There’s a decidedly Abbott-esque note to yesterday’s announcement by Prime Minister Malcolm Turnbull and his Treasurer Scott Morrison that, henceforth, the big four banks would have to front a parliamentary committee once a year to explain themselves — yet another in a long line of efforts by a party that has received $2.5 million in donations from the big banks since 2010-11 (that we know about) to shield them from a royal commission.
At some stage the penny might drop inside the Liberal Party that the banks are convinced they own it — for nothing else can explain the insouciance with which they failed to pass on this week’s interest rate cut or explain themselves, thereby massively complicating the government’s efforts to protect them.
The royal commission has nothing to do with banks’ cost of capital, their pricing decisions or where they set interest rates, but rather about their at best unethical and often outright evil behaviour toward so many Australians, whose lives have been ruined by bank-employed financial planners, insurers and advisers. But interest rate decisions have a way of focusing minds on the ethics of banking for ordinary Australians.
However, let’s put aside the monstrous behaviour of banks aside and think clearly about the rate cut — and who benefits from the banks’ decision.
So, those of us with home loans will benefit — and would have benefited more if more of the rate cut had been passed on. Around a third of Australian homes are covered by mortgages. But it’s mainly owner-occupier mortgagees who will benefit — investors mostly won’t (it doesn’t worry them because of negative gearing, and besides most have fixed-rate mortgages or interest-only arrangements. The rest of us as taxpayers look after them.)
[Why is the RBA letting inflation slide?]
But there’ll be little economic stimulus via those with mortgages because we know that mortgage holders tend to use savings from falling interest rates to build equity buffers by paying off their home loans faster than they should. The RBA estimates the mortgage pre-payments exceed $230 billion, or nearly two years of payments (now a bit more given the two rate cuts since the last estimate). That is one of the reasons why the impact of the last few rate cuts has been more muffled — we’ve just got on with paying off our mortgages quicker.
Small businesses will also benefit, to the extent the cut is passed through to small business lenders, although there, too, the stimulatory benefits will be limited, but for another reason — interest rates are so low already that if businesses aren’t borrowing now, it’s not because interest rates are stopping them.
But those who benefit from the banks not passing on all of the cut isn’t small either. Even though the media like to focus on families with mortgages, you’re probably aware of the impact of rate cuts on retirees who depend on bank interest from their deposits. Many people on pensions and fixed incomes are among the poorest in the community — even those ostensibly asset-rich who own their homes, and interest rate decisions have a real impact on their lives.
But the beneficiaries of the lack of pass-through don’t stop there. The four big banks account for around 24% of the value of the Australian Stock Exchange, and their $20 billion a year in dividends flow to shareholders, large and small. Those shares are overwhelmingly owned by superannuation funds — large, small, retail, industry and self-managed. In fact, the finance sector (including smaller banks like Bendigo and Macquarie) is the largest destination for super funds, large and small.
Our retirement incomes (current and prospective) thus depend heavily on the sharemarket value of the banks and the flow of dividends from them. If the banks passed the RBA cut on in full to mortgagees, their net interest margins would come under more pressure, profits could fall or start weakening, dividend growth (already facing more pressure than at any time in the past five years), would also weaken, or start turning negative.
The share prices of the banks would weaken, superannuation returns (and income from the lower dividends) and retirement incomes would take a hit — as would your super. Hardest hit would be those investors depending on the banks’ fully franked dividends, especially to self-managed super funds whose investments are dominated by their holdings in the banks.
[ASIC: a reform package by bankers, for bankers]
Whenever we have this contretemps over banks and RBA interest rates, no one bothers to ask the question about whether the greatest benefit lies with mortgage holders (who are reluctant to spend their savings, instead they save them, thus defeating the purpose of the rate cut) or with investors, many of whom will spend much, if not all of that dividend income, because it is their retirement income.
And by the way, there’s actually a pretty potent inquiry into the banks already underway: the Productivity Commission has kicked off an inquiry into superannuation at the instigation of Morrison, and a critical part of that will be the integrated offerings of the banks. A draft report has been issued and there’ll be more consultation. But the banks won’t be happy with the PC’s extensive discussion of “competition in banking” efficiency, benchmarking results, best interest of members and the cost of funds management. And the beauty of the PC report is when the inquiry is finalised, and a report sent to the government, the pressure will be on Turnbull and Morrison — particularly from the Nationals — to deliver on the commission’s recommendations.
The PC won’t deliver the steady drip of revelations and dramatic moments of public hearings that a royal commission would, but its hard-nosed recommendations will be more difficult to ignore or explain away. And the PC will be focused on what is best overall for the economy.
The banks have been making hay while the sun shines, but there is a rainy day not far away. Overseas funding of our banks may well dry up and if that coincides with a significant decline in the property market then most of these banks will be in significant trouble.
And will the Commonwealth really bail out more than one? Certainly they have not budgeted for that.
Glenn Stevens & the Reserve Bank board appear hellbent on encouraging Australians to plunge into deeper debt (to fund an off-the-leash property market) while simultaneously penalising people who have saved. I don’t get it….
To a layman without the benefit of an economics doctorate this seems plain dumb.
All these points are salient, GD and BK, which begs the question, is the underlying assumption that a rate cut is stimulatory wrong. In fact, does it at some point work the other way and become contractionary, and that we are well past that point.
This is the problem with economics, linear (and usually stupid) thinking. Given your points, which I believe have some basis in fact, should the RBA increase interest rates to stimulate the economy. For a number of reasons I think they should, but mostly it is a gut instinct, counter-intuitive move.
As for the connection between bank profits, interest rate levels, an overblown housing market, superannuation linked to banks share prices and dividends, we really have put all our eggs in the one basket. Really makes for great economic thinking.
This is going to blow up, and the effects through the system will be like Krakatoa’s eruption.
Leaving aside the question of the Reserve Bank and interest rates – the reason that the government can/should demand answers from the banks is that the government insures domestic savings accounts to $250,000, that is to say a vast majority of ordinary savings accounts. A commercial insurer for that amount of money would be asking plenty of questions.
The problem with raising interest rates in the current international environment is that it would produce a flood of international money into Australia. This would raise the value of the Australian dollar undermining exports (which include tourism and education) and increasing deflation pressures as imports got cheaper. I think we may be in a lose-lose scenario no matter what direction is taken.