A licence to print money: bank profits in Australia

The result of the tendency for increased concentration is that the big four banks have increased their share of banking itself. The big four now have 76 per cent of the banking market and the rest is shared among 57 other banks. Most of those 57 are foreign banks that are represented here but never took off as was hoped.

A good example of the exploitation of market power on the part of the banks follows the increases in official interest rates by the Reserve Bank. Objectively the banks’ costs have not changed from one day to the next but they use the official interest rate decisions as cover to increase their interest charges. For example, on Tuesday, March 2, the Reserve Bank put interest rates up 25 basis points (0.25 per cent). The four major banks followed within a day or so with increases of 25 basis points. Their excuse is that as official interest rates increase, so do bank costs. Yet most customers know that the banks pay zero interest on a large number of their deposits. Likewise, the banks fund a lot of their operations through overseas borrowings. The Reserve Bank decision has no effect on the cost of those funds.

At most, around half of bank deposits and borrowings are market related, or at least potentially affected by changes in official interest rates and then with a long lag. Only a very small fraction of banks’ borrowings reflect the actual official interest rates that rule in the money market.

Westpac taught us that when the price of bananas goes up the maker of banana smoothies has to put up the price of smoothies. But Westpac did not say the price of smoothies has to go up by the same percentage - bananas are only part of the cost. Likewise when official interest rates increase that does not affect all of a bank’s costs. We should not expect to see banks’ interest charges respond exactly to changes in official rates.

So far Australian policy-makers have used competition as their main weapon against the banks. Almost a century ago the Commonwealth Bank was established as a people’s bank to provide genuine competition against the private banks. Since then there have been waves of competition coming from the credit unions, building societies, finance companies, mortgage originators and the foreign banks. Despite a century of competition the big four banks are as strong now as they have ever been.

Clearly competition and deregulation have not worked. It is time for other approaches to be considered.

The Finance Sector Union has called for a social contract with the banks. There should be a community debate about what society wants from its banks to inform the content of the social contract. To reinforce the social contract there should be tough regulation that gives everyone access to low cost banking. Fees and charges should be controlled so that they represent actual costs and no more.

If we try everything and still banks earn excessive profits they should be controlled through special taxation measures of the sort used with respect to the mining companies when they make excessive profits through their access to Australian resources. Clearly bank profits depend on privileged access to the Australian payments system just like the high profits of some miners is due to their privileged access to Australia’s unique resource endowment. In both cases, high profits reflect the attributes of what the companies are exploiting and should share that high profit with the owners of the resource in question.

Since the report was written the Australian Bankers’ Association accused The Australia Institute of a “disappointing interpretation” of the banks’ role especially during the financial crisis. It should come as no surprise to anyone that the Australian Bankers’ Association would have a different interpretation of the industry’s profit. Their job is to defend the banks, not to critically analyse them.

Among other things the Australian Bankers’ Association says the Institute “ignores the social benefits of successful banks - profitable and well capitalised banks provide finance for businesses and, therefore, keep people employed”. The point that has to be emphasised is that while the economy requires a healthy finance sector it does not require one that is “extremely profitable” or “exceedingly privileged”.

The Australian Bankers’ Association tries to assert that banking in Australia is competitive. The role of competition in a market economy is to ensure that suppliers are not in a position to earn excessive profits. The idea is that if anyone is earning excessive profit, new competitors will be attracted into the industry offering consumers a better deal and forcing the incumbent to match the new-comers. The effect of that type of competition is to eliminate excessive profit. It is obvious that competition in the banking industry has not been sufficient to eliminate excessive profit. The excessive profit is evidence that competition has been ineffective.

The Australian Bankers’ Association also refutes the suggestion that banks are profiteering. The report certainly accuses the banks of exploiting their market power. To accuse banking corporations of exploiting market power is not a criticism of the banks themselves or any of the individuals involved in the banks or elsewhere. Indeed, the management of a bank has an obligation to act in the interests of shareholders. It is certainly not in shareholders' interests to have a bank voluntarily refrain from earning its full potential profit. A management would be sacked if it did not seek to maximise its bank’s profit.

Instead it is the duty of government to address monopoly power with policies appropriate for the industry to ensure that Australians get their essential services at a reasonable price. So when the banks are accused of making excessive profits it effectively amounts to saying that governments have not done their job in controlling the monopoly power of banks.