Tuesday, December 14, 2010

Battling the big banks

THE public response to Treasurer Wayne Swan's banking reforms seems to be a growl of disappointment. Australians are fed up with being ripped off by bank bosses who are paid several hundred times more than them. They are angry that banks are able to charge us what they like, and get away with it. They want tough action to hit banks where it hurts and these reforms don't do it.

They're right. These reforms won't lower your mortgage rate. They won't stop the big banks jacking it up even higher if they can get away with it. And so long as we ask them for three out of every four home loans we borrow, they will get away with it.

But why didn't Swan go further? Were there tougher reforms that he and his colleagues were just chicken to take on? Or was it that there is no simple way to reduce the market power of the banking cartel and that some of the solutions proposed could end up being worse than the problem?

Let's start by looking at where we are, and how we got here. And we'll start with the positives, because they are big positives.

First, unlike most in the West, Australia's banking system did not collapse in the global financial crisis. That's partly because the Australian Prudential Regulation Authority did an outstanding job as our watchdog before the crisis. It's partly because the government moved in the heart of the crisis to guarantee the banks' debts and deposits. But it's also because our banks were prudent and sensible lenders, when their overseas counterparts were not.

That matters for us, because the banks emerged in good shape to finance the recovery. Mortgage lending alone has grown by $162 billion in the past two years. The banks are greedy, yes, but they're good at their job and that's good for us.

Second, interest rates and bank margins have soared over the past year, but with mortgage rates now typically 7.15 per cent after discounts, it's not crippling. If we're in trouble with rates at that level, then we've borrowed too much.

But there is also a big negative. The banks' margins were driven down in the 1990s and early 2000s by competition from new lenders, who derived much of their funding from securitisation: selling bundles of our mortgages to investors, and reinvesting the proceeds in new loans.

The global financial crisis began when this market was poisoned by American banks filling their securitised bundles with bad mortgages. As they went bad, the market for securitisation collapsed even for Australian lenders, whose bundles remain good. And as it collapsed, so did the new lenders.

The big banks swooped, bought up their weakened rivals, and regained their lost market power. The four big banks now hold 80 per cent of all loans. The other banks have 17 per cent, and all credit unions and building societies, just 3 per cent. They're to be our fifth pillar? This will be a long wait.

We got here partly because the GFC wiped out securitisation and the new lenders, but also because in good times and bad, governments and competition regulators have allowed the big banks to gobble up their rivals.

Consider this list: since 1990, the competition watchdogs have allowed the Commonwealth Bank to take over the State Bank of Victoria, the State Bank of NSW, BankWest, Colonial State Bank and Wizard Home Loans. They allowed Westpac to take over Bank of Melbourne, RAMS home loans and St George (in addition to its earlier acquisitions: the Challenge Bank, Advance Bank and Bank SA).

Three times, the regulators allowed one of the big four to swallow up the next biggest bank: first, the State Bank of Victoria, then the Bank of Melbourne, then St George. The result is a cartel that, by and large, does not compete on price.

What could the government do? The most effective way to boost competition would be to set up its own bank, using the post offices as retail outlets. But that would need to be a big venture, with outlays rivalling the national broadband network. It's not surprising Swan turned that down.

It could require the banks to offer loans with margins fixed over the Reserve Bank's cash rate. University of Melbourne finance guru Kevin Davis points out that Australia's variable loans are unusual in requiring borrowers to bear all the risk of rising interest costs. But wouldn't it be better to try to fire up the competitive pressures that will bring those margins down?

That's essentially what Swan's reforms aim to do. One stream of changes would make it easier for us to change lenders by banning exit fees on new loans, and possibly by giving us portable account numbers and thus put pressure on all lenders to compete on price.

A second stream aims to widen the funding sources for potential competitors: by continuing and publicising heavily the government guarantee of their deposits, which was due to expire next October, and by the government buying up another $4 billion of mortgage securities.

The third stream of reforms is aimed at a separate problem: stemming the foreign debt. It will allow banks and credit unions to issue covered bonds a variant of securitisation in which the risks lie with the institution rather than the investor to attract the super funds to invest at home. And the government will try to set up an Australian bond market, to increase options for investors and lenders.

None of this will reduce your mortgage rate next year. But bit by bit, it will build competition, and that will lower rates.

If you're paying too much for your mortgage, you'd better find your own solution: tightening your belt to pay down your debt, refinancing with a credit union, whatever. Best of luck.