to borrowers. Moody's ratings agency, in its recent review of the Big 4 (press release 16 February), was explicit: "The banks' franchises have been enhanced -- and their pricing power maintained -- by market consolidation and by the exit of price-led, securitization-funded competitors."
The Big 4 banks reported an aggregated $20.7 billion in profits for 2009-10 (Westpac $6.3 billion, CBA $5.7 billion, ANZ $4.5 billion, NAB $4.2 billion) – up from $13.7 billion in 2008-09. The Big 4 sit at the apex of a financial system that has gradually made inroads into profitability of the 'real economy', an insidious process called 'financialisation'. In 1959-60, the gross income of financial corporations in general as a percentage of total corporate income was 5.8 per cent; as a percentage of total business income, it was 2.4 per cent. By late 2006, the percentages had risen to 20 per cent and 15 per cent respectively, and have fluctuated around those levels since.
Bank consolidation and the resulting enhanced market power increase lender leverage over customers, the leverage being exacerbated during general crises. Traditionally, the most vulnerable customers are in the small and medium enterprise (SME) and family farmer (hidden within 'agribusiness') segments. These segments have long been subject to unconscionable practices by major bank lenders. But the practices have typically been condoned by the courts when litigation ensues (partly a consequence of an uncomprehending legal culture and partly due to judicial complicity). Moreover, the regulators entrusted with mitigating malpractice have been singularly missing in action. 'Business to business' unconscionability was legislated into the Trade Practices Act (s.51AC) in 1998 but the Australian Competition & Consumer Commission pursued no credit provider under the section, in spite of complaints by SME/farmer customers against their bank lenders. Business to business unconscionability in financial services was moved to the ASIC Act in 2001 (s.12CC), but the Australian Securities and Investments Commission has replicated the inaction of the ACCC.
The Australian Prudential Regulation Authority, atypically, formally combines structural and macroeconomic regulatory responsibilities. At the structural level, APRA has the power to intervene in bank practices but has exercised that power only once (with respect to trading desk illegalities at the National Australia Bank in 2004). APRA monitors bad debt figures but remains detached from bank lending portfolios and the terms on which the banks determine the quantum of bad debts (and associated defaults and foreclosures).
De facto, then, APRA confines itself to the macro picture. APRA's interest is with system stability, which in practice means major bank viability. The acid test is comparison with the 'bad times' of the early 1990s recession – the bank impaired assets to total assets ratio was 3.46% as at June Qr 1990 (the first consistent figures), rising to 6.91% by March Qr 1992. The ratio for June Qr 2009 was 1.11%, so APRA's mentality is that the 2008 crisis was pretty small beer.
Nevertheless, this 1% represented $29 billion of impaired assets, up from $4 billion two years previously. In 2009-10, when the crisis had supposedly blown over, the aftermath remained, with the impaired assets ratio at 1.23%. It is true that $10.3 billion of bad debt provisions was returned to balance sheets as 'cured loans' (c/f $8.5 billion for 2008-09). But an additional $25 billion of 'new impaired assets' was provided for during 2009-10, and $11.6 billion of impaired assets was written off (c/f $6.4 billion for 2008-09).
These are aggregate figures, the scale of which APRA and the RBA consider inconsequential. The regulators have not confronted the material reality behind the abstract figures. The figures are the reflection of ill-considered lending, enhanced during the hot-house climate of boom. The banks lent to dysfunctional companies (ABC Learning, Babcock & Brown, Allco Finance). The banks lent indiscriminately on commercial property (Centro as exemplar). In particular, banks threw millions at 'pub' buyouts at ludicrously inflated prices.
If APRA and the RBA looked behind the numbers they might be led to inquire as to the lending practices of the banks, the skills and payment structures of the staff, and of bank culture in general. Rather than self-congratulation, questions might be asked as to how such dysfunctional elements can be reduced to ameliorate future crises.
Having opened the door to material detail, the financial regulators might be forced to confront the qualitative character of the beast. The neglected human side is most transparent in the housing loan sector. By June 2009, .62% of home loans (by value) on bank balance sheets were in (90-day) arrears (admittedly the figure was higher for mortgage broker loans). Little to worry about claims the RBA, but the pain associated with thousands of home repossessions goes unnoticed. Indeed, disgracefully, there are no official national figures for home repossessions.
The unsavoury dimensions exposed by the crisis are multiple. Of course, some of these dimensions are outside the banking sector, such as dodgy funds managers (City Pacific, MFS) and dodgy agribusiness 'managed investment schemes' (Great Southern). But banking, given its central role and licensing privileges, can't avoid the temptation of murky waters.
Foremost, there is the new odious scam on the block, margin lending. Opes Prime would have been of marginal significance if not for the funding deal with the ANZ bank. ASIC got a measly $253 million out of ANZ as blood money for the Opes debacle.
Storm Financial would have been of marginal significance if not for the funding deals with the CBA and its subsidiary Colonial First State (with supporting roles from Macquarie Bank and the Bank of Queensland). The 2009 Ripoll Parliamentary Inquiry into Storm Financial gave the CBA an imperceptible slap on the wrist. ASIC is still at the starting blocks regarding CBA involvement.
Meanwhile, staff at CBA subsidiary Commonwealth Financial Planning have been found to be misdirecting investor funds into high risk investments contrary to investor intent, attracting a class action but regulatory inaction. In addition, Colonial First State is still drawing management fees from a mortgage income fund that it froze two years ago, denying investor access to funds.
And this is from two of the financial sector's four pillars. ASIC skirts around the edges of this stuff, with minimal success. The Big 4 CEOs treat Parliamentary Inquiry hearings with contempt and are absolved.
Meanwhile, APRA busies itself with the latest round of Basel reforms. Basel III confronts what previous rounds denied – that short-term illiquidity can bring down a bank regardless of its capital adequacy. The Australian banks were illiquid, but were saved by stop-gap regulatory intervention – direct access to funds from the Reserve Bank and favoured access to funds raised elsewhere via RBA guarantees (at favourable rates to the major banks).
Nevertheless, Basel III remains in the hands-off tradition. Remarkably, bank off-balance sheet holdings remain untouched. In 2008, the NAB had over $5 billion in various derivative instruments off-balance sheet, and was forced to write-off 90% of the face value of a $1.2 billion tranche of Collateralised Debt Obligations – again prompting a class action but regulatory inaction. During the next post-boom crisis, the RBA will find itself providing liquidity and guarantees to the banks as in 2007-08. None of the fundamentals regarding bank practices and culture have changed.
In one of the more egregious developments, in December the Government mooted legislation to allow banks to issue 'covered bonds' to facilitate fund raising. The regulators have acquiesced. A covered bond involves the redefinition of bank liabilities (deposits) as 'assets', thence to be leveraged for greater borrowing. Apart from the scandalous removal of depositors from the first rank of creditors, the move will merely further entrench major bank dominance.
In general, commentators look at crisis management through the wrong lens. The four major banks are now sacred cows. The regulatory response to future financial crises in Australia will be mediated through, and at the discretion of, the Big 4. Whatever adverse economic and social consequences eventuate will continue to be ignored.