Ddiscussion of the super profits tax has focused on energy companies, which have enjoyed huge windfall profits as a result of the Ukraine invasion. But why aren’t there calls for a similar tax on banks, which profit from rising interest rates? While energy company earnings are highly cyclical, Australian banks are consistently among the most profitable in the world.
Rising rates increase the margin between what banks charge borrowers and what they pay depositors. Lending rates closely track Reserve Bank rate increases but deposit rates often lag behind. In addition, low official rates over the past decade pressured banks’ margins as they were unable to reduce deposit rates sufficiently due to regulations requiring them to maintain minimum levels of retail deposit funding. As long as borrowers don’t default en masse, lenders’ profits will increase with higher interest rates.
Last year, Australia’s big four banks made a profit of $28.5 billion. Their return on investment was 10.6%, well above the global average. Banks are large relative to the size of the overall economy at 160% of GDP, around twice the global average.
Several factors affect this performance. As mortgages make up about 60% of Australian bank lending – one of the highest proportions in the world – they have benefited from a period of unusually low interest rates and high property prices, which boosted the volume of home loans.
The industry is dominated by four major banks, which make up about 72% of the market. Deregulation does not increase competition. The industry has been consolidated through acquisitions and mergers. Foreign banks have largely withdrawn or shifted their focus to wealthy clients and multinational corporations.
The tacit support of the Australian government and taxpayers, illustrated during the 2008 crisis and pandemic, guarantees profits. There are more subtle factors. Major banks vigorously control payment systems, meaning competitors have to pay banks for access.
Over the past four decades, bank profits reflect their role, not only in providing essential services, but the sector’s tendency towards oligopoly. Profit maximization has reduced access to banking services, particularly in regional and remote communities, and led to financial exclusion. There are also well-documented cases of predatory behavior and outright fraud.
Structural reforms are needed. Although superficially attractive, the windfall tax has a problem – what is the normal return? Does the government subsidize the industry when profits fall? A better approach is fundamental reform of the sector.
Limited bank levy 2017 can be extended. Currently, it only applies to banks with over $100bn of specified liabilities. The current rate of 0.06% may be low when compared to the benefits of implicit government support which is estimated to reduce bank borrowing costs by 0.22 to 0.34% – although the amount is disputed.
Given the need for financial services, banks should be responsible for providing affordable access to basic banking. This is similar to the need for energy, water and telecommunications firms to provide much-needed services.
More competition is needed. Opening access to eligible participants on fair terms is one element. A bare-bones, government-owned bank, perhaps based around Australia Post, providing convenient services primarily to the financially excluded is one option. However, the now-forgotten debacle of Australia’s state-owned banks shows that caution is necessary.
Important financial infrastructure, such as payment systems, should be under state control, with various eligible parties, other than banks, having access.
Such proposals would attract fierce, well-trained and well-financed opposition, with changes described as undermining confidence in banks and the financial system and creating unwanted instability and economic damage.
Banks will argue that such a move threatens the supply of credit for the economy or will cause house prices to fall. Accelerating action, it will be argued, could damage international perceptions of the bank, which plays a key role in channeling foreign funding to meet Australia’s funding needs and affects the operation of monetary policy.
Lobbying efforts will exploit the fact that many people and businesses are customers and investors in the bank, which makes up more than 30% of the Australian share market. Tighter rules, it will be argued, will affect bank share prices and reduce profits and dividends, affecting about 14 million Australians. Banks will be described as major employers and taxpayers.
Actually, such “sky-will-fall-in” arguments are absurd. For example, much of the large tax paid by banks is effectively passed on to investors through the dividend imputation system, limiting the gains to government revenues.
Australia needs a diverse, competitive and cost-effective financial sector that provides secure payment systems, secure deposit repositories, appropriately priced funding and simple and effective risk management instruments. Current arrangements may not provide this outcome for all Australians.