The dangers of delinking from base rates. Banks play a risky game...

HAMISH_MCTAVISH

Month after month, the Australian Bureau of Statistics unveils figures detailing a drop in lending for new housing and for business, falls to levels not seen in decades, sometimes of a magnitude never before recorded. No-one is borrowing.

But the response from our lending institutions has run counter to the most fundamental laws of economics and logic and, in so doing, they may well be laying the foundations for serious financial problems for themselves and the nation.

Rather than cut their margins, and lower their interest rates in an effort to spur demand for new lending, they have spent the past few years raising the cost of money to existing customers to compensate for the lack of growth in their lending.

It's a short-term solution to their predicament. It may temporarily boost profits. But it dampens demand for debt. That, in turn, can work in a far more insidious manner to undermine the health of our economy, our financial system and our lending institutions by creating a liquidity trap. More on that later.

There was some justification for these actions during the darkest days of the global financial crisis. In the boom years leading up to 2007, our banks - wallowing in cheap and easy to obtain cash from foreign wholesale markets - were falling over one another to push money out the door, offering incentives and special deals to anyone who asked.

Effectively, they had cut their margins to grab new business and had failed to factor in the risks that some borrowers could default if economic conditions soured.

When that cheap cash dried up, they were forced to refinance their offshore loans at much higher prices which seriously squeezed their margins.

As a result, they passed on those higher costs either by not passing on Reserve Bank cuts in full, or adding an extra little whack to official rate rises.

That initial taste of power in 2008 lingered. Emboldened by their success at breaking the nexus between official interest rate movements and their own lending rates, the banks continued to fatten their margins as the global economy settled during 2009 and into 2010 and even last year.

On each occasion they have employed the same excuse. Offshore funding costs have increased, their margins have been squeezed, so they need to raise their lending rates.

But evidence collated by the Reserve Bank refutes those claims. While offshore funding costs do occasionally rise, they also occasionally fall and the banks' margins now are healthy, as evidenced by their record profits.

The ANZ has gone a step further, declaring it will set its own monthly lending rate a fortnight after the Reserve Bank board meetings, irrespective of the official cash rate position.

Suddenly, the Reserve Bank, the independent body that controls monetary policy, has found its power to influence Australian economic activity seriously diminished.

On Tuesday, the Bureau of Statistics will release the inflation numbers for the March quarter, which are expected to show inflation cooling. If that is the case, the Reserve Bank has signalled it will cut interest rates when it meets on the first Tuesday of next month.

But we now have a stand-off between the retail banks and the body governing our economy. ANZ pushed its lending rates higher last week and the other three majors have refused to rule out a similar move.

So at a time when the Australian economy is coming off the boil with subdued activity in retail, construction, manufacturing and housing, and with the central bank clearly of a mind to provide a shot of adrenalin to kick things along, our retail banks have decided instead to dole out the tranquillisers.

This has put the nation into unchartered and potentially dangerous territory. Should they refuse to pass on a rate cut, or even worse push rates higher, the banks will further dampen economic activity at the worst possible time, with the federal government doggedly pushing ahead with massive spending cutbacks in order to deliver a budget surplus for purely political purposes.

This incredibly short-sighted approach from our major lenders - all of which are looking to maintain record earnings - could well come back to bite them and bite them hard.

For when the economy cools, the level of bad debts rise, forcing banks to write off the value of those loans. That flows directly through to the bottom line. As a result, earnings are likely to plummet, just as they did during 2008.

That negative impact tends to snowball. Bad debts result in foreclosures, which in turn results in increased selling pressure as homes and businesses are put under the hammer. That eventually forces asset prices lower which, in turn, affects the value of the collateral held by the banks as security for their loans.

When that happens, their credit ratings are cut and it becomes more expensive for them to raise cash offshore. That in turn puts a bigger squeeze on their margins and their earnings as they become trapped in a liquidity vice, caught between rising costs on one side and falling asset values on the other.

There has been a great deal of commentary in recent months about the need for the central bank to lower interest rates to help take pressure off the Australian dollar, and many commentators have been critical of the RBA's reluctance in this regard.

But official interest rate movements that are not passed on through the general economy are wasted. It is economic ammunition fired in vain.

Those at the helm of the Reserve are well aware of this, which explains the escalating war of words emanating from Martin Place in recent months.

It is time those running our financial system took heed of the warnings before they land themselves and all of us in hot water

http://www.theage.com.au/business/banks-playing-risky-game-with-rates-20120420-1xc3z.html#ixzz1sqdPalM5

It can surely only be a matter of time before we have global revulsion at the way current bankster profiteering is risking a return to a global financial crisis.

ILW

HAMISH_MCTAVISH wrote: »

http://www.theage.com.au/business/banks-playing-risky-game-with-rates-20120420-1xc3z.html#ixzz1sqdPalM5

It can surely only be a matter of time before we have global revulsion at the way current bankster profiteering is risking a return to a global financial crisis.

Because everybody loves bankers at the moment.

HAMISH_MCTAVISH

ILW wrote: »

Because everybody loves bankers at the moment.

It's going to get worse for them.

ILW

HAMISH_MCTAVISH wrote: »

It's going to get worse for them.

Do they care?

I can think of very few businesses who do not make the largest possible margin they can get away with. I know I do and would suspect you are the same.

Would you drop your rates to help the economy?

michaels

Presumably the Aussies have a competition authority who can look in to whether the concentration within the banking sector is leading to excessive profit levels and propose remedies such as a bank breakup if that is the case - unless of course the politicians are in the pocket of the bankers in which case hard luck....

HAMISH_MCTAVISH

ILW wrote: »

Do they care?

I can think of very few businesses who do not make the largest possible margin they can get away with. I know I do and would suspect you are the same.

