One of the more bizarre rituals of global finance is the Australian Monetary Policy Dance, where we all wait to see whether an adjustment to official interest rates is “passed on”.
Monetary policy — the last remaining economic policy lever — is an attempt to influence an important price by changing one of the costs of a group of privately owned, very powerful, institutions. Economic policy is, in effect, outsourced to a private oligopoly.
The price that the RBA influences (deposits) is not the only cost: it used to represent less than half of the banks’ cost of funds, now it’s three-quarters. The rest of the money is borrowed somewhere else because Australia’s thirst for loans is greater than its willingness to lend.
However, for some peculiar reason the banks only change their lending rates when the RBA changes the overnight cash rate target, even though that affects only a portion of their costs.
Here’s a mad suggestion for the bank managers: level with your customers. Explain how your funding costs work and then when there’s a change in the price of the 26% or so of funds that come from wholesale financial markets, change the interest rate on your loans then, rather than waiting for the first Tuesday of the month, when the RBA board meets.
I have suggested this to each of the banks and to their lobbyists, and each of them agreed it would be a good idea. But then they shrug with a helpless smile. Banks hunt in packs, you see.
What’s more, they don’t want to expose their true margins to customers or, indeed, their true pricing. The published price is not the real price — it’s flexible, not fixed. The day-to-day management of the book — cost in, price out — is a dark art, the essence of banking.
The more fundamental problem is that banking is a utility in which the amount of equity is regulated, but not the return on it.
With other utilities, such as electricity, the regulator determines the price that can be charged with reference to the return on equity it will allow the firm to earn above its cost of capital. It’s generally somewhere in the low teens.
The return on capital employed in retail banking is at least double that, but it’s not disclosed. The overall ROE of the big four banks is about 15% at the moment, but that’s brought down by lower returns from institutional banking, where the competition is global, and intense.
In retail banking, which is a 90% cartel comprised of NAB, ANZ, Westpac and Commonwealth, they make what is technically called a motza. I was once told it’s more than 30% ROE, but I’m not sure if it still is.
By keeping their cards close to their chests, the banks are playing a dangerous game, as my colleague Robert Gottliebsen pointed out yesterday.
Instead of regulating the banks’ ROE, as it does with other utilities, the government is looking at imposing higher taxes on returns above the cost of capital. Same thing, really.
The only way to avoid this would have been to be more transparent with customers about what’s going on, and to move lending rates when the cost of funds actually changes rather only doing it under the cover of the RBA.
*This article first appeared on Business Spectator