You’ll soon think back longingly to the times when Australian banks were stupidly profitable:
‘Remember the good old days when The Age reported, ‘the combined yearly profits of the big four banks now total more than $1000 for every person in Australia.’ Back then, people thought profits were bad. Ha, little did they know…’
The Australian banks might be profitable right now. But for good reason. It’s their last gasp. Australia’s banks are about to get hit with a double whammy. Banking is about managing the asset side of the balance sheet, and the liabilities side. It’s a question of what to invest in, and how to fund those investments. Both sides are in trouble.
Pretty soon, you’ll be contributing to more than the bank’s profits as a customer. You’ll be on the hook for their government bailouts and their cosy monetary policy relationship with the central bank. You’ll be paying tax, the inflation tax and the interest on Australia’s ballooning sovereign debt. Then you’ll wish the banks were profitable again.
On the asset side, Australian banks are in trouble because the loans they made and the collateral they took are dodgy, to the extent that the banks are now indirectly raiding retirement funds so borrowers can avoid foreclosure. Last year this added up to $100 million taken from retirement savings and shovelled into bank profits.
On the liabilities side, Australian banks are about to go from being awash in funds to needing a central bank rescue. The kind we’ve seen all around the world.
Foreign Lenders About to Desert the Australian Banks
First, to the liabilities – how the banks get the cash they lend. As the Australian economy continues to slow down, Reserve Bank interest rates will fall. That will end the interest rate arbitrage that’s been going on.
Foreign investors, faced with near 0% interest returns in Europe, the US and UK, have been ‘investing’ in Australia to capitalise on our higher rates. That’s provided the banks with plenty of funding. And pushed up the Australian dollar. But if all that foreign cash goes home, it will leave the banks high and dry.
Ben Davies of Hinde Capital told listeners of King World News how this plays out:
‘Australia is running out of luck. This is a country that’s got an oversized banking system very reliant on external financing. They’re going to have the bursting of a housing bubble. Really, this has been masked to some extent by the great resource boom that’s been coming out of China… So I think what’s going to happen is the RBA is going to continue to reduce rates. At some point there is potentially going to be a balance of payments crisis… I think foreigners could actually pull funding to the Australian banks. I think that the RBA will do what the European Central Bank did, which is… an LTRO type vehicle – provide liquidity – because domestic savers are not in a position to fund the banks in Australia. And obviously they can’t afford for the banks to go down.’
Davies also reckons the Australian dollar’s recent strength comes from foreign central bank buying. As an aside, the Australian dollar will collapse if Davies is right and foreign investors pull out of Australian banks.
All the cash will go home, flooding the world with Aussie dollars. That is usually a good thing for exporters because their goods appear cheaper to foreign buyers. But it’s tough for exporters to take advantage of that if the banks have less cash to lend out.
The Australian banks know that foreign capital is about to desert them. They’ve been issuing hybrid securities left right and centre to shore up their funding. And people have been buying the new securities, which have the worst characteristic of debt and the worst characteristics of equity baked into them.
But this source of funding won’t be enough. There aren’t enough savings in Australia to support our huge financial services sector. As soon as debt begins to contract on an economy wide basis, credit bubble businesses like banks begin to struggle because there is less cash to loan out.
The Festering Problem in Australian Banks
In the meantime, over on the asset side of the balance sheet, you’ve got the festering housing bubble. And Australia’s secret sub-prime lenders, who have had some success suing the banks. When loans start going bad and houses cannot be sold for more than the loan taken out to buy them, the banks’ assets will be in trouble.
They’ll be making less money and they’ll be left owning assets that are falling in price.
What’s really worrying, even if you’re not planning on being a borrower or bank shareholder, is that most of the economy is reliant on Australian bank funding. Before banks funded just about all business, businesses funded the purchase of their inventory with equity – cash they brought into the business. Their profit would be the difference between the cost of what they bought and what they sold it for.
But the Australian banks allowed this process to happen on steroids. Instead of only buying the inventory you can afford with investors’ cash, you can now buy vastly more of it using borrowed cash. Once it’s sold, you repay the debt and earn vastly more in profit because of the far larger amount of bought and sold inventory.
Of course, everyone else figures this out. They did more than two hundred years ago. So profit margins were simply squeezed back to where they were before debt financing became the norm. But the economy can still buy and sell the vastly increased amount of goods funded by debt. That makes everyone better off.
Especially the banks. But it also makes things very fragile. If the banks struggle and stop lending, inventory can’t be bought. Shelves go empty.
The hidden problem is that bankers don’t just lend out money they borrow from someone else. They also lend out money they create out of thin air. Without real savings funding borrowing, banking becomes a Ponzi scheme. At some point, the game is up because the banks lent more than they took in. That’s why financial crises happen so easily.
You Won’t Believe This
Don’t worry too much about all this. The bankers have a solution. It’s called ‘The Banking and Finance Oath Limited (BFO)’. You cannot make this stuff up (our emphasis added):
‘The Banking and Finance Oath Limited (BFO), incorporated last month, will oversee and enforce a voluntary oath of conduct to be sworn by professionals employed across the Australian financial services industry.
This is the oath:
‘“Trust is the foundation of my profession
I will serve all interests in good faith
I will compete with honour
I will pursue my ends with ethical restraint
I will create a sustainable future
I will help create a more just society
I will speak out against wrongdoing and support others who do the same
I will accept responsibility for my actions
My word is my bond.”
‘Unlike other professions, such as medicine and law, where practitioners are bound by professional oaths for the duration of their careers, the banking and finance oath may endure for only 12 months. If members don’t renew their annual subscription to the company their oath lapses as a binding commitment.
‘Under the BFO’s constitution, members are also free at any time to terminate their obligations if they believe they are no longer able to adhere to each of the oath’s nine tenets.’
Can we read from that that if any banker doesn’t renew membership they’re admitting that they won’t serve all interest in good faith, they won’t compete with honour, they won’t pursue their ends with ethical restraint, they aren’t interested in a sustainable future or a more just society, and they won’t speak out against wrongdoing or accept responsibility for their actions?
It seems their word is their bond, but only for 12 months at a time. And even then, ‘members are also free at any time to terminate their obligations’.
Best of all, the people running this thing are the bankers who it’s supposed to be protecting you from. And the very same ones who will be held responsible when their company is doing something wrong. What do you think they’d do if any whistleblower was dumb enough to come to them?
Until next week,
Your mortgage-free editor,
Nick Hubble
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