Establishing a People’s Bank

This touches on another one of those rarely-discussed nuances. That is, the tension between CEOs and their shareholders, who are mostly focused on maximising raw returns in the short-to-medium term, and the much longer-term system-wide interests of taxpayers and policymakers who would like to see these institutions behave in a manner that minimises the prospect on them calling on our insurance (i.e., bank bailouts).

This now situates us at the heart of the regulatory questions that are being asked by some academics, politicians and policymakers: given their protected-species status, should the banks be subject to stricter regulatory constraints on what businesses they can and cannot operate? Should they just stick to their knitting and focus on savings and loans? Do they need to be stockbrokers, corporate financiers, investment bankers, proprietary traders, and bankers to businesses and home owners in, say, China? For some observers, and for Glass and Steagall way back in 1932, the answer to most of these questions was “No”.

These issues raise another incongruity. Everyone appears to agree that the oligarchs need to reduce their reliance on short-term wholesale debt and boost the funding they source from deposits (setting aside the fact that whether you use deposits or wholesale debt, you still have a profound asset-liability mismatch that is the source of the fragility that sits at the heart of the banking business model). From memory, the major oligarchs derive around 60 per cent of their funding from deposits, which is up from circa 50 per cent prior to the GFC.

In comparison, the much more lowly-rated Bendigo & Adelaide Bank sources around 93 per cent of its funding from deposits. Even more importantly, Bendigo & Adelaide Bank very much conforms to the highly conservative “narrow banking” model that Glass and Steagall, and some contemporary policymakers, aspire to see. That is, it sticks to the core business of providing safe-harbour for savings and redistributing that capital as credit to businesses and households throughout the economy. There is no investment bank. No proprietary trading desk. No stockbrokers. No certain-to-embed-much-higher-risk “pan-Asian” banking designs. (I have frequently drawn attention to the apparent contradiction of the major banks rushing to expand overseas following the GFC when it was the claimed absence of these exposures that many believe protected Australian banks from the crisis in the first place!)

Rather than being rewarded for its highly conservative approach (notwithstanding some minor miss-steps that originate from the Adelaide Bank legacy), Bendigo has been punished by investors, ratings agencies and even policymakers. Yet if you evaluated Bendigo’s business purely through the lens of the risk of catastrophic failure outside of the core savings and loan domain, you can mount the case that it is a demonstrably safer concern than the majors who have embedded so many other independent hazards into their activities (NAB reportedly acquiring a UK bank, Northern Rock, is just another example of this). Now in the “base-case” (aka the “good times”) it can be argued that these independent operations diversify bank earnings. But whether it be through investment banking operations, trading of stocks, currencies or commodities, or direct foreign banking exposures in the US, UK, Indonesia, or China, these non-core activities all boost the probability of catastrophic loss.

This is exactly what happened to the long line of once plain-vanilla banks during the GFC. A striking example is Royal Bank of Scotland (RBS), which morphed from a simple Scottish retail banking concern to a global trading and investment banking powerhouse. Yet it was precisely these investment banking exposures that brought it down. Today the UK taxpayer owns more than 84 per cent of RBS.

The experience during the GFC undermines the notion that private banks are inherently safer than publicly-owned enterprises. Indeed, if history tells us one thing, it is that private banks have a very high propensity for failure due to the asset-liability disconnect that is the source of so much of their instability.

This brings us to the question of the People’s Bank. I have spent much of the past two years arguing, with some success, that the Rudd Government should create more competitive neutrality in the banking and finance sectors by establishing a level playing field between deposits, wholesale debt and securitisation. And they have made some inroads here with the $16 billion of liquidity they’ve injected into the RMBS market.

To my mind, there does not seem to be a super strong case for a People’s Bank in the mainstream markets. As I noted last time around, we already have a strong second tier of smaller banks, credit unions and building societies outside of the oligarchs who, with appropriate public encouragement, could bring significant competitive pressure to bear. And a new non-bank model will inevitably emerge as securitisation spreads compress.

Yet even the most hard-headed of major bankers have privately confided to me that there would potentially be a role for Australia Post to deliver banking services in rural and regional Australia. To be sure, Bendigo & Adelaide Bank valiantly services part of this market. But with the retreat of the majors from rural Australia during the 1990s and 2000s there is an argument for a simple, low-cost banking service furnished by the state. Those living in rural Australia are members of the taxpayers I highlighted above who have supplied so much direct and indirect protection to the banking system throughout the GFC. And let there be no doubt that “banking” is a necessary public good that all Australians require access to in order to make their way in life. This is why, for example, academic research has shown that micro-finance is crucial to pulling families out of poverty.

So Ahmed Fahour could secure his first banking mandate in rural Australia. This would also provide Kevin Rudd and Wayne Swan with a powerful political wedge. The Nationals would find it impossible to oppose empowering Australia Post to deliver banking services to their constituencies. At the same time, the “dry” faction of the Liberal Party would presumably be opposed to any form of state intervention in the banking sector even though such opposition would be based on an ideological fiction (the fact is that the state already underwrites much of the industry). In short, this would be a policy that would either cleave the Coalition in two, or represent something they'd be forced to embrace if the “dries” were rolled.

I recently had a long chat with Danny John at the Sydney Morning Herald about all of this, and he subsequently published an outstanding piece on what to expect from Aussie Post. Danny notes that Aussie Post is effectively a monopoly in decline. Standard mail is a thing of the past. So the main test facing our chief postie, Mr Fahour, is how to reinvigorate the franchise while avoiding the adverse political spectre of closing non-economic post-offices.

Here it occurs to me that there is another reason why Australia Post could achieve these aims while further enhancing competition in the banking and finance sectors. Australia Post has the one thing that many smaller lenders do not: an extraordinarily strong national branch network. With over 4,000 outlets nationwide they have a distribution capability comparable to the majors. So while Australia Post may not want to compete directly in the mainstream savings and loan markets in metropolitan Australia, they could develop a financial services distribution capability.

Imagine if in every post office you could find a dedicated professional who would have the capacity to offer you non-commission-based finance on behalf of the smaller banks, building societies and non-banks. Aussie Post could remunerate these professionals on a time-basis and avoid some of the conflicts associated with mortgage brokers. Concurrently, they could negotiate at the corporate level very lucrative distribution deals with all the non-major lenders in Australia on a volume basis. In time, it is easy to imagine this service being expanded to other staple products: for example, various forms of insurance, Australian government bonds, superannuation, and so on.

At the very least, this should be some food for Mr Fahour’s thoughts.