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You can’t bank on the Big Four to do the right thing

Jessica Irvine

by Jessica Irvine

08 Oct 05:45am

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Filed under: Banking, Banks, Economy, Interest Rates, Money, Rba

33 comments

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).

I can… but I choose not to. Pic: News.com.au

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.

Comments on this post will close at 8pm AEST.

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33 comments

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    • Tubesteak says:

      06:50am | 08/10/12

      The only thing that’s in the interests of banks, as for any private enterprise, is profit. That’s the only way it should be.

      Their funding costs are increasing. The RBA’s cash rate is just one part of the story. They are finding it harder to get money from other sources as funds dry up from overseas.

      “the government stepped in to go guarantor on all their debts”

      Not exactly true. The government guaranteed deposits with the banks of up to $1m. This wasn’t anything new. The RBA has always guaranteed deposits with all banking institutions.

      But this never came to opass and no bank was bailed out or funded by Australian taxpayers. Two of our banks did seek a bailout from the US because that has been their policy since it was introduced by Dubya back in 2002. The dodgy assets and conditions were created by the US government so naturally they should be forced to pay out on their promise.

      Reply

    • Esteban says:

      12:29pm | 08/10/12

      When the banks were de regulated back in the 80’s part of the deal was that the Govt guarantee was withdrawn.

      The last Govt guarantee was for the CBA which phased out about 5 years after it was fully privatised.

      So prior to the GFC there was no Government guarantees of Australian banks and hadn’t been for years.

      As the GFC unfolded European Governments were forced to Guarantee deposits to prevent runs on banks. Although Australian banks were strong at the time it was prudent for the Australian Govt to put guarantees in place to prevent flight of money to foreign banks with govt guarantees.

      Actually the guarantee of Australian Banks became a no brainer and was the most effective component of the Govt response to the GFC and in the end didn’t cost the taxpayer a single red cent.

    • SAm says:

      07:08am | 08/10/12

      Ive decided to simply save and buy a house in cash eventually, pretty much to spite the banks

      Reply

    • fml says:

      07:36am | 08/10/12

      Best bet would be to purchase gold. It’s cost has been consistently rising.
      Safe as houses, well probably even safer.

    • PW says:

      08:13am | 08/10/12

      The trouble with gold is that the rise in capital value is the only return possible, since gold does not pay interest, dividends, or rent. Its value rises only when other investments are failing. When shares and property are doing well, gold always loses value.

      So it’s a great investment in bad times, but poor in even average times and abysmal when there is a boom in other investments. Like everything else, you need a crystal ball.

    • Bomb78 says:

      01:33pm | 08/10/12

      If you want exposure to gold, buy a gold miner. You don’t have to pay to store shares, unlike physical gold, and you might even get a dividend on the way through.

    • Kika says:

      02:07pm | 08/10/12

      I am with you Sam. I am a nouveau ‘conscientious objector’ in getting into the mortgage cycle. I too am a saver and whilst I have enough for a comfortable deposit I refuse. My parents think I’m being tight or being too picky in refusing to buy a dump in Logan or something, but it’s not that at all. I’d rather buy a house in cash when I need it rather than having nothing now and nothing later except for the bricks and mortar around me. News people - look at Christchurch. What happens if all your money goes into your house and something happens which damages your house and you’re not getting paid out by insurance - what have you got? Nothing.

    • Brenda says:

      07:22am | 08/10/12

      Firstly, the GFC was caused by people who over-borrowed at interest rates that they ultimately could not afford. Bill Clinton encouraged the notion that US citizens, regardless of their financial position, should be able to take a mortgage.  if you borrow money you should first make quite sure you can cover interest rate fluctuations.

      A loan is a privilege, not a right.  If you can’t afford something that a private enterprise is offering, don’t buy it.

      No Australian banks needed bail-outs because they were well-regulated.
      You need profitable banks operating business models that can withstand downturns. They are not charitable servants of the public.

      Why do borrowers expect that they can dictate interest rates while depositors get no say about the declining value of their savings with interest rates that suit one section of the community to the detriment of another?  Bashing banks about their home loan rates has become a boring subject.  Don’t like the rates? Reduce expectations, lower the borrowings or don’t ask for a mortgage loan if you can’t afford it.

      Reply

    • Economist says:

      08:20am | 08/10/12

      I’m not convinced by the claims it was the Community Reinvestment Act that caused the GFC. There’s also a difference between encouraging and forcing? The CRA was a way for the government to abandon the idea of public housing and implement a private sector solution?

