Ddiscussion about a super profits tax has been focused on energy companies, which have enjoyed huge windfall gains thanks to the invasion of Ukraine. But why has there been no call for a similar tax on the banks, which gain from soaring interest rates? While energy companies earnings are highly cyclical, Australian banks are consistently among the most profitable in the world.
Increased rates boost the margin between what the bank charges borrowers and what it pays depositors. Borrowing rates closely track the Reserve Bank’s rate rises but deposit rates frequently lag behind. In addition, low official rates over the last decade squeezed bank margins as they could not reduce deposit rates sufficiently because of regulations requiring them to maintain a minimum level of retail deposit funding. As long as borrowers do not default in droves, lender’s profits should rise with higher interest rates.
In the past year, Australia’s big four banks have made $28.5 bn in profits. Their return on investment was 10.6% , well above the global average. The banks are large relative to the size of the overall economy at 160% of GDP, around double the global average.
Several factors influence this performance. As mortgages make up around 60% of Australian bank loans – one of the highest proportions in the world – they benefited from the period of abnormally low interest rates and resulting high property prices, which increased home loan volumes.
The industry is dominated by the four major banks, which make up approximately 72% of the market. De-regulation did not increase competition. The industry has consolidated through takeovers and mergers. Foreign banks have largely withdrawn or redirected their focus on wealthy customers and multinational corporations.
Implicit Australian government and taxpayer support, illustrated during the 2008 crisis and the pandemic, underwrites profitability. There are subtler factors. Major banks zealously control the payment system, meaning competitors have to pay the banks for access.
Over the last four decades, bank profits reflect their role, not only in supplying vital services, but the sector’s tendency towards oligopoly. Profit maximization has decreased access to banking services, especially 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. While superficially attractive, a windfall tax has problems – what is a normal return? Does the state subsidize the industry when profits fall? A better approach would be fundamental reform of the sector.
The limited 2017 bank levy could be expanded. It only currently 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 was estimated to lower bank borrowing costs by 0.22 to 0.34% – although the number is disputed.
Given the necessity of financial services, banks should be under an obligation to provide affordable access to basic banking. This is similar to the requirement for energy, water and telecommunication firms to provide indispensable services.
More competition is needed. Opening up access to qualified entrants on equitable terms is one element. A bare-bones, state-owned bank, perhaps based around Australia Post, providing simple services especially to the financially excluded is one option. However, the now forgotten debacle of Australian state-owned banks suggests that caution is necessary.
Essential financial infrastructure, such as the payment system, should be under national control, with a wider variety of qualified parties, other than banks, having access.
Such proposals will elicit ferocious, well rehearsed and well-financed resistance, with changes portrayed as undermining confidence in banks and the financial system as well as creating unwanted instability and economic damage.
Banks will argue that such measures threaten the supply of credit for the economy or will cause falls in house prices. Precipitate action, it will be claimed, may damage international perceptions of banks, which play an important role in channeling foreign funding to cover Australia’s financing needs and jeopardise operation of monetary policy.
Lobbying efforts will exploit the fact that many people and businesses are both clients of and investors in the banks, which constitute more than 30% of the Australian stock market. Stringent regulations, it will be asserted, would harm bank share prices as well as reduce profitability and dividends, affecting about 14 million Australians. Banks will be depicted as major employers and taxpayers.
In truth, such “sky-will-fall-in” arguments are specious. For example, much of the substantial taxes paid by banks is effectively rebated to investors through the dividend imputation system, limiting the gain to government revenues.
Australia requires a diverse, competitive and cost effective financial sector providing a secure payments system, a safe repository of savings, appropriately priced funding and simple and effective risk-management instruments. The present arrangements may not deliver these outcomes for all Australians.