Glenn Stevens has helped the cause of those who think Wayne Swan’s banking “reforms” are a response to a problem that has yet to be demonstrated and, indeed, have the potential to distort competition and create new risks for a system that has proved to be quite resilient.

The Reserve Bank governor’s opening statement to the Senate committee inquiring into competition in the banking system helps put the debate about competition — and Swan’s proposed reforms — into perspective.

One of the critical issues in trying to determine whether reforms are required, or not, is to choose the reference point from which the intensity of competition is measured.  Swan, Hockey and most of the big bank bashers look to the period immediately preceding the financial crisis, when there was intense competition, particularly in mortgage lending, mainly from the non-banks but with some contributions from the regional and foreign banks.

Stevens told the committee that risk had been repriced since 2007 but implied that this wasn’t a bad thing.

“It is widely held that risk was under-priced for some years before then. That is to say, investors demanded very little risk compensation in their expected returns, perhaps in some cases because they didn’t understand the risks,” he said.

“So financial institutions of all types could get ample funding cheaply and this could be passed onto borrowers. Business models that took particular advantage of low-cost wholesale funding and/or securitisation were able to provide a very competitive edge to certain markets, particularly (but not only) to markets for mortgage lending.”

In 2007 and 2008 investors around the world changed their attitude to risk and the compensation they required, which has affected all financial institutions but to varying degrees and which had affected the locus of competitive forces — where previously the competition to lend money was intense more recently it was the competition to raise money that was intense.

Stevens, after saying the market remained “a good deal more competitive” than it was in the mid-1990s, with borrowers having access to a much larger range of products and an adequate supply of housing finance, went on to warn that with the market price of risk having risen various players wanted the public purse to take on some of the higher price through various forms of support and regulatory change.

“In some instances at least it would appear the taxpayer is being asked to shoulder more risk, one way or another, in order to facilitate the provision of private finance,” he said.

The key points that Stevens made were canvassed here recently (CBA’s competition confession).  The period leading up to the crisis was an aberration, not a norm, characterised by credit that was too cheap and too easily available and where investors weren’t properly pricing risk or differentiating between the riskiness of individual institutions.

The whole debate about bank profitability and competition in mortgage lending demands the question of whether it is prudent and desirable to seek to return to industry settings that the crisis demonstrated were risky and unsustainable. Do we want a riskier system simply so that we can increase the supply of cheap home loans?

Wayne Swan’s package, thankfully, isn’t radical. It is more tinkering than landscape altering and, indeed, probably does more for the major banks than it does for their competitors.

The proposal to allow listing of Commonwealth government securities (which would provide a pricing benchmark for issues of highly rated bank and other corporate paper) and to allow institutions to issue covered bonds could be very helpful to the majors, because it would diversify their funding bases, but will be of little use to the smaller banks and non-banks.

The future abolition of exit fees hurts the smaller banks and non-banks a lot more than the majors, two of whom have voluntarily abolished them already.

The $4 billion of extra funding for the securitised mortgage market is too modest to have any material impact.

All account portability would do (if Bernie Fraser can devise a workable way to create a world-first system) is add immensely to the industry’s technology costs — which may be beyond the financial capacity of the smaller banks and non-banks.

All the anti-signalling legislation would do is lead to a less informed market and community. The major banks borrow and lend in the same markets, they don’t need to signal each other to understand each other’s margin pressures.

Making the deposit guarantee permanent, if the structure of the current financial claims is maintained, would effectively mean that the rest of the system — which means the majors — would ultimately underwrite the risk-raking of smaller institutions because they’d eventually have to cover any shortfalls.

Swan wants to build a “fifth pillar” based on credit unions and building societies but has yet to explain how a sector with $76 billion of assets and without any significant improvement to their capacity to raise funds competitively is going to be able to discipline the four majors, with their $2 trillion-plus of domestic assets.

While, ideally, more competition is better than less, the core lesson of the financial crisis (as the US and Europe could testify through gritted teeth) is that too much competition in financial services is far more dangerous than too little and too much government intervention and taxpayer involvement in manufacturing and distorting competitive outcomes invariably produces unintended and unpleasant consequences.

*This article originally appeared on Business Spectator

Peter Fray

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