Home > Miscellaneous Musings > Banks – The Ultimate Safehaven Employer

Banks – The Ultimate Safehaven Employer

If I only knew this when I was 18.  Aim for a Big Four Bank and don’t look back.  From the SMH:

When it comes to banking in Australia a strong tradition is emerging, that is the tradition of taking from the poor to give to the rich.

And so it is that, despite taxpayer guarantees and all manner of taxpayer largesse afforded the big banks, they continue their cowardly stand-off over mortgage rates in the wake of yesterday’s cut to the official cash rate.

This is the ultimate game of bluff. Nobody wants to go first because nobody wants to pass on the Reserve Bank’s full 25 basis point reduction.

And the reason for this is twofold: firstly if the bankers pass on the full rate cut that will put a little more pressure on their profit margins. More pressure on profit margins translates into more pressure on the share price, which in turn translates to, potentially, less executive pay.

This is the great dread, the menacing spectre of a decrease in $10 million executive salaries due to lower profit growth and its impact on long and short term incentive schemes.

If somebody else however, that is another bank, “does the dirty work” and goes first by withholding all or some of the official rate cut then this “first-mover” gets the bad publicity while all the rivals sit out the day of shocking headlines before cutting their mortgage rates by a tad more than the first-mover.

The big banks tend to take it in turns to be the ugly banker. Westpac chief Gail Kelly did it two years ago and departing CBA chief Ralph Norris did it last Melbourne Cup day.

The stand-off then, this game of chicken, comes down to the fear of poor publicity and consequent threat to market share, and therefore profits, by being first-mover.

In the banks’ defence, their primary responsibility is to their shareholders, not their customers, so as long as management tactics don’t turf off too many customers, thereby affecting the share price and shareholders, they have done their job. Luckily for them, their pay also depends on appeasing and delivering for shareholders.

This brings us to the second reason for not wanting to pass on the official rate cut. It is not greed alone. Although the banks, with their collective $20 billion in bottom line profits, can definitely absorb a 25 point cut to mortgage rates, roughly one-third of their funding for mortgages hithers from overseas markets.

That is, two-thirds of mortgage funding derives from deposits but the rest comes from bond markets, mostly offshore. This sovereign debt crisis in Europe has made investors particularly wary about bonds, even bonds which are effectively guarantees by a rock-solid sovereign credit such as Australia.

So the price of getting this funding has gone up – some people believe it might freeze completely – and therefore banking costs are potentially on the rise. It gets back to profit growth and executive salaries again because the price is not prohibitively high at the moment but our banks don’t want to pay any blow-out in costs or it will affect their profits.

At the moment it is “rainy day” stuff. Witholding the Reserve Bank rate relief means protecting profits from the potential for a blow-out in wholesale funding costs. It is insurance against the “Armageddon Scenario”.

But this only notionally helps taxpayers, that is to shore up the system against collapse. There is a disconnect here though; executives and shareholders benefit by the banks holding back on rate relief but those who provide the guarantees get nought, except vicariously via some funding fees paid to Treasury.

But since the very survival of the banks and the risks of the bankers are underpinned by taxpayers there may be little point in the fees anyway.

RBA assistant governor Guy Debelle spelt out the safety net in his address to Risk Australia Conference in August 2010:

The institutional framework determines the point at which the public sector needs to be called on. But in terms of insurance of the system as a whole, at some point, it has to be provided by the public sector.

I do not believe it is socially optimal for the individual entity to fully insure itself. It would be excessively costly for the financial sector to hold enough capital and liquidity to enable it to survive a freezing of capital markets of the type that occurred in 2008. At some point, it is not even affordable.

There you have it – a protected species. The government will bail out the banks. And if that is the case, there is a strong argument that, as they are underpinned anyway – mollycoddled unlike any other “private business” in the country – they should do as Wayne Swan tells them.

In a metaphorical sense the banks are performing a “Reverse Robin Hood”, taking from the poor taxpayer to give to the rich chief executive, and all with the imprimatur – albeit sometimes reluctantly – of King Wayne.

Right now, the bankers will be watching this website and the assorted news services, waiting for a move from their rivals, evaluating the public mood. What this really amounts to however is “price signalling”. This behaviour sits at the edge of the law. The longer the stand-off goes on the more obvious it is that nobody wants to move at all. They are nodding and winking to each other.

In this way, they can seek the comfort of the pack. No banker is worse than the other. Absent external pressure they are emboldened in their “sit tight and do nothing” strategy. Only one thing is sure, when there is a public utterance it is London to a brick that the public will hear how tough it is out there.

Categories: Miscellaneous Musings
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