What is the GFC doing to our banks?

In the last decade, the Australian financial sector has become broader, more dynamic, accessible and competitive.

The deregulation of Australian financial markets, which began in the 1980s, allowed foreign banks to enter the market. Access to wholesale funding and securitisation markets meant new players like Aussie Home Loans and RAMS could undercut established competitors, giving borrowers access to cheaper loans and a broader range of products - like non-conforming and low-doc loans. The growth in online banking and the emergence of brokers that compare rates across institutions has also increased competition.

The benefits have been clear. The spread on business loans has dropped by 2.5 per cent per annum over the last decade. Margins on home loans have dropped by 0.3 per cent - 0.5 per cent p.a. over the same period, and banks offer greater discounts off their headline mortgage rates.

The wider array of products and growth in the size of the financial sector generally has given more people from more diverse backgrounds access to credit.

Now for the bad news.

The GFC has caused a sudden contraction and consolidation in the financial market that threatens to reverse these gains.

Wholesale funding costs have increased significantly thanks to the GFC, leaving small, regional banks and non-deposit taking institutions without access to affordable funding. Without these funds, it is impossible to compete against the larger banks, which can rely on their established deposit bases in order to make loans.

The securitisation markets allowed banks and institutions to free up their capital, so that they could make more loans. The GFC has effectively killed off the Australian securitisation market. Even with the government program to purchase $8 billion of securitised Residential Mortgage Backed Securities (RMBSs), the securitisation market can barely raise $2.5 billion a quarter. It used to raise $18 billion a quarter.

Foreign banks, another source of competition, are withdrawing from the market or have at least put any expansion plans on hold, as they focus inwards and shore up their capital base.

The Rudd Government's three-year guarantee on saving deposits with banks (but not other financial institutions) has unintentionally caused a flight to safety, resulting in a massive exodus of deposits from non-bank institutions, which are not covered by the guarantee, to those that are covered.

The Big Four are uniquely placed to weather the GFC. They have a stranglehold on the domestic banking market, holding about 70 per cent of all deposits and 70 per cent of all loans. Indeed, the Big Four are using their entrenched market position to capitalise on the immense pressures facing their competitors. Since the GFC started, CBA has taken over BankWest, Westpac has bought St George, and Suncorp is desperately seeking a suitor. In the non-banking sector, Westpac has bought RAMS and ANZ bought out Aussie Home Loans. NAB bought Aviva's life insurance arm and is now an industry giant in the life insurance industry.

Normally, the ACCC would never have allowed this sort of consolidation, and would have rejected the mergers on anti-competitive grounds. But in these extraordinary times, with extraordinary pressures on Australia's financial stability, the government has felt compelled to put competition policy on the back burner and focus on immediate threats.