091209_Clarifier

Westpac continues to be attacked in the press after Australia’s largest bank raised variable home loan rates by 45 basis points last week, almost double 25 basis point rise announced by the Reserve Bank. The man who announced the changes, Westpac retail boss Peter Hanlon, was quietly shifted to a new role only days later, while one of the world’s most powerful businesswomen, South African-born Gail Kelly, has endured possibly the most difficult week of her corporate life.

Westpac’s problems didn’t improve this morning after Fairfax’s Julian Lee reported that “according to Westpac, mortgages are much like banana smoothies and the cost of borrowing money little different to that of buying bananas”.

A resent email sent by Hanlon to bank staff had attempted to compare the recent increase in Westpac’s mortgage rates to the higher cost of banana smoothies after the devastation of Cyclone Larry. Westpac claimed:

Once upon a time, there were big large fields of banana crops. But one day, a terrible storm rolled in and hit the banana fields. So the crops were damaged and there was not enough to go around.

Because of the devastating storm, the cost of bananas went up and it cost more to make banana smoothie, that’s why the cost of smoothies increased by 50 cents …

We all understand the formula. A + B = C.

But the same formula is so much harder when it comes to talking about money.

In 2007, the world of money changed. The money that banks needed to buy started to cost them a lot more, just like bananas for smoothies.

The problem with Westpac’s comparison is that the markets for banana smoothies and home loans are completely different.

The first major distinction between the markets for banana smoothies and home loans is supply. Anyone with a blender and  20 square metres of retail space is able to start selling smoothies. By contrast, it is somewhat more challenging to open a major bank and offer finance products. In particular, the billions in capital costs it would take to create a major bank led to a fairly substantial “barrier to entry”. Banks are also highly regulated institutions operating in a somewhat less competitive market.

Following Westpac’s acquisition of St George and Commonwealth’s purchase of BankWest in 2008, the Big Four banks now dominate the home lending market (almost every home loan made is by a Big Four bank). This has been furthered by the federal government’s funding and deposit guarantees, which substantially favoured the Big Four banks over their smaller competitors. (By contrast, the federal government did not announce a special Banana Farm Guarantee, in which the four largest banana smoothie stores would be permitted to purchase bananas from overseas farms with the benefit of a government guarantee during the “banana crisis” of 2006).

The next major difference between bananas smoothies and home loans is that smoothies are a low value, short-tail good and customers can readily switch between sellers. Simply put, you can easily buy a banana smoothie from one store one week and switch to another store one the following week. By contrast, it is extremely difficult to switch home loan providers because home loans tend to last for decades (Westpac, of course, is well aware of this). Apart from expensive break fees, customers will often have numerous other accounts or products with their home loan provider, as well as direct debits and other items attached to their account. For the sake of perhaps $600 annually, it is almost certainly not worth the hours of hassle (and thousands of dollars in immediate expense) for the customer to switch banks. Not only that, but there is no guarantee the rival bank won’t lift rates by the same amount in the next period.

There is one other small difference between banana smoothie sellers. That is, executives of banana smoothie retailers (who arguably operate in a far more competitive market with more sellers, homogeneous products and less barriers to entry) are paid far less than banking executives. Westpac’s top 16 executives shares in $42 million last year, most of which was paid in cash. While smoothie sellers do not publish their annual remuneration figures, we suspect that few smoothie employees take home such largesse.

The decision by Westpac shows the fallibility of yet another celebrity CEO — Gail Kelly. Kelly was hired by Westpac in February 2008 from St George, replacing the respected David Morgan. Since then, Kelly has undertaken a costly acquisition of her alma mater (which has led to the bank already writing of $500 million) and now completely bungled the bank’s interest rate policy. (Westpac’s rise allowed not only NAB’s position to improve after the fourth largest bank announced a 25 basis point rise, but also allowed rival CBA to escape relatively unscathed despite itself raising rates by 37 basis points).

While business banking (and credit card) consumers have had a far more torrid time than home loan customers, Westpac did not (publicly anyway) note that its higher home loan rates have been offset by lower business loan rates (the Commonwealth Bank advertised today that its residential-backed business loans are cheaper than Westpac’s). Rather, Westpac has claimed that the rate rise  was necessary due to increased costs of funding as a result of the global financial crisis.

However those arguments are difficult to believe given the bank’s earnings do not appear to have been adversely affected by the crisis. Westpac’s reported cash earnings last year were $4.67 billion, compared with $3.5 billion in 2007. This does not appear to be a bank in desperate strife.

Meanwhile Kelly’s salary rose from last year $6.1 million to $8.4 million.

It appears that victims of the global financial crisis are equal, but some are slightly more equal than others.