      There seems to be a reluctance to acknowledge that loans made under the CRA were not anywhere near the majority of loans defaulted on. Nor any acknowledgement that the repelling of Glass Steagall that created an environment of unfettered, unmanaged greed.

    • Tubesteak says:

      12:00pm | 08/10/12

      Economist
      Brenda was right.
      Also, whilst encouraging is not the same as forcing, if you create market conditions where everone wants to jump in the pool then effectively you’re the one to have created those market conditions. While you didn’t force anyone into it you certainly fostered the conditions.

      I’ve been trying to find the article where one of the first economists/analysts believed there was a problem as far back as 2005/06. He did a tour of certain areas and found people on incomes as low as $35k having $700k mortgages with the balloon payments not that far off being payable. This was created by the US govt encouraging these types of loans. It was the CRA that laid the bedrock. This influenced the rest of the market. As you should know, nothing happens in isolation in economics. Least of all consumer behaviour and demand.

      However, Brenda should sleight home some blame to Dubya. To wit: http://www.youtube.com/watch?v=kNqQx7sjoS8

    • andye says:

      12:22pm | 08/10/12

      @Brenda - That is a load of crap. When the “gold rush” was on and the banks were desperately getting as many loans as they could to sell on in the Credit Default Swap market, the CRA you are talking about only covered a small percentage of the loans, and was in fact HOLDING BACK those lenders. The unregulated lenders were lending more.

      What you are repeating is the standard Republican line in order to blame Clinton.

    • bananabender56 says:

      02:00pm | 08/10/12

      Economist
      I was living in the US prior to the GFC and took out a bank loan for effectively 105% of the purchase. IMHO one of the biggest issues with fixing something that wasn’t broke was the banks introducing interest only loans, with people relying on selling the house to cover the principal. I could never understand why, in the US, 20 or 30 year fixed interest (low) mortgages were the standard, while in Australia if you asked for 5 year fixed term your looked at as if your from another planet. The semi government institutions of Freddy Mae and Fanny Mac also seemed to lose squillions.

    • Blerghhh says:

      07:28am | 08/10/12

      I know attacking bank profits is the new national past time, with every mortgage holder and the treasurer all getting involved; but the benefits that a profitable banking sector gives the nation i feel justify their profits. this idea that a corporation all of a sudden earns too much money is ridiculous. they’re corporations, they exist to make profits for the benefit of their shareholders, they aren’t charities whose responsibility is to make society happy; they’re banks who make profits. i personally don’t understand why people have a huge problem when banks act how banks should; and ultimately the whole country benefits as a result. . if you don’t like the big four go to a credit union or a smaller lender. but the whole point of being with a bigger bank is you pay a bit extra for the security of a major lender (keep in mind that BOQ is expecting an annual loss).

      Reply

    • Economist says:

      07:57am | 08/10/12

      I don’t have a problem with the interest rate differential, I have a problem with the fees for accessing money and the arrogance of the banks to charge you for basic transfers.
      They then have the gall to argue if you have $50,000 in deposit,varies from bank to bank,  fees are waived on most items, but not all.

    • Jeremy says:

      11:27am | 08/10/12

      @Economist - I have a normal bank account, with a VISA debit card and not that much money in there, I haven’t paid a fee in years. I can’t remember the last time I paid a bank money. If you are being inundated with fees, it’s your own fault. You should to wise up if you’re going to keep using that nom de plume

    • Esteban says:

      12:45pm | 08/10/12

      You have let yourself down today economist.

      There is a cost in providing banking services. I am not sure what the break even point is but if you never have an overnight balance of say $1,000 your account would probably cost more than it makes.

      (By the way what other businesses are compelled to have a huge block of customers that cause them to make a loss ?)

      On the other hand if you always had a minimum balance of $50,000 in the bank then you would be profitable to the bank. Enough profit to be able to waive cost recovery fees.

      The offer of no fees if you maintain a minimum balance of $50,000 comes about because banks willcompete for your valuable business.

      Why would Banks want to compete for an account that makes it a loss?

    • andye says:

      05:49pm | 08/10/12

      @Esteban - Apparently it isn’t that much of an issue, considering the massive profits. Banks are more than just a simple business, they are part of the financial system and regulated accordingly. They also receive guarantees from the taxpayer. People require a bank account just to get paid and function in society. Furthermore, the older people get, the more likely they are to become those “good” customers you are talking about.

      Banks and their massive profits are just going to have to deal with the basic social cost of the services they need to provide for our society to function. They only exist as part of a relationship with that society, and that society does provide protection to them.

