Murray tackles ‘too big to fail’, but are we increasing the risk of failure?
When a financial services inquiry was first proposed by Joe Hockey — borrowing from an eclectic group of economists — in 2010, the banking environment was somewhat different. The banking cartel had been lifting interest rates above the RBA’s rises for a year, although few people understood that that merely meant the RBA would be slower to lift official rates and the eventual difference would be minimal. There was considerable focus on the dearth of competition in the banking system in the wake of the financial crisis, which had allowed the big banks to consume some of their nearest smaller rivals.
And there was a lot of talk of “too big to fail” — the problem on institutions that are so large, everyone knows a government won’t let them collapse during a financial crisis, giving it an implicit guarantee that enables it to access funding at a lower cost than smaller competitors and encourages riskier behaviour. In a speech back then, Hockey correctly observed:
“… we have the major banks claiming that they need to expand offshore to pursue higher growth opportunities than those they can find domestically, or move into non-core areas of business, like funds management. But it was precisely the absence of these overseas exposures that the RBA regularly opined was the chief saviour of Australia’s banking system during the Financial Crisis.
“With massive taxpayer risk in play we as policymakers need to decide if we want the major banks to be unrestrained growth stocks, like resources or technology companies. Or do we want the industry to be more akin to bullet-proof utilities that are focused on delivering stable returns to shareholders? One possible solution here is to quarantine the risks that taxpayers will insure, and accordingly quarantine the coverage of our moral hazard.”
So strident was Hockey on the performance of the banks that an exasperated Mike Smith, CEO of the bank most prone to behaving like an unrestrained growth stock, ANZ, compared him to Hugo Chavez. Hockey talked tough in response: “Bank CEOs can shoot me, they can decry me, they can have a go at me. I don’t mind, because we are standing up for consumers, we’re standing up for small business, we’re standing up for the people that are missing out on more competition in banking.”
Well, maybe. After becoming Treasurer, that focus on too big to fail was watered down by Hockey in the terms of reference for the Murray financial services inquiry, reflecting the much more bank-friendly nature of the inquiry that Hockey finally delivered.
Still, too big to fail occupies some space in the interim report. The report concludes that it “is difficult to estimate the size of any possible funding cost advantage that the perception of being too-big-to-fail provides large banks. This is in large part due to different creditors having different perceptions around risk.” But it knows it’s there, because in the stability section, the report devotes a lot of space to how to address it, asking for comment on measures like:
- “imposing losses on particular classes of creditors during a crisis” — albeit acknowledging this could actually worsen a crisis given how banks lend to each other;
- giving financial sector regulators greater “resolution” powers to use during a crisis (a regulatory process that’s already underway);
- more pre-planning and “pre-positioning” for crises by regulators and banks, so everyone is clearer about how a “resolution” process would work;
- further increases to capital requirements to reduce the likelihood of failure and need for bail-out;
- imposing a charge for the government’s retail deposit guarantee; and
- ring-fence certain banking activities, Volcker Rule-style, to minimise the risk of contagion from riskier activities.
None of these ideas are likely to win favour from the big banks, but then again the report is a million miles from Hockey’s original talk about regulating them like utilities. However, the inquiry has picked up and run with an issue raised by the Reserve Bank that provides a different context for too big to fail: homegrown contagion from property.
The way our tax system “tends to encourage leveraged and speculative investment in housing” is a problem, the inquiry suggests:
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