Research shows the banks will pass the bank levy on to customers


Fabrizio Carmignani, Griffith University and Ross Guest, Griffith University

Studies of European countries show that bank taxes similar to the 0.06% bank levy introduced by the government in the 2017 federal budget will be largely borne by customers, not shareholders. The Conversation

The levy could also make the banking system more, rather than less risky. The fact that a bank is asked to pay the levy is a confirmation that it is “too big to fail”. This could in turn encourage riskier behaviour. The levy might also trigger a higher probability of default by reducing a bank’s after-tax profitability

But it is difficult to say whether banks will pass the levy on to customers by increasing their loan rates, fees or both.

In its response to the levy, NAB confirmed it will not just be borne by shareholders:

The levy is not just on banks, it is a tax on every Australian who benefits from, and is part of, the banking industry. This includes NAB’s 10 million customers, 570,000 direct NAB shareholders, those who own NAB shares through their superannuation, our 1,700 suppliers and NAB’s 34,000 employees. The levy cannot be
absorbed; it will be borne by these people.

Aware of this problem, the government has asked the Australian Competition and Consumer Commission (ACCC) to undertake an inquiry into residential mortgage pricing. The ACCC can require banks to explain changes to mortgage pricing and fees.

When banks pass on these taxes

The bank levy is similar to taxes recently introduced by some G20 economies, including the UK. These had the dual purpose of raising revenues and stabilising the balance sheets of large banks in the aftermath of the global financial crisis.

An analysis of bank taxes in the UK and 13 other European Union countries shows that the extent to which taxes are passed on to customers depends on how concentrated the banking industry is.

The more the industry is dominated by a small number of banks, the greater the share of the tax that is passed on to customers and the less that is borne by shareholders. In more concentrated industries customers have relatively fewer alternative options and therefore tend to be less mobile across banks. This in turn gives the large banks greater market power to increase interest rates and fees without losing customers.

Australia’s banking industry is quite concentrated. In fact, we’re around the middle of the pack of OECD countries, much higher than the US, but lower than some European countries. From this we can surmise that at least some of the cost of the bank levy here will be passed on to borrowers through higher loan rates, fees or both.

An IMF study of G20 countries suggests that a levy of 20 basis points (i.e. 0.2%, approximately three times higher than the Australian government’s bank levy), could lead to an increase in loan rates of between 5 and 10 basis points. This means that the monthly repayment on a loan (assuming an initial rate of 5.5%) would increase by approximately A$6 for every A$100,000 borrowed.

The IMF also found that the bank levy doesn’t just hit customers. A 0.2% levy would reduce banks’ asset growth rate by approximately 0.05% and permanently lower real GDP by 0.3%.

The impact on customers

If the banks pass on the levy to customers then it becomes just another indirect tax, similar to the GST. The question then is whether this is regressive – does it have a greater impact on those on lower incomes than higher incomes.

Lower income earners are likely to borrow less than higher income earners. However, lower income earners are also less able to bear an interest rate increase. They are also more likely to be excluded from borrowing when the cost of borrowing increases.

In this sense, then, if the bank levy is passed on to customers it could become a barrier to home ownership for some lower income borrowers.

More generally, if the value of bank transactions is a higher proportion of low incomes than of high incomes, then the bank levy would operate as a regressive tax and contribute to sharpening (rather than smoothing) inequalities.

Both of these would be unintended, but undesirable, consequences of the levy.

Fabrizio Carmignani, Professor, Griffith Business School, Griffith University and Ross Guest, Professor of Economics and National Senior Teaching Fellow, Griffith University

This article was originally published on The Conversation. Read the original article.

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Budget 2017: lack of competition is why government is moving so hard against the banks


Harry Scheule, University of Technology Sydney

With it’s latest budget the government has made a number of moves to create a level playing field in the banking system. It’s taxing the five largest banks, announced a review of rules around data sharing, a new dispute resolution system for banks and other financial institutions, and new powers for the regulator to make bank executives accountable. The Conversation

All of this is on top of a Productivity Commission inquiry into the competition within the Australian financial system, announced this week.

While some of these moves – such as the bank levy – will have a positive effect on making smaller banks more competitive, there are more policies that could be considered. These could include the separating out of the retail arms from the other areas of the large banks, increasing the capital requirements of larger banks to equal those of smaller banks, and developing new sources of funding for smaller banks.

