Prudence best answer to calls for banking sector inquiry

After getting much of their wish-list in Treasurer Wayne Swan's sustainable banking package in late 2010, credit unions and building societies are looking for deeper reforms to the nation's banking market.

Calls for an examination of the financial system along the lines of the 1997 Wallis inquiry hit a crescendo two years ago when big banks were at the peak of their market strength. But the review was batted away by Canberra, so the question is, why the latest pleas for a review?

A report prepared by Deloitte Access Economics for the mutuals association, Abacus, calls for a full-scale inquiry into the banking system. The release of the report is designed to coincide with this week's public hearings as part of a separate Senate review of the post-GFC banking market.

But to launch a review of the country's banking sector with the aim of increasing competition in one area would be the wrong approach. As financial markets have repeatedly shown, a push to secure a desired outcome in one area often leads to significant distortions in others.

Any additional aid to credit unions risks disadvantaging regional lenders such as Bank of Queensland or even Bendigo's community-based banks.

And the last thing any banking system wants is dollops of unsustainably cheap money to encourage lenders - big or small - to take large gambles with little capital reinforcing the balance sheet. Critically, the report reveals it is not so much the demand side that is hobbling credit unions and mutuals; rather it is supply - their access to funds.

With global credit markets still demanding a premium for wholesale debt and new global bank rules encouraging deposits over wholesale funds, banks quite simply have been crowding out other lenders in the chase for deposits.

For mutuals, generally 90 per cent of their lending book is funded by deposits. For a big bank, the figure is closer to 60 per cent.

The chase for deposits, with banks paying above and beyond the market rate for savings, is also forcing mutuals to lift the price they pay for deposits - particularly term deposits.

The problem is that, unlike banks, mutuals have few other avenues to raise funds. And this is an area that is worth tackling.

Even the one-time booming market in residential mortgage-backed securities (RMBS) is still on a low simmer, despite the Australian Office of Financial Management pumping more than $15 billion into issues by small lenders. But to throw more funds at the market would amount to increasing taxpayers' bet on the health of the nation's housing market.

The Deloitte Access report again raises the prospect of converting Australia Post into a bank. Remember the distortions? This would be a bad outcome for credit unions because it would intensify the jostle for funds. In taking a deeper look at the banking market, the Deloitte Access report also focuses on the benefits for big banks of being ''too big to fail''.

It argues that the major banks have an implicit government guarantee against failure due to their importance to the financial system. It estimates the benefit for the big banks of this guarantee at between 10 and 50 basis points.

However, this ignores the higher levels of capital that large lenders are required to hold, mostly to reflect the higher-risk nature of their lending and the complicated nature of their balance sheet.

Here the sheer regulatory cost of being a big bank would arguably wipe out any implied benefit.

The notion of ''too big to fail'' is already flexing the minds of bank regulators.

The world's biggest banks now face an additional capital charge of between 1 and 2.5 percentage points to act as a safety barrier.

While no Australian bank is on the global list, regulators are now turning their attention to what in the banking world are known as ''domestically significantly important banks'' or D-SIBs.

This could ultimately result in Australia's big four banks holding even higher levels of capital than the new tougher Basel rules demand.

Increases in the capital that banks are required to hold on their balance sheet lower their profitability and limit their lending.

The banking regulator, the Australian Prudential Regulation Authority, is considering this so-called D-SIB proposal. However, APRA chairman John Laker noted recently that developing rules to regulate D-SIB's other policy tools, particularly more intensive supervision, can also play an important role.

It is worth noting that much of the big banks' market-share gains in the housing market since the GFC have not come at the expense of the mutual sector.

They have been at the expense of the regional banks and previous non-bank financiers such as Wizard and GE Money, which largely funded their book through RMBS issues.

On home loans, the big banks since June 2007 have increased their mortgage rates by an average of about 135 basis points compared with the cash rate. For credit unions and mutuals, the increase has been about 97 basis points relative to the cash rate.

The headline mortgage rate offered by mutuals is usually slightly below those of the major banks - given their lower absolute cost base.

The lending side sees market competition well at work.

The big banks are battling it out for a greater slice of the low-growth mortgage market, with lenders such as National Australia Bank playing a cat-and-mouse game on mortgages with market heavyweight Commonwealth Bank. Elsewhere, lenders such as ANZ are quietly offering the bigger ''under the table'' discounts to new home-loan customers.

A strong, stable and highly competitive banking system should be the focus of any Wallis-style review, but the temptation to favour one form of lending over another should be resisted.

The story Prudence best answer to calls for banking sector inquiry first appeared on The Sydney Morning Herald.

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