What parliamentary inquiry on banking missed

It’s what CBA chief Ian Narev wasn’t pressed to say that matters to investors - and they know it.

The politicians could have probed deeper into the links between risk weighting, repricing and returns. Picture: Kym Smith/AAP.

It was more what Commonwealth Bank chief Ian Narev didn’t say or wasn’t pressed about at yesterday’s parliamentary bank hearings that matters for investors -- and they know it.

Narev battered away the majority of questions from MPs, only stumbling in explaining the record high margin between small business loans and credit card interest rates and the cash rate, plus attempting to play down the free kick from the government guarantee if CBA was on the brink.

Indeed, despite Narev’s performance, he didn’t really have to raise much of a sweat as politicians focused on the bank’s scandals previously covered off in other forums and other issues of the nation’s biggest lender.

For example, Liberal MP Craig Kelly asked how big CBA’s asset base was -- public information freely available from the bank’s financial accounts or the banking regulator.

When probed on competition and shifts in market share, politicians seemingly forgot CBA’s transformational acquisition of distressed lender Bankwest at below book value at the height of the GFC and the question of whether, in hindsight, that should have been waved through.

In June 2007, the year before the Bankwest takevoer, CBA’s market share of home loans was 18.5 per cent -- today it’s 26.7 per cent, the biggest in the market.

Narev obviously didn’t bring Bankwest up, only noting some unnamed business models were exposed by the crisis.

On the topical and populist issue of bank profits, politicians also failed to focus on two drivers of the big banks’ stellar returns performance globally since the crisis -- risk weighting and repricing.

On the latter, wasn’t the banks’ recent mortgage repricing in their favor -- by holding back half the RBA’s rate cut -- a key motivator of the hearings before the House of Representatives standing committee on economics?

Yet Narev barely had to dip into his bag of tricks to explain the “opaque” pricing of interest rates and complex funding of loans, including the link to the RBA’s cash rate.

A bit of homework by the MPs would have discovered analysts have for years pointed out that repricing has allowed the banks to successfully offset the headwind of rising regulatory costs and lower growth since the GFC.

In the past 18 months alone, the big four hiked home loan rates independent of the RBA and held back official moves on multiple occasions, building on 29-46 basis points of repricing in 2012-13 that boosted earnings 7-12 per cent, according to Macquarie.

“The structural improvement in the pricing power of the Australian banks post the 2008 onset of the GFC has been one of the four key attributes that saw the Australian banks sail through the GFC, and still contributes to their loft share market valuations,” CLSA analysts noted in April.

Finally, the banks’ complex “risk weighting” of assets has also been a key driver of their lofty returns since the crisis.

Approved by regulators just prior to the GFC, the big four and Macquarie use “advanced” internal models to measure the riskiness of loans, thus how much “expensive” equity they require. Essentially, falling mortgage risk weights -- up until recently -- enabled the banks to grow leverage as the housing market remained healthy, resulting in few defaults.

On Morgan Stanley’s numbers, the average mortgage risk weights of Australia’s banks, at 12 per cent in September last year, compared to 53 per cent for US banks.

“Until recently, these internal models seem to have been generating ever declining housing risk weightings, with declining housing regulatory capital intensity a major contributor to the banks rising dividend-payout ratios,” CLSA analyst Brian Johnson noted.

But the issue was barely touched on, other than Narev noting CBA raised $5.1bn in equity last year to meet the regulator’s tightening of mortgage risk weights to an average 25 per cent, as recommended by the financial system inquiry to boost competition in the market for smaller players beholden to stricter “standardised” risk weighting rules.

In contrast, Narev explained that the banks’ relatively high ROE was partly due to the lack of recessions and bank failures since the GFC that have plagued Europe and the US, pointing out that there were similar returns in Canada.

The politicians could have probed deeper into the links between risk weighting, repricing and returns, and whether rules should be further revised to boost competition and further reduce the big four’s need for government support.

Perhaps they will when ANZ’s Shayne Elliott continues to front the hearing this morning and Westpac’s Brian Hartzer and National Australia Bank’s Andrew Thorburn appear tomorrow.