More for competition

A new “one-stop shop” for dispute resolution will replace the existing three schemes – Financial Ombudsman Service, the Credit and
Investments Ombudsman and the Superannuation Complaints Tribunal. Called the Australian Financial Complaints Authority (AFCA), it will give consumers, businesses and investors a binding resolution process when dealing with financial services companies. The scheme will provide for a basis for more competition as disputes on financial services are consistently resolved regardless of the provider.

And A$1.2 million has been given to fund a review of an open banking system in which customers can request banks to share their data, which could assist financial startups and other competitors enter the market and compete against the big four banks. Banks will likely be forced to provide standardised application programming interfaces (API) that enable financial technology companies to provide services for interested consumers.

The government has also provided A$13.2 million to the Australian Competition and Consumer Commission (ACCC) to further scrutinise bank competition and to run the AFCA. This follows a House of Representatives report that called for an entity to make regular recommendations to improve competition and change the corporate culture of the financial industry.

The ACCC will provide Treasury with ongoing advise on how to boost competition in the sector. This may include a reduction of cost advantages of big banks, barriers to entry for new firms including change costs for consumers.

A more concentrated and changing finance sector

All of these changes come after a decade of consolidation and upheaval in the financial system, which has hurt competition and increased risk.

This chart shows the market shares of the big four Australian banks in terms of Australian loans and deposits:

Market share Big 4 banks.
Australian Prudential Regulation Authority

As you can see, since 2002 their market share has grown from 69.7% to 79.6% for loans and from 66.3% to 77.3% for deposits. Also, the gap between market dominance in loans versus deposits has closed since the global finance crisis. This means the big banks are attracting a greater share of bank deposits, which has an impact on the smaller banks.

With limited access to deposits, which is a relatively cheap way of raising capital, smaller banks have had to rely on the more expensive wholesale debt markets. Small banks also have difficulties to tap other funding sources such as covered bonds. This makes their products less competitive, and they have struggled as a result.

In part, that’s because a number of banks disappeared or merged with the big banks after the global financial crisis. This includes St George, Bankwest, Bendigo Bank, Aussie Home Loans, Adelaide Bank, RAMS and Wizard.

The Murray Inquiry found the big four banks have less than half the capital set aside for emergencies than some smaller financial institutions do. Again, this makes the smaller banks less competitive and needs to be addressed. The government should increase the capital requirements of larger banks to close the cost advantage for larger banks.

In addition, rising house prices have led to a further increase in the concentration of mortgage and other housing loans in the Australian banking system. Today Australian banks have about twice as many mortgages on their books as in the next highest developed economy.

New financial startups, such as peer-to-peer lenders, have entered the banking system. In time they may rival the big banks in areas like personal lending, but they remain small in terms of market share. And the big banks’ unwillingness to share data may be a hindrance.

Something needed to be done

The concentration in the banking sector does not provide the best outcome to all Australians. It has led to a low range and low quality of financial services as well as high costs. This needed to be addressed.

The new banking levy will support competition, as it pushes up the cost for the big banks. The review into data sharing could also be a boon to financial startups and other competitors, although we don’t yet know what the outcome will be.

But even stronger government actions may needed to create a level playing field. The government should consider separating out of the retail arms, from the other areas, of the large banks. Failing that, the low capital buffers of the big banks need to be addressed.

Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology Sydney

This article was originally published on The Conversation. Read the original article.

Banks may squeal about new tax but they are outgunned



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Scott Morrison and Malcolm Turnbull have landed themselves in a fight with the banks.
AAP/Lukas Coch

Michelle Grattan, University of Canberra

Paradoxically, the budget item currently generating the most heat is one that instantly won bipartisan support. The Conversation

The big banks are livid at the new tax on them, designed to raise more than A$6 billion over the budget period in the cause of “budget repair”. It is accompanied by measures to force better behaviour, and to help people who’ve been treated badly to get redress.

What’s not yet clear is whether the banks will ramp up their anger from rhetoric into a serious campaign.

The fight against Labor’s mining tax springs to mind. But the banks aren’t in the position the miners were in 2010 and later.