    • pete says:

      07:57am | 08/10/12

      Two out of the big four have low cost operations where you can get a loan or a refi between 5.62-5.82% (before latest cut).

      Switch or pay more and spend your days moaning on Facebook.

      Reply

    • Bob says:

      08:01am | 08/10/12

      You can’t broadly apply something the central bank does to every private bank around. That’s just stupid and poor practice. These banks have their own requirements and situations, and I would much prefer an extremely profitably bank than a bank taking the populist position. So a few people go without a movie one week or have to buy a cheaper meal. That’s not a big deal. When a bank makes regular losses or goes bankrupt that’s a big deal.

      By the way, the point about the government not letting one of the big banks going under is a ridiculous point. Didn’t the US bail out some major banks after some collapsed during the GFC? Look at the position the United States is in now. Yeah, bail them out, but it’s going to hurt you big time.

      Reply

    • Loddlaen says:

      08:53am | 08/10/12

      Genuine question. Has there been an instance of the big 4 not passing on a rate rise in full?

      Reply

    • Alfie says:

      09:29am | 08/10/12

      I have more faith and trust in the ‘Big 4’ than I do in clowns like Glen Stevens and Wayne Swan.

      At least the banks are responsible and accountable for their decisions.

      Reply

    • Sync says:

      10:49am | 08/10/12

      Responsible…? Depends what side of the fence you’re on, I suppose. It’s irresponsible to pass on a rate rise in full (or more) the same day the RB announces it, while taking up to a couple of weeks to pass on a rate cut (and often not the full amount) when the RB reduces rates. It’s irresponsible to slug customers $2 per transaction to use the ATM or another bank when there are no ATMs of your bank within 10km of your current location. Its irresponsible to charge customers $50 to dig up old statements when the guy on the end of the phone is only clicking a few buttons on a web page. I could go on.

      Accountable…? Only to the board and shareholders. They don’t appear to give a tinker’s cuss what the government and people think of them and their decisions.

      I do, however, agree that Wayne Swan is hardly the person I would go to for any kind of financial advice.

    • Alfie says:

      01:58pm | 08/10/12

      Sync
      Firstly, banks are busenesses, they are not automatically obliged to follow the RBA. As for your complaints about interest rates, bank fees and the $2 ‘slug’ at the ATM, you have a choice - don’t us them.
      Perhaps you should just stuff your money under the matress and stop bitching.

    • the moor says:

      10:58am | 08/10/12

      As per usual the banks are thumbing their noses at the government and us.  Thats the price we pay for the lack of competition in Australia.  Given that a large part of their profits come from Home mortgages and Credit Cards why not allow the Industry Superannuation funds into this market.  ie allow them to operate as quasi banks providing us with loans for our housing and credit cards.  It would improve their bottom line and introduce competition.

      Reply

    • Esteban says:

      01:15pm | 08/10/12

      Have you seen your super statement since they started disclosing the fees they take out.

      Jessica thinks running a bank is easy but how easy is it to run a super company? A few analysts and a few buyers sitting behind computers and charge huge fees.

      The super funds can apply for a banking license but they don’t . No one is stopping anyone from applying but they don’t.

      Super funds have probably looked at the returns of the banks and thought it looked lousy compared to what they charge and couldn’t be bothered operating a banking license.

    • AdamC says:

      11:18am | 08/10/12

      Bank-bashing is not unqiue to Australia. The Yanks, for example, have a long history of it, exacerbated in recent times by having to stump up hundreds of billions in public capital to save impecunious firms.

      Australia’s big banks are large and have strong market positions. That is pretty typical of commercial trading banks globally. Unlike most of our international peers, however, our banking sector - for a few reasons - has not seen crashing profits and trashed capital positions. That is not a bad thing.

      Because of their strong market positions, along with the utility-style nature of banking, the big banks are in the admirable position of being able to pass on rising costs, in this case interest costs, to conserve their profitability. Most businesses, even large ones with strong brands and big client bases, can only dream of doing the same.

      So a bit of bank envy is perfectly OK and quite justifiable. Silly, naive bank-bashing, is not.

      Also can we please stop having this debate about what caused the subprime crisis in America? There were lots of factors that contributed to it, many (if not most) of which did not involved government encouragement to give loans to poor people and minorities.

      Reply

    • Tubesteak says:

      02:16pm | 08/10/12

      “Also can we please stop having this debate about what caused the subprime crisis in America?”

