Imagine if the government routinely chipped in half the cost of McDonalds’ and KFC’s bun orders. Other fast food restaurants had to buy their own buns. As you’d expect, the two chains would spread further, enjoy bigger relative profits than other restaurants who in turn would struggle to compete.
Such a policy would not survive public scrutiny. But banking works similarly in Australia, where taxpayer are each contributing up to $7 billion a year to the bottom lines of the big four banks – ANZ, Westpac, National Australia Bank and Commonwealth Bank.
The money doesn’t flow directly, but if the banks lose enough in a financial crisis taxpayers are on the hook to ensure their creditors get paid. No matter what governments might say, the GFC showed in the United States and Europe that they will come to the rescue when the financial system looks like choking.
In the meantime this implicit insurance for creditors means they are willing to lend to banks at lower interest rates than they otherwise would, a boon for big banks’ bottom lines. It is curious the government has devoted so much energy to introducing a new tax on resource firms when they don’t enjoy any implicit subsidy from taxpayers.
Standard and Poor’s business is to work out the likelihood creditors will get their money back. In December it said very clearly that were it not for Australian taxpayers standing behind the big four banks their credit ratings would drop two notches.
That would give them similar credit ratings to smaller banks like Suncorp or Bank of Queensland, which do not enjoy the implicit guarantee and pay about half a percentage point of interest more on their borrowings.
If we ignore deposits, which are insured explicitly up to a maximum $250,000, the big four banks have total wholesale liabilities of just over $900 billion. Reasonable people can argue about what fraction of those are affected but the annual benefit to banks is probably worth between $2 billion to $7 billion, which is about 30 per cent of their combined annual profits.
Lo and behold the big banks’ interest margin – the gap between what they borrow at and what they lend to their customers at – is also roughly half a percentage point greater than that for regional and smaller Australian banks. You don’t need a PhD in economics to know that part of that gap is substantially owing to taxpayers’ free insurance.
Last week the Bank of England said the subsidy from British taxpayers to Britain’s biggest banks was at least 6 billion pounds a year. Governments overseas are attempting to deal with this unfair and damaging benefit. The Swiss and British governments, for example, are forcing their biggest domestic banks to hold more much capital, to reduce the likelihood their taxpayers will be called upon in a crisis.
The subsidy is not only unfair for taxpayers and smaller bank competitors, it also distorts the whole economy. Ordinary Australians are pushed out of the housing market as outsized pay packets in the teeming upper ranks of finance drag up prices. The subsidy encourages banks to grow even larger, dragging more of society’s best and brightest into financial services. The subsidy has also helped Australian households become among the most indebted in the world, as loans are more plentiful than they would otherwise be.
An alternative to forcing large banks to hold more capital would be a flat tax of half a percentage point, say, on banks’ non-deposit liabilities and the new revenue should be used to cut personal income tax rates for all taxpayers. But sadly governments can rarely be trusted to use new revenue to cut other taxes.
The GFC showed that genuine competition among banks is a farce; the possibility of failure, which underpins capitalism, has been removed. How to rectify this problem is not clear though. It’s always possible further government meddling would make the problem worse. Nevertheless authorities here should at the very least work out how much the implicit guarantee is worth so taxpayers can better understand what is going on.
Follow Adam on Twitter: @adam_creighton
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