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Having survived the 2008 financial crisis relatively unscathed, Australian banks project an enviable image of sound, well-managed and highly profitable institutions. In recent years, the total share market value of the Australian financial sector has been large when compared to that of its eurozone and U.S. counterparts. While the respective valuations fluctuate, this is a staggering outcome given the relative populations, comparative sizes of the economies and the vastly larger asset bases of European and American banks.
But the stellar reputation of Australian banks requires re-evaluation. The Australian banks had a lucky escape from the worst of the financial crisis because their near-death experiences of the early 1990s made them slow, cautious, conservative and overwhelmingly domestic in focus. Extensive government deposit guarantees and underwriting of borrowings insulated them from funding difficulties during 2008-2009.
Subsequent revelations, investigations and settlements have exposed extensive misconduct, strikingly like that of American, British and European peers. These include product mis-selling, manipulation of key financial benchmarks, breaches of money laundering regulations, and alleged anti-competitive collusion.
The ongoing Royal Commission into Australian banks, a formal public inquiry presided by a retired judge with broad coercive powers, has highlighted major failures. It has heard evidence of poor credit policies, predatory and unconscionable lending practices. There have been examples of poor and inappropriate investment advice, charging fees for no services provided, siphoning fees from deceased estates as well as impersonating clients and forging signatures on documents. The Royal Commission has heard testimony on bribery, fraud rings, pervasive lying to regulators as well as an unwillingness to act on legitimate client grievances. Some accusations are of doubtful merit reflecting cases of buyer’s regret and unrealistic expectations. But the impression is of poor mismanagement, emphasis on short-term interests of managers and shareholders, ignorance of fiduciary duties and a cavalier disregard of regulations.
The fallout has been significant. Share prices of financial institutions have fallen by 20% or more from their peak in 2015. The chief executives of the Commomwealth Bank and AMP as well as the chairman and several directors of AMP have resigned. Others may follow. Class actions and prosecutions, including criminal proceedings, are likely. Prime Minster Malcolm Turnbull’s conservative government, which disparaged earlier calls for the Royal Commission as an inquiry looking for something to inquire about, now finds its business-friendly policies, such as tax cuts, and re-election prospects threatened by events.
The likely remedies are tiresomely familiar: better training and licensing of staff; tighter regulation, harsher penalties, better resourcing of regulators and aggressive enforcement. But fundamental concerns about the structure of the sector, especially the over-concentration of market power among too few banks will remain unaddressed.
Vertically integrated banks frequently provide advice, and manufacture and sell financial products to clients, in ways that create conflicts of interest. Performance-linked remuneration policies encourage mis-selling of high-margin products. As Charlie Munger, Warren Buffett’s long-time business partner once noted: “Show me the incentive and I will show you the outcome.”
The banks’ power is exacerbated by limited competition, which decreased after 2009 when foreign banks withdrew from the domestic market. Australia’s four largest banks control around 80% of the loan market. They account for around 20% of revenues from mortgage broking. The banks and their funds management subsidiaries control around 25% of all investment funds under management, accounting for around 30% of all asset management fee revenue. The banks account for a quarter of all life insurance industry premiums and investment revenue. The banks receive around 40% of the revenue generated in financial planning and advice services.
This hegemony is reinforced by Australia’s compulsory retirement scheme which channels 100 billion Australian dollars (US$75.6 billion) in annual flows into the financial system. The position is enshrined in the four pillars pensions policy which favors the major banks. The arrangements are de facto underwritten by the Australian government and tax payer, as evidenced during the global financial crisis. A 2012 study estimated that the aggregate public subsidies to the financial system were over A$11 billion per annum, not far short of the forecast budget deficit for 2018-2019 of A$18.2 billion.
Meaningful changes are unlikely. Well-financed and skilled lobbyists will deploy well-rehearsed arguments to preserve existing arrangements. The industry will argue that it is a case of a few rogue employees whose actions could not have been foreseen. Over $340 billion in fines and settlements paid out by global banks since 2009 suggest that the problems are not isolated cases of a few bad apples.
Harsh actions will be portrayed as undermining confidence in the financial system, creating unwanted instability and economic damage. Australian banks are disproportionately large, with the combined assets and loans of Australia’s big four banks being around 130% and 115% respectively of Australian gross domestic product, well above the comparable figure of less than 50% of U.S. GDP for America’s four largest banks.
Bank lobbyists argue that additional restrictions could threaten the essential supply of credit for the economy, especially the crucial housing and construction sectors, or cause falls in house prices, a sensitive electoral issue. Banks will be depicted as major tax payers and employers as well as key channels for monetary policy. Precipitate measures, it will be argued, may damage international perceptions of banks which play an essential role in securing foreign funding to cover Australia’s significant and persistent current account deficit.
Lobbying efforts will exploit the fact that many people and businesses are both investors in and clients of the banks, which constitute more than 30% of the Australian stock market’s total capitalization. Stringent regulations, it will be asserted, will harm bank share prices as well as reduce profitability and dividends affecting around 14 million Australians.
The banks will press for self-regulation. Major changes such as separating product and advice will be resisted because it requires a major restructuring of the financial industry and is unjustified on unspecified cost-benefit grounds. In a variation of the “devil you know” argument, the spectre of bank clients turning to other providers, potentially unregulated, will be used to limit changes.
Where additional regulations are unavoidable, banks will use “salami slice” tactics to weaken changes, challenging and debating each measure individually. They will delay, awaiting a more sympathetic government or better environment when they can argue that the proposals are no longer necessary.
All economies require a diverse and competitive financial sector without excessive concentration, focused on essentials like a secure payments system, a safe repository of savings, market-priced funding and effective risk management instruments. For Asian policymakers, the Australian financial system highlights the problems of an excessively large and powerful financial sector. A banking system that is too big to fail, and (it seems) too large for managers to run properly or regulators to oversee effectively is not in any country’s long-term interests.
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Author: Satyajit Das
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