When is competition good for the economy? Any time apart from now if you listen to the talking heads on the business channels and ‘respected experts.’
Early last week former Reserve Bank of Australia (RBA) governor Ian Macfarlane told an ASIC conference that Australian banks had survived the credit crunch because of the ‘Four Pillars’ banking policy.
You know our views on competition – Competition is the only way to ensure the consumer receives the best value. No ifs or buts. No exceptions. No “but not in this case.”
Yet the gist of Mr. Macfarlane’s comments was two-fold. First, that because the four major Australian banks are not able to merge with each other there was less focus on competition, which means the banks were able to take fewer risks.
Secondly, because of Australia’s poor savings rate, the banks did not have the surplus funds needed to put to work in investments. This means they were not drawn into big investments in US mortgage-backed securities and derivatives contracts.
But does this argument stand up? Let’s take a look…
On point one, the implication is that because European and American banks were able to merge, they immediately became vulnerable to collapse. When you look at the argument from this perspective, the argument doesn’t stack up.
We’ll take the UK banking system as an example. Twenty years ago, the UK had four major ‘high street’ banks: Barclays, Lloyds, National Westminster, and Midland Bank.
In addition there were many ’second tier’ institutions that were at the time known as building societies. They weren’t able to convert into banks until the 1990s. These included Halifax, Leeds, Alliance & Leicester, The Woolwich and the Abbey National.
Roll the clock forward to 2007, just before the banking industry went pear-shaped and the landscape had changed, but it was still familiar. The four majors were still there, but they were now part of bigger organizations.
Barclay’s bought out The Woolwich. Lloyds Bank merged with the Trustee Savings Bank (TSB) to form LloydsTSB. National Westminster Bank had been acquired by the Royal Bank of Scotland. And Midland Bank had been taken over in the early 1990s by HSBC.
Joining these four in terms of size was the newly merged Halifax and Bank of Scotland [note that this is an entirely different entity to the Royal Bank of Scotland] which became HBOS, the owner of BankWest before it sold it to Commonwealth Bank.
The other major building societies, the Abbey National and Alliance & Leicester were taken over by Spain’s Banco Santander.
As you can see, there has been consolidation in the UK banking sector. But is it really any different to the consolidation in the Australian banking sector? And is this the reason why UK banks have been nationalized or bailed out?
Look at the Australian banks: CBA now owns BankWest. Westpac bought St George, Challenge Bank and Bank of Melbourne. Adelaide Bank and Bendigo Bank merged. And that’s just some of the major consolidations.
It is taking a very long bow to suggest that because Australia maintained a ‘Four Pillars’ banking policy that has somehow saved the local banks from oblivion. In the world of cause and effect ‘Four Pillars’ is nowhere to be seen. It is a mere coincidence.
What the ‘Four Pillars’ policy has ensured is that customers are subjected to a government mandated banking cartel. This cartel has allowed them to get away with charging customers high fees. We don’t have a problem if a bank wants to charge fees, in fact we would have a problem if the government tried to legislate against it.
That is why a completely free market is necessary to make sure that companies do not have the opportunity to take advantage of a distorted market. In a market without distortions, customers would have more competition and would have greater choice to move to a bank that didn’t charge high fees. Now, there is very little choice.
So, if the ‘Four Pillars’ policy was abandoned, what effect would it have on the Australian banking industry.
For a start, they would compete with each other for customers. Would this necessarily mean the banks would take more risks? Mr. Macfarlane clearly believes the two are connected. Why competition in the banking system should be treated differently to competition in any other industry is hard to fathom.
If banks are allowed to compete fairly and do not have an implicit or explicit guarantee from government, they should manage their books responsibly. And if they do not, then the bank will fail, other banks will buy the assets (home loans, etc), and depositors will take any cash they have left and deposit it elsewhere.
Only, depositors would be more cautious next time. And knowing this, banks would become more cautious in their lending practices in order to encourage deposits by showing them the bank is safe. Of course, other depositors will also require a higher interest rate which may encourage the bank to increase its risks.
But that is where the market is much more efficient in pricing risk. The bank would reach an equilibrium at which it was attracting sufficient risk averse and risk tolerant depositors.
The interference of government only succeeds in distorting the pricing of risk one way – in the favour of greater risk.
It is the pressure put on the banks by government, telling them to lend to small business, first homebuyers, and commercial property developers. The three riskiest credit groups.
The pressure to lend to sub-standard applicants in the US is part of the reason for the banking collapse there.
Mr. Macfarlane’s second argument is European banks had surplus funds they needed to invest compared to Australian banks. This assumes the only risky assets are those in the US and Europe.
Aside from that, was there really a lack of cash deposits invested in Australian banks? Or did the Australian banks just have their hands full lending the cash to Australians. Lending against residential property developments, commercial property developments, margin lending accounts, cash withdraws against rising home values, etc.
But look, the truth is, we don’t know. Mr. Macfarlane could be correct. But summarizing the banking woes into an “Australian banks good, foreign banks bad” approach is merely looks at the surface.
The results reported by the banks over the next few weeks should make for interesting reading.
Other Stuff on the Markets
US unemployment rate rises to 8.1%, the highest level for 25 years.
This week the Aussie market will be bracing for a series of economic data that could provide further insight into the state of the economy.