I had an OpEd piece in the AFR on the banks yesterday. See below:
The current round of bank-bashing means one thing: Our politicians and business leaders have completely missed the big picture lessons from the global financial crisis. So, while the rest of the world is tackling financial regulation, Australia has its head in the sand.
The big lesson from the GFC is simple. The Australian government will underwrite deposit holders, bond holders and, at least in part, equity holders in our major banks. If you have a deposit in one of our big-four banks or in our key second-tier banks, the Australian government has shown by its actions that it will protect your money. It will not let your bank fail. If necessary, it will actively seek out a buyer for the bank, as in the case of Bankwest.
This lesson is important because it turns our pre-GFC bank regulation on its head. Australia was meant to be one of the few OECD countries without deposit insurance. Post-GFC we know that is wrong. Like it or not, it is politically impossible for the federal government to let a major Australian bank fail.
Why does this matter? If the government insures the banks then it needs to start acting like an insurance company. The first step is to make the insurance explicit. The government needs to clearly state what assets it insures. It also needs to charge the banks an appropriate insurance premium. This is not a bank tax. It simply recognises that the government is underwriting the banks. As individuals we expect to pay for car and home insurance. The banks need to pay for the asset insurance provided by the federal government.
Second, the government needs to recognise that bank insurance is not like normal insurance. The bank cannot refuse the insurance – because the government cannot credibly let the bank fail. Similarly, the government cannot invalidate the insurance if a bank acts irresponsibly. Politically, the government will have to step in even if a bank’s failure is the result of excessive risk taking and stupidity by bank management. So as an insurer, the government needs to explicitly limit the range of activities that banks can undertake.
This is more than capital adequacy requirements. As insurer, the government must restrict the banks from activities that create too much risk. For example, banks may be required to divest their fund management activities if these create too much risk from the government’s perspective. Of course, someone else can take up these activities. But whoever takes on these activities must be completely separate from the banks and it must be clear that they are not insured. The government will protect bank depositors, not investors in non-bank financial institutions.
Third, we need to carefully design the new insurance-based bank regulation. We have a lot of experience with industry regulation in Australia. Let’s apply it to the banks. We need a Son-of-Wallis inquiry to work through our banking rules and recommend appropriate changes. We will not get perfect regulation but we can design clear regulation that is not subject to gaming.
The banks will not like these changes. They have been getting free insurance for years. Why would they now want to pay for it? They have had a government insurer who has placed too little restriction on their activities. Why would they want to face (actuarially sensible) restrictions now?
The banks will argue that changing the financial rules and limiting their activities will make them worse off. Yes! They will. The banks have had a free ride through the government implicitly underwriting their activities, so obviously they will be worse off by having to pay for an insurance service that they previously got for free.
The banks will argue that ‘others’ will be able to compete in markets that they cannot compete in. Of course! But the ‘others’ better not have an implicit (or explicit) government guarantee.
The banks will argue that money will flow to these ‘others’ to avoid the regulations. Correct! If people wish to place their money in a riskier, non-insured option then that will occur. The government needs to make sure it can credibly commit not to underwrite these ‘others’. But given that commitment, if consumers want to take the risky alternative they can do so. But the banks cannot – because the government cannot credibly let the banks go bust.
The banks will argue that these new regulations reverse the changes of the 1980s and 1990s. Absolutely! The deregulation of the 1980s and 1990s assumed that the government did not insure the banks. We now know that assumption was wrong.