You can’t bank on the Big Four to do the right thing
One of my first jobs in journalism was as the banking reporter. The thing you learn quickly on the banking round is that banks like to give out free stuff to journalists (Mortgage holders? Another matter entirely).
Offers of free lunches at swanky city restaurants are swiftly forthcoming. Umbrellas emblazoned with the corporate logo are common gifts, and yes, I took a few.
And so it was that on a rainy day in early November 2010, I found myself heading out to dinner, casting a wary eye at the skies and another at my Commonwealth Bank freebie umbrella sitting by the front door.
Some context: Two years earlier, the global financial crisis had struck. The Reserve Bank begun slashing interest rates and the banks, citing higher funding costs on turbulent international capital markets, started cutting their lending rates by less. Then, in late 2009 as the economy began to recover, the Reserve Bank began lifting interest rates, and the banks passed on super-sized interest rate rises, again citing higher funding costs. Stung on the way down and slugged on the way up, mortgage holders were furious.
Fortunately, the Reserve Bank took all this into account and kept adjusting its cash rate until it saw mortgage interest rates where it wanted them to be. But it was a public relations disaster for the banks.
In late 2010, the Commonwealth Bank was singled out for particular scorn, having passed on 0.45 percentage points to the Reserve Bank’s 0.25 percentage point hike - the highest of the big four. Customers were livid.
But it was raining, and I didn’t want to get wet. As we walked up the street to dinner sheltered by the super-sized yellow and white umbrella I did notice passersby taking a second look. We hailed a taxi. The first question from our driver: “You don’t work for Commonwealth do you?” Me: “Nah.” Driver: “Good, I almost didn’t stop for you carrying THAT umbrella”.
Australians have never much liked bankers. In the old days, we resented having to suck up to get a loan, donning our best suits and going cap-in-hand to beg for finance. Then, in the 1990s, when foreign banks and smaller lenders came into the market, the banks began slugging customers with all sorts of unpopular fees to make up for squeezed profit margins.
Then the global financial crisis hist. Smaller lenders struggled to raise finance and dropped out of the market or were taken over. Commonwealth ate BankWest. Westpac swallowed St George.
While most other companies got hammered by the GFC, Australia’s big four banks have risen, stronger than ever.
They are amongst only a handful of AAA-rated banks world wide. Lending growth has slowed, but they are in rude health. In 2010-11 they posted combined profits of $24 billion (Westpac: $7 billion; CBA: $6.4 billion; ANZ: $5.4 billion; NAB: $5.2 billion). Why so profitable?
For most businesses, the prices they charge are a function not just of their costs, but also what their customers are willing to pay before switching to a cheaper supplier. But Australia’s big four have the market pretty much stitched up. They charge what they like.
For share holders, this is great news. Commonwealth Bank’s profits represented a return on shareholder equity of 18.6 per cent in the 2010-11 financial year, according to research firm Morningstar. For Westpac, it was 15.1 per cent, ANZ 14.9 per cent and 13 per cent for NAB. When property prices are flat and cash returns are falling, that’s a pretty sweet little earner.
Former Commonwealth Bank chief David Murray last week insisted banks need a return on equity of about 16 per cent - but why?
One of the golden rules of investing is the “risk-return trade off”’ - the riskier the investment, the higher the potential pay off. When you look at the ASX200, some of the companies with the highest returns on equity are James Hardie (76 per cent), Fortescue Metals group (75 per cent), Wotif.com (58 per cent) and Cochlear (35 per cent). Investors in asbestos suppliers, speculative minerals investors, internet companies and medical technology companies require some sort of “danger money” to stump up the cash.
But the big banks can’t go under. They government wouldn’t let it. During the GFC, the government stepped in to go guarantor on all their debts. There is no safer investment.
Nor do Australian banks do anything particularly innovative. The basic business of banking hasn’t changed in centuries: borrow at a low interest rate, lend at a higher interest rate and pocket the difference. Banks are basically intermediaries between depositors and borrowers. It’s pretty boring really and it’s not at all clear why investors should need such a high return on their investments in Aussie banks.
Aussie banks sailed through the GFC courtesy of taxpayer funded guarantees and passing on higher costs in full to their customers, all the while sustaining near record level profits.
Not only should they pass on last week’s interest rate in full, but given their high levels of profitability, there’s no reason they shouldn’t be passing on even more.
No more free umbrellas for me, I guess.
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