Contractual certainty - banks need to play by the rules as well

Banks are now an essential service. All money, even welfare payments at some point flow through banks. People cannot function without banks. It is for that reason that banks, like all essential services must be regulated by the government. The greed displayed by the four majors in nearly doubling the latest Reserve Bank hike makes regulation of bank interest rates imperative.

Banks will not behave responsibly. They cannot. It is not in their DNA. "The social responsibility of business is to maximise profits", so declared Nobel Prize winning economist Milton Friedman four decades ago. Corporate behaviour has not moved one inch from that mantra.

Concepts such as corporate social responsibility are merely labels designed to attract more profits. CBA boss Ralph Norris should be commended for his honesty when he declared that his job is not to be popular. He only has one goal: to make more profits for his bank.

The argument that banks needed to lift rates to fund increased borrowing costs has been exposed as a con. Figures released earlier this week by the Australian Prudential Regulation Authority show that between the June quarters of last year and this year the Reserve cash rate rose 1.36 percentage points while the average rate paid by the banks for money it borrowed only increased 0.88 points.

The real villain in this increasingly obscene profiteering is not the banks - they are only doing what they programmed to do, and their booming profits prove they are doing it mightily well.

The culprit is the Australian government and to a lesser extent the ill-informed, small-minded Australian consumer.

We live in an economic system where banks assert a contractual right to change at their whim the interest rate on loan products. Thus, after a bank and customer have entered a contract the stronger contracting party supposedly gets to unilaterally change the most important term of that contact. This is probably illegal. It makes the contract void for uncertainty.

Banks raising rates for existing loans at their choice is the legal equivalent of landlords ramming up the rent part-way through a lease or bosses reducing wages when they get the urge.

As noted by Professor Kevin Davis, Australia is out of step with most developed countries in tolerating rate-changing moves by banks for existing loans. Germany is the only other of 12 surveyed big economies that allows banks discretionary control over loans.

Comments by some free- marketers that regulating bank rates would damage our banking system are grossly ill-informed. Banks are already regulated - hence the reasons Australian banks were not at risk during the GFC - and weren't heard to squeal a fraction when the government regulated to guarantee bank deposits, resulting in a tsunami of undeserved money flowing their way.

Adding one layer of extra regulation on banks would do nothing to undercut our market economy. This is especially when the regulation is merely injecting a near universal principle of fairness into the relationship between banks and their customers.

All other financial entities live in a world where contractual certainty regarding the main terms of an agreement is a necessity. Banks should not be excluded from this imperative.

Legally, banks are probably already living in this world. Most loan contracts are probably void for uncertainty. So why hasn't a court stepped in to strike down these contracts?

It is because our legal system is too expensive. No one in Australia has the money and inclination to take on the banks in court. The banks would draw out the litigation, making it a million dollar plus dog fight.

More interesting, is why there haven't been louder calls in the community for the government to regulate interest rates. In Australia we have an intellectual and political deficit when it comes to calling for change and an over-willingness to accept change inflicted on us.

We are too trusting of politicians and institutions. When our government increased the retirement age by two years recently there was not a beep. When the French government did the same thing last month, the country almost went into civil war. This is because the French don't trust the mantra from their government and value leisure time. The middle-class comfort enjoyed by most Australians coupled with our uneventful political and social history has placed us into a political and intellectual slumber.

The only solution is for the government to legislation. It is not that hard. Here are the clauses:

"After a loan contract has been signed a financial institution cannot increase the interest rate more than the size of a rate increase by the RBA during the term of the loan."

Next clause is:

"If during the period of a loan, the RBA reduces the official interest rate, this must be passed on in full to the customer".

This would still mean that during the life of a loan, there would be fluctuation in the rate. But the change is pegged to an objective measure (RBA movements), which gives the contract the certainty that is required by law.

Any action less than this by the government is an abdication of its responsibility to community. No amount of shaming, embarrassing or telling off the banks will work. For institutions that lack a moral and social conscience, the only lever that works is coercion, in the form of clear legal regulation.

To date, the only embarrassments on this front are Wayne Swan and Julia Gillard whose tough rhetoric, do nothing approach has even the bankers laughing, all the way to the bank.