Parliament gets an education on banking

The hearings could become useful if they lift Canberra’s understanding of banking from the low base on show this week.

One would hope the committee confines itself to questioning, listening and learning.

The chief executives of the four major banks were subjected to the first of their planned annual “grillings’’ before a parliamentary committee this week. Had it been anywhere but Canberra, they would have emerged with sun tans.

Ian Narev, Shayne Elliott, Andrew Thorburn and Brian Hartzer did experience the odd moments of discomfort, largely because of the odd nature of some of the questions they were asked, but generally escaped unscathed from the erratic and unfocused experience.

Despite the exorbitant hourly cost to their organisations of having four of the most highly-paid executives in the country spending hours before the committee, the investment would, from their perspective, probably be regarded as worthwhile.

Anyone who suffered the experience of actually watching the hearings, and saw and heard the questions and assertions of the parties (Labor and the Greens) calling for a royal commission into banking, would have concluded that they completely failed to make even the flimsiest outlines of a case for spending tens of millions of taxpayer funds and several years on a formal public inquiry.

What the hearings did illustrate, apart from the predictable mix of empathy, contrition and assertiveness shown by the CEOs as they tried to contain the damage done by the various “conduct” issues and failings exposed in recent years while defending the larger workings of their organisations, is how little politicians understand banks and the financial system.

If the experience has helped educate the members of the House economics committee, then that is also a positive return on the banks’ investment.

The obsession of the Liberals’ Scott Buchholz with credit card interest rates helps illustrate the extent of the misunderstandings people, not just politicians, have of how the banking system actually operates. He continually raised the 20 per cent-plus interest rates on cash advances on cards attracting the highest rates, almost pleading with the banks CEOs to reduce them.

Credit cards are an interesting product and a useful product to illustrate the complexity of factors that are taken into account in the pricing of bank products.

The card market is competitive. There are more than 70 card providers offering more than 200 different cards. The prices – the interest rates and fees – on those cards are the outcomes of quite fierce competition, not of an oligopolistic market.

Each of the majors offers a variety of cards, with a variety of features, from lower-rate cards with few frills or reward points to high-rate cards linked to popular reward schemes and carrying other benefits like insurance. As they pointed out, consumers are able to choose the cards they want and move between the types of cards quite freely and without cost.

A majority of card users don’t pay interest but, in paying off their balances each month, effectively receive free credit along with whatever bells and whistles might be attached to their card.

Those who don’t pay off their balances are drawing down on a line of unsecured credit, which from the banks’ perspective is the riskiest form of credit they provide and the first product that will experience losses if there is any downturn in the economy.

Their pricing will reflect that risk but only consumers who can’t pay off their balances, self-evidently exposing themselves as higher-risk, are exposed to it. Those who use the cards to obtain cash advances, despite the rates, are obviously the highest-risk customers.

So there will be a significant risk premium in credit card interest rates generally and an even higher premium for cash advances.

The falling usage rates for credit cards – debit cards have surged in popularity – the Reserve Bank’s continuing reforms to interchange rates, the cost of rewards programs and the scale of the cross-subsidy from those who actually pay interest on their card balances and the majority who don’t, means that the rates will inevitably be higher relative to other less-risky and less complicated forms of credit.

The banks obviously have to fund both the interest-free and interest-generating credit they extend.

As the CEOs pointed out to the committee, repeatedly, while the cash rate may have fallen steeply in the post-crisis period they don’t fund themselves off the cash rate.

There is a significant proportion of their funding base offshore and there is an increased proportion of the base sourced from term deposits. Relative to the cash rate, the cost of both has risen. They are also now required to hold more low-yielding assets and more capital that doesn’t generate returns.

The other element of the discussions about cards, which is relevant to bank lending more generally, is that the banks price the products for their expectations of what they expect to occur through economic cycles, not just for the external circumstances of the moment.

There will be moments through a cycle where cards, or unsecured loans to business, are highly profitable. There will also be periods when the banks experience significant losses. The Australian system is coming of a period of almost unprecedented low levels of loans losses, but they have started to pick up.

The complexities of the combination of funding costs and risks also surfaced in response to the similar obsession the committee’s chairman, David Coleman, has with ‘’tracker’’ products, or mortgages whose rates are linked directly to, and move with, a benchmark rate like the cash rate.

The products have been quite popular in other markets, particularly the UK and Coleman, a former director of the Yellow Brick Road non-bank financial service group, repeatedly asked the CEOs why they weren’t offered here and whether the committee should recommend their introduction.

All the CEOs said they had looked at them, all said they had some appeal – ANZ continues to look at them -- and all said they saw no need and considerable difficulties in offering them.

Brian Hartzer, who ran one of the UK’s biggest retail banks – the retail businesses of RBS – made the obvious point that offering a product whose rate moved in line with the cash rate, off balance sheets whose funding costs don’t move in line with that rate, would be fraught with risk. Indeed, he pointed to the role of the products in the collapse of Northern Rock in the UK as an example of how risky they might be.

To reflect the funding mismatches the banks would be exposed to with trackers they would have to price them at a significant premium to their standard mortgages and engage in some specific and sophisticated risk-management.

Tracker products, moving in a direct line with the cash rate, might be appealing when the cash rate is falling and the banks aren’t passing on the entirety of the RBA’s cuts. One suspects they would be quite as attractive in a rising rate environment.

The committee might also consider why, if tracker products are as compelling as its chairman appears to believe, a bank or non-bank hasn’t already introduced them? If there’s money to be made, surely someone would be chasing it? They obviously don’t believe the risk-adjusted returns are attractive.

There is a risk that the committee will feel the need to justify its existence by recommending various new regulations of bank activities even as the Financial System Inquiry’s recommendations are still being implemented.

The Greens’ Adam Bandt is still calling for a tax on the majors for a government guarantee of their deposits that doesn’t exist (and which, in any case, they already paying in the form of the 1 per cent capital surcharge for being domestically system important institutions).

Some committee members want individual managers to be accountable for the behaviours of their staff. They want a new tribunal to adjudicate disputes with banks. One member even wants compulsory ‘’unconscious bias’’ programs to be imposed on all bank staff.

The Australian financial system has proven itself resilient. The major banks are well-regulated, profitable, well-capitalised and among the most efficient and (surprising to some) innovative of banks around the globe.

The system is quite competitive – net interest margins have more than halved in the past two decades, which wouldn’t have happened in an oligopoly – and the vast majority of the profits it generates flow back to Australians either directly or via their super funds.

Most importantly, and in contrast to most other developed world banking systems, it is stable and able to supply credit to households and businesses in line with demand and therefore play its role within the economy. In other systems the banks are a significant part of the economic problems that countries face.

As a forum for questioning the major bank CEOs an annual parliamentary committee hearing might, over time, become quite useful as the politicians’ understanding of the banks and how they operate increases. It certainly provides an opportunity for the banks to respond to criticisms and queries.

Given the nature of what we saw and heard this week, however, one would hope the committee confines itself to questioning, listening and learning.

It should leave recommendations on regulation of banks to those – such as the financial system inquiry, the Australian Prudential Regulation Authority, the Australian Securities and Investments Commission, the Reserve Bank and others with financial service expertise – who understand them.