We can't bank on risky Rudd

WHETHER Kevin Rudd struts the world stage at G20 summit meetings probably ranks well below AFL draft picks and the next series of MasterChef in the consciousness of the average Australian. A small minority of us may have an aversion to his nerdy hubris when he fakes smiles at his mates Barack Obama, Gordon Brown and Nicolas Sarkozy. But most of us feel something between anaesthesia and mild satisfaction that our bloke's there.

And while most of us understand that much of Rudd's time, effort and posturing is devoted to polishing up his CV for his next job as UN secretary-general or something similar, who really cares? When Rudd prances around the globe attending myriad shindigs, it doesn't really affect us, does it?

Well, it might. Indeed, two apparently esoteric matters of high finance look set to become the catalyst to a wider realisation: adopting stupid regulations so we can show off to our G20 pals has a high cost at home when it means carpet-bombing a perfectly healthy economy. More directly, Australian home buyers may discover they can't get a home loan because the PM wants to impress his new chums and improve his future job prospects.

What follows is a cautionary tale about the dangers of imposing one-size-fits-all regulation on Australia in order to win diplomatic brownie points. Regrettably, some of this is a little technical. That's why it has sailed under the radar. But bear with me, as the consequences are profound and widespread.

First, we should remember how well our banks and our banking regulations performed through the global financial crisis.

The PM, Deputy PM and Treasurer have missed no opportunity to point out that our banks and banking system are the developed world's paragon of banking virtue. Unfortunately, this near universal acclaim has not stopped Rudd dragooning the Australian Prudential Regulation Authority into leading the G20 charge to set up standardised frameworks for regulating banks, regardless of local circumstances.

Despite the folly of trying to fix something manifestly not broken, APRA has responded by proposing two little fixes: a leverage ratio and a liquidity ratio. Our political leaders and regulators will be hoping the very names of these so-called reforms put you to sleep. Don't fall for it.

The leverage ratio is the ratio of a bank's capital to its total assets. At its Pittsburgh meeting in September, the G20 agreed to bring in a leverage ratio to stop banks over-gearing themselves in their haste to expand and make higher profits. The more capital a bank has, the less risky the bank. But equally, the more capital a bank is required to set aside, the less it has available to lend.

So what's wrong with that? Maybe nothing, if we're talking about some British and European banks. However, in Australia regulators will be choking off credit to solve a problem we never had. This is not just futile. It's dumb. And it's dangerous.

Australian banks already have sophisticated and effective rules about how much capital they must hold. The rules are based on previously agreed international rules and demand that banks hold different amounts of capital depending on how risky their assets are. Australian banks must hold more capital against high-risk corporate loans than they do against, say, a loan to a government agency. And they are allowed to keep significantly less capital against home lending because our banking history is that home mortgage loans have proved to be very low risk.

The new leverage ratio may end up recognising none of this local Australian history or any of its subtlety. It will require banks to keep as much capital for a low-risk home loan as they must keep for a highly leveraged loan to a corporate raider. This will have the perverse effect of encouraging banks to lend to the riskier, but more profitable, corporate end of the lending market and less to the low-risk and low-return home lending end of the market as the capital requirements will be the same no matter how risky the loan.

This will be particularly disastrous for the home lending business. Why would a bank voluntarily lend money to home buyers at profit margins already squeezed to the bone by political monitoring, when mortgage lending requires the banks to put aside as much expensive capital as is required for more profitable forms of lending?

Indeed, just quietly, the banks have already told APRA precisely that. Some have warned that the new leverage ratio will cause banks' appetite for home lending to dry up.

To those who say this just proves banks are greedy, profit-driven bastards that should be nationalised, there is a better answer. Don't change the system. Changing the status quo so that Rudd can preen at G20 meetings is folly of the highest order.

Ditto the liquidity ratio. APRA has proposed new tests for a bank's liquid assets, driven by the conclusions of the G20 finance ministers meeting in September.

Before your eyes glaze over, let me simplify. Banks must hold some of their assets in a form that can be readily turned into cash. Liquidity ratios bolster confidence in the banking system to avoid a run on banks and to ensure that, as far as possible, deposits are paid on back on time.

In Australia, banks have traditionally been allowed to count cash, government securities and loans to other banks as liquid assets for the purposes of liquidity ratios. APRA now appears to want to limit liquid assets to government securities. Political cynics will quite rightly recognise this as a masterstroke for a cash-strapped government trying to finance a hefty deficit. While there are not enough government bills to support this new liquidity ratio, that may change. And every dollar that a bank is forced by foolish regulation to lend to fund a Julia Gillard school hall is a dollar not available to finance more productive enterprise.

Overnight, the government becomes much more important to the process of allocating capital, and banks correspondingly less so. To Rudd and the G20 central control and command club, that is obviously their sweet aim.

But again, bank borrowers will suffer the consequences. And so will the economy. Credit will become more scarce and more expensive. So beware these apparently arcane technicalities. A magnificently functioning economy is about to be sacrificed to the Rudd government's desire for G20 glory.