Mining companies mightn’t have been corporate favourites, but the banks are deeply unpopular. Their cries of woe and warning are likely to fall on the deafest of ears.

Most important, the mining tax was seized on by the then-opposition to flay Labor, and that strengthened the miners’ hand. When government and opposition agree about a tax, it is extremely hard for the affected sector to get political leverage.

The banks did get some comfort on Wednesday from former prime minister John Howard. Calling what the government dubs a “levy” a “tax”, Howard said “the arguments against the mining tax applied by Wayne Swan can be applied here with equal force” and contested the government’s point that the tax was in line with other advanced countries. “I think some of the comparison with the UK are not complete,” he said.

He was also concerned about the government’s level of intervention in relation to the banks, notably its proposed Banking Executive Accountability regime, that will require senior executives to be registered with the Australian Prudential Regulation Authority, with the threat of breaches leading to disqualification from holding executive positions.

For a government that has trenchantly resisted a royal commission into the banks – which is still a partisan division between the Coalition and Labor – its measures are certainly highly interventionist.

While the government continues to protect the banks from the ultimate probe, it demonstrably has little patience with them. “Cry me a river” was Morrison’s reported dismissive remark in the budget lock-up about how the levy would go down with them.

The government’s attitude is seen in the argument about who’ll be hit by the new tax. It insists the banks should absorb the levy, not pass it on to customers.

But Westpac chief Brian Hartzer said: “There is no ‘magic pudding’. The cost of any new tax is ultimately borne by shareholders, borrowers, depositors, and employees.”

Morrison was blunt at his National Press Club Wednesday lunch: “A company has its value in the way it treats its customers.

“The banks want to send a message to their customers about how much they value them? Don’t do what they may be contemplating doing. Don’t do it. They already don’t like you very much,” he said. “Tell them you’ll pony up and you’ll help fix the budget.”

There’s been speculation of a personal element in Morrison’s issue with the banks, such was his fury at the Australian Bankers’ Association’s appointment of former Queensland Labor premier Anna Bligh as its CEO. The job had been sought by Morrison’s then-staffer Sasha Grebe.

But the key point is that the big five banks are the ideal soft target for a tax raid because they are both rich and lacking in friends.

Less ideal is the target of the budget’s other tax impost – the general taxpaying community.

The budget’s planned 2019 increase in the Medicare levy to fund the National Disability Insurance Scheme is being sold as a necessary measure in a good cause. Morrison drew on his own family experience on Wednesday by telling the story of his brother-in-law Gary – present at the lunch – who suffers from multiple sclerosis.

Labor has yet to announce its attitude to the levy increase. It’s caught between the temptation to score off the government over a tax rise and its commitment to the NDIS. One option would be to propose the increase should not apply to those on lower incomes.

What’s been termed by some a “Labor-lite” budget has raised the degree of difficulty for Shorten in crafting a budget reply that isn’t seen to fall short.

In Thursday’s speech he will reiterate that Labor opposes the ending of the deficit levy on high-income earners, saying: “At a time when the government is asking every other working Australian to pay a higher rate of tax, Labor will not support spending at least $1.2 billion each year on the wealthiest 2%.”

But the opposition has no power to stop the removal of the deficit levy, which comes off automatically at the end of June.

While Shorten is expected to leave open the possibility of reintroducing the levy, he is not expected to commit to doing so. If Labor had won the 2016 election it would have been easily able to maintain it. Once it’s gone, reimposing it becomes harder.

https://www.podbean.com/media/player/55eic-6aa7da?from=yiiadmin

Michelle Grattan, Professorial Fellow, University of Canberra

This article was originally published on The Conversation. Read the original article.

Budget bank levy: too big to fail, not too big to take a hit


Kevin Davis, Australian Centre for Financial Studies

The budget announcement of a 0.06% levy on a subset of bank liabilities looks arbitrary, and is certainly politically opportunistic. But it could be rationalised as a response, albeit probably not the best response, to offsetting a number of distortions in Australia’s banking market. The Conversation

The levy will certainly have consequences for bank pricing, forms of funding and competition – and will interact in complex ways with other prudential regulatory changes in the pipeline.

The levy will affect the four major banks and Macquarie. It will apply to liabilities other than deposits protected by the Financial Claims Scheme (ie. under A$250,000) and additional Tier 1 capital instruments.

