More capital is just a banking tax
- Alan Kohler
- The Australian
- April 6, 2016
Yesterday we glimpsed the fact that banks are an arm of government.
They create money, provide capital, support home ownership and facilitate transactions entirely within the umbrella of government — controlled by the regulator and guaranteed by taxpayers.
Normally this mutual enslavement is hidden in the language of regulation, capital adequacy and the free market, but yesterday, at a banking conference organised by the Financial Review, we saw some of the truth.
The regulator, APRA chairman Wayne Byres, came across in his speech as the managing director of the banking system, as he is. He spruiked how well things were going — how strong and profitable his banks were — with Powerpoint slides reminiscent of an investor presentation.
He showed this chart to demonstrate how APRA had strengthened the banks’ capital:
chart 1
That chart is the one that matters. There was another one showing that the “risk-weighted” Tier 1 capital ratio is now 12 per cent, up from 7, but that only counts a quarter of real estate mortgages as an asset in the calculation.
That is, the capital is “adjusted” according to someone’s idea of how risky the asset is. They have decreed that real estate is a quarter as risky as an unsecured business loan, which sounds fine in theory, and no doubt the lenders to Arrium today are wishing they had some real estate as security … anything!
The chart above just says an asset is an asset, which has more appeal to common sense, especially in Australia where real estate assets are patently overvalued and due to correct.
Anyway, Wayne Byres used it to boast that the ratio had gone up from 4 per cent to “approaching” 5.5 per cent, which is supposed to be a good thing and for which he and APRA take full credit.
Actually, I would say the correct comparator is pre-crash, not post, since the 5 per cent ratio in 2007 did nothing to prevent the need for Government guarantees to keep the banks afloat when the manure hit the fan.
A 5 per cent capital ratio wasn’t enough back then, and now it’s 5.3 per cent. That’s enough now? Really?
Sort of acknowledging that it’s not, Wayne Byres concluded: “we can’t be complacent,” before calling for more resilience and therefore still more capital.
One wonders what he has in mind: that the value of bank assets — that is, house prices — must fall by 6 per cent before wiping out all bank capital, rather than 5.3 per cent as now?
Anyway, NAB chairman and former head of Treasury, Ken Henry, succinctly punctured Byres’ balloon in his speech, admitting that the major banks are still too big to fail and will once again have to be supported by taxpayers if there’s a crisis.
The only thing achieved in the past seven years, he said, has been a reduction in the amount of liabilities on bank balance sheets that would have to be guaranteed by the government.
“The entire flow of new funding would still have to be guaranteed.” In that context, it’s irrelevant whether the ratio of capital to total assets is 4, 5 or 6 per cent, or whether the ratio of capital to risk weighted assets is 8 per cent, as it was during the entire 2000s, 9 per cent as it was in 1996, or 12 per cent as it is now.
What should it be? No one knows.
The Financial System Inquiry (FSI) recommended that banks need to be “unquestionably strong” without clarifying what this meant.
Those two words have been APRA’s guiding star ever since, but in his speech yesterday, Wayne Byres said they’re probably not there yet.
He said: “…there are a large number of important components of the bank capital regime that are still being debated in international forums.
As a result, our consideration of what constitutes ‘unquestionably strong’ in an Australian context will need to wait until around the end of the year.” Just a couple of percentage points more?
Poacher turned gamekeeper, and head of the FSI, David Murray, agreed that we’re not there yet and said the banks might have to get by on 12 per cent return on equity instead of the current 15 per cent.
The truth is that “unquestionably strong” only has any meaning during good times. In any financial crisis banks are questionable by definition — that is the nature of a crisis.
They only occur because the strength of banks is questioned so that people want to take their money out. “Unquestionably strong” and “financial crisis” are oxymoronic.
And as former IMF chief economist Simon Johnson said the other day, there WILL be another financial crisis, which could be of a similar magnitude or even greater than the last.In the light of all this, regulators increasing bank capital requirements can be seen as nothing more than a tax on shareholders in return for standing behind their bank.
As Ken Henry pointed out, nothing fundamentally has changed since the GFC — banks are still too big to fail and are still implicitly, and actually, government guaranteed
It’s just that the price of that guarantee has gone up. Instead of earning as much as 18 per cent return on equity pre-GFC, bank management and shareholders now have to live with 14 per cent, and according to David Murray, probably 12 per cent.
The increase in required capital that is causing that reduction will make no difference whatsoever to whether the banks have to be support by the government — unless of course bank capital got to 50 per cent of assets (not risk-weighted) as it was 150 years ago, before the advent of central banking and the release of the banking hounds.