      No. Principally, because it’s one of the most fascinating things in recent times. Perhaps since Bretton-Woods.  But also because ignorance like this still abounds:

      “. . . many (if not most) of which did not involved government encouragement to give loans to poor people and minorities”

      Wrong. This is what inflated the market. The expectation that poor people and minorities be given loans and affordable housing sent a shockwave throughout the rest of the mortgage sector that it created a large housing bubble that popped when many balloon payments (ironic naming) came due and payable and weren’t able to be paid by most people because they had loans on houses with inflated prices for payments with a long honeymoon period. See my comment to Economist above and watch the youtube link. It’s GWB at his finest.

    • Disgraceful banks says:

      11:52am | 08/10/12

      Thank you Jessica,

      Our banks have become largely foreign owned and controlled rent seekers on our economy.  They borrow huge amounts of money from overseas to build asset bubbles in Australia, and ultimately they know they can do exactly what they like because they are government guaranteed.

      Our Australian banks are a disgrace.  They have become part of the problem, not part of the solution.

      Reply

    • Esteban says:

      01:03pm | 08/10/12

      I don’t have the exact figures on Bank shareholders but I think you are wrong that they are foreign controlled (owned?)

      Australian banks are very popular with Auistralian super funds because they are safe and reliable dividend paying shares.

      So if you have superannuation you actually indirectly own shares in an Australian bank. Also your super has done very nicely on the back of those bank shares so I hope you don’t feel too guilty when you are spending that bank money in retirement.

      Australian banks distribute about 60 - 70% of their after tax profits as dividends to the mostly Australian shareholders. Apart from super funds many of these shareholders are self funded retirees who appreciate the reliable dividend stream.

      Don’t forget “self funded” means not drawing a taxpayer funded pension.

    • Inky says:

      01:37pm | 08/10/12

      I have two main problems with my bank.

      1) When I lodged a credit card dispute with they, I provided all the information that I could and they proceeded to do nothing until 6 months later when is sent them a snarky email one night telling them that if they’re not going to do anything to at least let me know. They sent out such a letter, via snail mail.

      2) They seem to call me every 6 months to try and flog their insurance at me.

      These are hardly the big gripes, but that’s because I don’t have any loans, nor do I intend to have any. I’d rather rent the rest of my life than be in debt to a bank, because I trust them about as far as I can throw them. Which is to say, I stand at the corner of the building, grunting and heaving and not make any progress.

      Reply

    • Siege of Perth says:

      02:22pm | 08/10/12

      Someone should show what actual bank rates should be if they hadnt separated from the RBAs rate a few years ago. They always decrease by less and increase by more. Wouldnt surprised me if they are as much as 2% better off by now.

      Profitable banking sector is very good for us as a country. But the author raises a good point, 16% is a massive return in finance terms, why do shareholders need such a big return. The Banks have a responsibility to their share holders yes, but they also have a responsibility to the country. Cough up 3-4% (would still be 12%!) off the return of equity and lend it out so people can drive the country forward through investment.

      Reply

    • Esteban says:

      06:32pm | 08/10/12

      Banks have to meet certain balance sheet requirements as set out by APRA.

      Those guidelines limit how much an individual bank’s balance sheet can carry in loans.

      By calling for the more loans to be written from equity you are asking for APRA guidelines to br broken.

      The other funny thing is that by increasing the amount of lending the return on equity would actually increase.

      I think Jessica is calling for reduced return on equity via reduced profit margins. In other words lower interest rates on loans which reduces earnings and therefore return on equity.

      To this end the banks simply reply “why should we?”

    • Esteban says:

      02:26pm | 08/10/12

      Jessica. I think it is a bit disingenuous to say “tax payer funded” guarantees.

      The Government took on a contingent liability by guaranteeing the banks but the gurantees were never called upon so there was no funding required.

      Perhaps “tax payer backed guarantees” is a more accurate description of what took place. Other wise you have left your comments open for people to assume that the Govt bailed out our banks which as you know is not the case.

      In fact why use the emotive term “tax payer"at all? If it is a Government guarantee then ultimately that guarantee is backed by the taxpayer. Does that not go without saying?

      A few weeks ago you stated that the Govt debt is easily managed.

      Given that the banks will pay about $8 billion this year on their profits I think Wayne Swann is very grateful for their profitability.

      In fact if the banks were to have tighter margins their reduced profitablility and hence tax contributions would see Mr Swann’s thin surplus of $1.5 billion evaporate.

      How easy would our debt be to manage if we went back into deficit due to lower tax receipts from the banks?

      Reply
 
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