As a ballpark estimate, it will apply to around 50% of a bank’s total funding, raising the overall cost of funding for the affected banks by around 0.03%.

The large banks are perceived to receive a competitive benefit (lower borrowing costs) from an implicit government guarantee associated with being “too big to fail”. On this basis, the levy could be seen as a charge for that benefit.

As it is in Europe, Australia could establish a “resolution fund” to enable the Australian Prudential Regulation Authority (APRA) to facilitate a smooth exit (ie by merger) of a failing bank. Although this levy is going to be set aside by the government for budget repair, rather than being set up in another separate fund, it could be argued that it strengthens the government to support APRA in regulating the banks.

The nature of the regulatory system (such as capital adequacy requirements) creates a competitive imbalance favouring the big four banks. The imposition of higher minimum capital requirements for mortgage loans by banks (five banks were actually subject to this levy) was only a partial response to this imbalance.

It’s often argued Australian banks have relied too much on funding, other than “core/stable” deposits and capital, with potential consequences for safety and systemic stability. Indeed, the large banks have funded their increased share of home mortgage lending since the global financial crisis to a significant degree from wholesale borrowings.

However there are better ways of dealing with these perceived distortions than the government’s quick, politically opportunistic, measure. And, together with other bank accountability measures introduced in the budget, it may neutralise whatever support exists for a Banking royal commission.

The levy is likely to have a number of significant effects on financial markets and consumers of financial services. The levy will flow through the banks’ funds transfer pricing systems to affect loan pricing.

In this regard it is somewhat silly to simultaneously suggest that the big banks shouldn’t increase loan interest rates, as the Treasurer has, but that the measure will improve the competitive position of smaller banks. The latter will only happen if the large banks do respond in that way!

The large banks will have incentives to fund loans differently. In particular, by originating and then securitising loans (pooling various types of contractual debt, to get them off-balance sheet and funded by the capital market) they will avoid the levy on that part of their activities.

However, that benefit won’t apply if they use “covered bond” securitisation. This is when debt securities are issued by a bank and collateralised against a pool of assets, giving the investor a claim against both those assets and the bank in general. The levy is thus likely to give a kick to traditional securitisation over on-balance-sheet lending, but stymie the growth of covered bond funding.

The levy will also affect the structure of bank deposit interest rates. Because retail deposits are exempt from the levy, the large banks can be expected to bid for these deposits – pushing up the interest rates offered relative to the cost of borrowing in wholesale and large deposit markets.

That’s going to compound the already apparent effect on relative interest rates due to recent and forthcoming liquidity regulations being applied by APRA. But it will worsen the relative returns that superannuation funds can get on (their large) bank deposits and possibly induce them to look towards investing more in securitised products.

It’s also worth noting that the budget involves changes which will increase competition for retail deposits. One example is the measure allowing individuals to make limited, tax advantaged, contributions to superannuation which can be subsequently withdrawn for a house deposit.

A further likely effect is to encourage banks to make more use of equity capital and additional Tier 1 (AT1) capital funding (that preferences share structures listed on the ASX and held by many retail investors), relative to Tier 2 capital funding (provided by the wholesale and institutional markets), or other wholesale funding. While more capital funding is still required to meet the “unquestionably strong” criteria proposed by the Murray inquiry, and accepted by the government, it’s far from clear that increased reliance on the complex AT1 is a desirable outcome.

The revenue to be raised is large in absolute dollar amount – but is relatively small as a percentage of current bank profits (in the order of 4-5%).

It could be expected that some part of the levy will be passed on to customers, or avoided by the banks shifting to other forms of funding which do not incur the levy, such that the short run direct impact on after tax profits and shareholders is somewhat less than that 4-5% figure.

But the big unknown is how the change, in conjunction with a plethora of other ongoing regulatory changes affecting the financial sector, affects the competitive balance between the big banks, smaller bank competitors and capital markets and their prospects in the long run.


This piece was co-published with Pursuit.

Kevin Davis, Research Director of Australian Centre for FInancial Studies and Professor of Finance at Melbourne and Monash Universities, Australian Centre for Financial Studies

This article was originally published on The Conversation. Read the original article.