Would you drop your rates to help the economy?

An interesting question.

In our business, keeping high levels of turnover is important to maintaining a profitable business model, mostly because of group purchasing power and supplier discounts. For us, being able to buy at the right price is every bit as important as being able to sell at the right price, and a contraction in our business size would therefore ultimately lead to our business failing as it could not compete with other large players.

So we reduce our margins when required to maintain or grow turnover.

For banks, keeping high levels of turnover is important to their long term viability as well, because an economy starved of liquidity is a economy that will contract, leading to business contraction, then increased unemployment, then increased bad debt, then asset price falls, then increased write offs for banks, then less lending, then rinse and repeat.

As the article points out, banks in recent times have tended to do the opposite of what is required though.

the response from our lending institutions has run counter to the most fundamental laws of economics and logic and, in so doing, they may well be laying the foundations for serious financial problems for themselves and the nation.

Rather than cut their margins, and lower their interest rates in an effort to spur demand for new lending, they have spent the past few years raising the cost of money to existing customers to compensate for the lack of growth in their lending.

And in so doing, they are putting at risk not just their own well being, but that of the wider economy.

This has put the nation into unchartered and potentially dangerous territory. Should they refuse to pass on a rate cut, or even worse push rates higher, the banks will further dampen economic activity at the worst possible time, with the federal government doggedly pushing ahead with massive spending cutbacks in order to deliver a budget surplus for purely political purposes.

This incredibly short-sighted approach from our major lenders - all of which are looking to maintain record earnings - could well come back to bite them and bite them hard.

For when the economy cools, the level of bad debts rise, forcing banks to write off the value of those loans. That flows directly through to the bottom line. As a result, earnings are likely to plummet, just as they did during 2008.

That negative impact tends to snowball. Bad debts result in foreclosures, which in turn results in increased selling pressure as homes and businesses are put under the hammer. That eventually forces asset prices lower which, in turn, affects the value of the collateral held by the banks as security for their loans.

When that happens, their credit ratings are cut and it becomes more expensive for them to raise cash offshore. That in turn puts a bigger squeeze on their margins and their earnings as they become trapped in a liquidity vice, caught between rising costs on one side and falling asset values on the other.

It's truly remarkable that bankers are allowed to behave in such a way.

Pushing profits to such record highs that they will take down the wider economy.

Yet it's happening all over the world, not just in Australia.

UK banks are making record margins on mortgage lending, up 300% since 2007, to compensate for the fact they're lending only a third as much as they used to.

It's just so short sighted.... And now presents a real risk to the recovery.

ruggedtoast

This is a curiously anti establishment thread from Hamish. If banksters are laid low who is going to hand out all those buy to let mortgages, or bankroll all the wars and corrupt politicians we need to maintain the status quo?

Modern banking is just a mirror of the modern world. 1% of people have long since passed the finish line, and everyone else defines success by not coming last at any cost. As long as you have one other person to trample over then you're still, somehow, a winner.

Globalfinantialcrisis

Every one is getting scared now that its looking likely interest rates are going back up. You will see more articles like this saying its dangerous, to raise interest rates too much. It is dangerous but still going to happen. Lower house prices here we come!

HAMISH_MCTAVISH

Globalfinantialcrisis wrote: »

..........

Another socky that can't even spell their username.:(

Let me guess, we should all sell our houses and buy silver instead.

ILW

HAMISH_MCTAVISH wrote: »

An interesting question.

In our business, keeping high levels of turnover is important to maintaining a profitable business model, mostly because of group purchasing power and supplier discounts. For us, being able to buy at the right price is every bit as important as being able to sell at the right price, and a contraction in our business size would therefore ultimately lead to our business failing as it could not compete with other large players.

So we reduce our margins when required to maintain or grow turnover.

For banks, keeping high levels of turnover is important to their long term viability as well, because an economy starved of liquidity is a economy that will contract, leading to business contraction, then increased unemployment, then increased bad debt, then asset price falls, then increased write offs for banks, then less lending, then rinse and repeat.

As the article points out, banks in recent times have tended to do the opposite of what is required though.



And in so doing, they are putting at risk not just their own well being, but that of the wider economy.



It's truly remarkable that bankers are allowed to behave in such a way.

Pushing profits to such record highs that they will take down the wider economy.

Yet it's happening all over the world, not just in Australia.

UK banks are making record margins on mortgage lending, up 300% since 2007, to compensate for the fact they're lending only a third as much as they used to.

It's just so short sighted.... And now presents a real risk to the recovery.

Your argument does seem a little one sided.
You object to banks charging a market rate which you consider profiteering. If that is the case why do you not object to landlords doing the same thing or do you wish margins to be somehow centrally controlled?

For example if someone bought a BTL in the past and is currently paying around £100 per month interest, should they be banned from renting the property at £1000 per month?

Generali

There are two forces at work here. Firstly you have a concentration of market power in the hands of the 'Big 4' banks (CBA, ANZ, Westpac & NAB) who have about 85% of the market between them.

There are plenty of small mutuals, one of which I bank with, but Australians are remarkably un-price sensitive in most things including bank providers. The banks can and do get away with what, IMHO, amounts to gouging.

The other problem is the fact that the Big 4 borrow a vast proportion of their funds to lend in international markets. This means that the price the banks are paying for funds is to a large extent out of the hands of the RBA (the Aussie Central Bank). That the RBA cuts or maintains rates doesn't mean that the cost of funding for the banks falls.

To help you decide whether the cost pressures of having to procure funding in international markets or whether a lack of competition locally allows for very high profits I leave you with a couple of facts:

- Last financial year the Big 4 made about $25,000,000,000 in profit between them
- At the last census there were 7,800,000 households in Australia so the big 4 between them make over $3,200 in net profit per Australian household.