Parliamentary inquiry into the banks fails on the key tests

Finance matches mining as the largest industry in Australia, ­accounting for almost 9 per cent of the economy, up from 6 per cent two decades ago. It is a larger share than in ­almost any other economy.

Finance is 10 per cent of gross domestic product in Britain, ­reflecting the City of London’s role as the world’s pre-eminent ­financial centre, and it is a higher share in small economies such as Hong Kong and Singapore, but its place in the Australian economy is surprisingly large. In Canada, by contrast, it is 7 per cent of GDP and in Germany just 4 per cent.

The big banks account for about 25 per cent of value of all companies listed on the Australian Securities Exchange, so the fortunes of every Australian investor are tied to their profitability through their superannuation or share portfolios.

The government also has a lot riding on the finance sector’s profitability, as they account for the largest slice of its company tax revenue, contributing $22 billion in the latest year, compared with $12bn from mining.

But banking’s size and influence in Australia is hard to square with its lack of global projection.

Total exports of financial ser­vices were just $3.7bn last year, or less than 6 per cent of all services exports. ANZ Bank and National Australia Bank have made some serious efforts at tackling foreign markets, only to withdraw with bloodied noses.

Other than New Zealand and the Pacific Islands, the big four banks have little international profile, despite all ranking in the world’s top 25 banks by market value. It suggests a lack of global competitiveness.

At the same time, the major banks have been able to fend off all comers in their domestic market. The big four’s share of financial assets has risen from two-thirds to 80 per cent since the global financial crisis knocked smaller competitors out of the market. It is not a cartel but the lines of competition between them are more in the nature of add-on services than price.

The banks’ rate of return — now about 12 per cent — is high by global standards, a point Labor parliamentarians have ­laboured hard in the parliamentary inquiry. They rank as the most profitable in the world, yet foreign banks have been ­unable to gain an appreciable share of the retail market, which is where the lion’s share of the pro­fits are made.

Banks perform a vital role in every economy, channelling savings into investments, financing the growth of business and the economy. They are able to turn short-term deposits into long-term loans by virtue of their skill in managing risk. They enable households to benefit from their future income by providing mortgage finance and also manage the payments system.

So how well do our banks perform these tasks? The striking feature of the banks’ growth across the past two decades has been their housing lending. Lending to business, which accounted for two-thirds of their portfolios following deregulation in the 1980s, has halved to just one-third. Since the financial crisis, for every dollar the banks have lent to business, they have lent $4.40 to home buyers and housing investors.

While non-mining business investment is languishing at historic lows, Australia’s household debt has risen to a record 125 per cent of GDP, among the highest in the world.

Access to ample credit has allowed households to bid house prices up to levels far above those in most other advanced countries, relative to household incomes or rental levels.

Is this the banks’ fault? Global banking regulation, ostensibly ­intended to make banking safer, is mainly responsible for the skew in banks’ lending towards mort­gages. Banks have to set aside anything from three to 10 times as much capital when lending to business, compared with mort­gages, making it far less ­attractive.

At the same time, there has been little significant growth in the corporate bond market, which suggests the weak growth in lending to business is due more to the lack of demand for funds than a lack of availability. Weak banks are hobbling business investment across Europe but Australia’s banks are as financially strong now as they have ever been.

Though small business always complains about the difficulty of obtaining bank finance, it is not obvious that we have a smaller small-business community here than any other advanced nation. It is hard to argue there is an economic issue here.

Regulation has also contri­buted to the growth in market share of the big banks, which can advance mortgage loans with less capital backing on each loan than the smaller credit unions, building societies and smaller banks.

The recommendations of the Financial System Inquiry have gone some way to redressing this imbalance but it remains.

The banks are responding to demand from households and ­investors, impelled in part by the tax system that overwhelmingly favours owner-occupiers and investors. The exemption of capital gains tax from owner-­occupied housing and the availability of capital gains discounts, negative gearing and depreciation allowances puts property ahead of other investment options.

The fall in rates, courtesy of the Reserve Bank, means households can support ever larger loans, and this has contributed to the bidding up of house prices and the surge in housing debt. If the banks have morphed into little more than grand building societies, it is tax, regulation and central banking that are to blame.

Preferring to ferret in the weeds, the parliamentary inquiry has not probed questions of the fundamental structure of banking, its role in the economy or its vulnerabilities, though nothing matters more.

Regulation that makes banking more secure is seen as an end in itself, with very little appraisal of its costs. Innovation and entrepreneurialism are the key to productivity growth but they are inevitably stunted by a financial system in which the sole focus of regulation is risk minimisation.

Banking, as any of the chief ­executives would have told the parliamentary inquiry if asked, is on the cusp of a revolution that promises to be every bit as disruptive as that which is transforming media, retail and postal services.

Money is the quintessential digital good and can be saved, lent or spent by anyone anywhere in an instant. Peer-to-peer lenders say they could claim 20 per cent of the credit market within a decade.

A banking Google is yet to emerge but, when it does, it will certainly ­unravel the business models of the big banks and give parliament something serious to think about.