Monday, February 01, 2010

Competition in banking

I remain fascinated by the ongoing discussion about the level of competition in retail banking in Australia. The latest comment by Karen Maley I think correctly notes that it would be an error for Australia Post to get into banking. She is right to note that we don't need Government funds tied up roviding the capital necessary for Aussie Post to get into lending, and nor do they have a distribution network that cries out as being ready to take on another product.

The argument for the need for greater competition is based on the assumption that the four banks can only increase lending rates faster than the official cash rate increases because of a lack of competition. This is patent nonsense, because the cash rate is only one of the factors that will influence a banks costs of lendng. The risk profile I'm prepared to accept as a lender is another, as is the overall position of the global availability of credit.

Yes the banks haven't increased rates at imes other than the RBA rises, but that's largely because the decision to increase rates isn't free of transaction costs. Apart from all the collateral changes and system changes, every rate rise will result in a high number of transactions with customers over requests for changed repayment terms, and inquiriers about early termination, or new lenders if the rise is elsewhere.

Therefore it is logical to vary rates at the same time as RBA rate changes especially if they are expected to be soon.

The decision by one bank not to go beyond the RBA rise may be due to a decision to squeeze margin to gain share, or it may simply be by achieving offsetting savings by, for example, restricting lending to "safer" propositions.

I want to remind all these commentators that the competition from mortgage originators in the 80s and especially 90s was the source of our current mess. These were the guys for whom the securitised debt instruments were created. These were the things that after derivative was added to derivative everyone became unable to accurately price (that is, assess risk).

(If you are into complexity theory it truly was wonderous. The collateralised securities were assumed to spread risk, because house prices had only ever gone down in the past in isolated pockets. What they didn't account for was themselves. The new products, by diversifying risk, increased the appetite of lenders to take risks. The availability of finance however also increased the demand, and hence price, for housing. As a consequence lending to anyone seemed like a good idea - after all the lending risk was diversified and the asset value of the securities were increasing. These were the NINJA loans (No income, no job, no (other) assets).)

If people really want a good old fashioned socialist kind of banking, the alternative is co-operative banking not government banking. We used to have a very vibrant Credit Union sector in Australia. It got a bad name through some building society failures but improved dramatically once there was uniform national regulation. Three things killed (they aren't completyely dead) the credit unions. The first was the arrival of the originators - a lower cost model that we now know wasn't sustainable. The second as the removal of the income tax concession granted to credit unions as "not for profit" co-operatives, that was a bad (Labor) government decision. The third was the inability of the credit union sector to make more of the co-operation between them to reduce their own costs.

I personally am far happier with four banks than I am with two supermarket chains. Apart from incentives for co-operatives the only other policy needed is one to limit the banks to just banking. The disaster in the US also had its genesis in letting DTIs get involved in activities that notionally didn't depend on the balance sheet, but in the end did.

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