Mortgage Obsession Bad For Business
Mortgage Obsession Bad For Business
The latest in a painful series of ‘determined to be different’ advertisements claims Commonwealth Bank has ‘more satisfied customers than any other Australian Bank’. Given they have the most customers by a large margin, this is probably true. No doubt they also have more dissatisfied customers than any other Australian bank (Telstra will probably start using the same line on us soon).
Most of the messages we hear from the banks are like this. Drivel. On mortgages, though, they have a point. Home loan rates should rise by more than any increase in the Reserve Bank’s official rate.
The banks’ funding margins have been increasing and they will continue to do so for a few years yet. Three years ago they could obtain funding for as little 10-20 basis points over the benchmark rate (a basis point is 0.01%). Today the same money costs 80-100 basis points. As the old, cheap funding rolls off and is replaced by new, expensive funding, the average cost of funds continues to rise.
Mortgage rates are, to make the understatement of the year, politically sensitive. Any bank that raises mortgage rates by more than the official change in rates is going to get bashed from all sides of politics. The banks have been very reluctant to be on the receiving end of such a public relations disaster, so have not recovered all of the increase in funding costs. They are making less on mortgages now than they were before the crisis.
Fear not if you are bank shareholder. The overall net interest margins for Australia’s big four have risen since the onset of the crisis. That’s possible because the lower margins on mortgages have been offset by charging through the nose for any loan that isn’t a home loan.
Small to medium businesses are paying margins 300-400 basis higher than they were before the crisis, compared with 25-40 basis points extra for homeowners.
This is a bad outcome for the overall economy. Resources are being diverted from productive business assets to unproductive housing and the banks, by charging below market rates on home loans, are making it almost impossible for anyone else to compete. All because of an unhealthy political obsession with mortgages.
The Australian banking sector is not competitive enough. It’s a cosy oligopoly where the profits made far exceed a reasonable return on capital. Contrary to popular opinion, Australia’s homeowners are the one group of borrowers that aren’t paying the price.
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so well put!
Nice post Steve, although I'm not sure using a photo of man of the moment Joe Hockey is fair for this point. At least Hockey seems interested in discussing how to nurture competition, which is of course the only worthwhile solution to reducing costs for bank customers. Just about everyone else in parliament is satisfied with jawboning on the singular topic of mortgage margins. Why do you think Mike Smith rubbished Hockey but leaves everyone else alone?
The political pressure only explains a part of the discrepency. I think the other part of the picture is the cyclical swing from risk margins being underpriced to overpriced (bankers and regulators always seem to collectively forget risk at the end of long booms and remember it with gusto during a financial crisis).
This explains part of the mismatch because the big banks still arn't seeing making loans on residential property in Australia as carrying any real risk for them and the "flight to quality" for Australian banks has been to try and grow their residential property loan books even higher as a percentage of their total balance sheet.
As for their return on capital, it's something that can only be fairly judged over a complete cycle. Whether that can be done at the moment depends on whether what we've had in Australia over the last couple of years was a proper downturn or not. I'd suggest that the boom was abnormally large and the downcycle abnormally mild so you'd need to worry about the medium term solvency of any bank that hadn't shown a high return on capital over the last fifteen years.
Disclosure: I used to work for a big 4 bank and still own shares in the same bank.
There are a couple of potential ideas to solve this. Not that they are easy or that I have the solution.
Make it easier for consumers to switch their mortgages between banks. Same goes for small business loans, personal loans, credit cards etc.
Increase competition. With the big four having taken the lions share of residential mortgages since the GFC, no one else can get a look in. If we had 10 banks, I could imagine that competition would be better, and there would be less focus on the mortgage rates.
Have the banks considered that people link the bank profits with the rates they get charged on bank products?
How can a bank produce a $3bn six month profit, and still say they need to raise their mortgage rates beyond what the RBA raises rates?
Maybe the banks need to decouple mortgage rates away from the RBA cash rate, and link it to their funding costs.
As the A$ goes up, does offshore funding get cheaper?
With US interest rates at practically zero, surely offshore funding should be cheaper?
It's easy to talk about increasing competition, but other than starting a government owned bank, there is very little any government can do. Whenever the big 4 feel any competition pressure, one of them just buys the competition out, e.g CBA buying Bankwest, WBC buying St George and the Rams Home loans group. Suddenly no more competition. competition.
To increase competition, the government can impose obligations to assist customers in switching banks.
They've done this with reasonable success in the telecommunications industy (with number portability for phones and the "fast-churn" process for ADSL), but there isn't anything comparable for the banking industry.
The banks don't even have the equivalent of Australia Post's mail forwarding services.
The problem can be summed up in one simple phrase "lack of savings by Australians!!"
Australian banks cannot fund their requirements from Australians due to people not saving enough. Consequently, these banks need to obtain funds from overseas where the borrowing costs are rising (perhaps government should be implementing a saving incentive, one like that suggested in the Henry Tax Review).
Therefore, to maintain growth, to pay the dividends that go into our Superannuation Funds, the banks need to maintain margins. So before we all bank bash, let take some responsibility and lets start the SAVING revolution.
Agree with your first comment, but if the government was intending to establish a new bank they would have done it already (it was one of the few alternatives to them providing the guarantee for existing banks).
I think the purchases of Bankwest, St. George and Rams had more to do with them being failed competition (and hence cheap) than real threats at the time the takeovers were done. Bankwest was owned by a UK bank who was under very serious financial stress and just looking to get out (if it had of continued under the same ownership Bankwest would have been starved of capital and therefore unable to keep expanding). Rams was unable to make loans because it couldn't source new funding and St. George was so agreeable to being taken over because it also was struggling to be able to fund itself.
Well said Steve, pity the pollies aren't looking at facts before putting mouth into gear.
I would be interested in your views on what apparently the Canadians are doing to increase the RMBS market, and therefore drive banking competition and what the implications for Australia following suit.
Thanks
Mark
The real action will start over the next few months as houses start to tank and the bank's run to the Fed's aka taxpayer to bail them out and then we will have a USA style meltdown.. All the first home owners bribes paid by the taxpayer will have gone up in smoke and house prices will never get this high again for a long time.
Steve
Do you work for a bank.? The marginal cost of bank funding has and is declining. Your tone suggests that banks have a right of entitlement to pass these costs on. You also fail to point out that the big 4 also have had significant lending growth to offset these costs and offered discounts to gain this market share. Most business executives have to manage businesses through good and bad cycles, because of the oligopoly that exists there is only one cycle for the banks. A good cycle.
If you strip out the bad debt reductions from the last results you can see that the underling outlook and growth for banks is poor. They are now yield stories.
Although I like the idea of increased savings I disagree with it as a solution somewhat.
While increased savings increases desposits that banks can then use through the multiplier effect to generate more revenue and potentially economic productivity at a lower cost. This only serves the banks unless the borrowings are injected into productive assets (new construction, productive businesses, etc). Established homes are not considered productive (counted in a prior year). Further, new constructions are only productive in the year they are built.
The real issue is that Australians are being encouraged continuously to follow the 'Australia dream' of home owner regardless of the debt obligations that they are creating.
The lower interest rates recently coupled with the First Home Buyers Grant (FHBG) have only served to worsen this effect. Increasing house prices far and above the real value of the properties. Which are inherently 'non-productive' economic assets that do not in anyway assist economic growth in Australia.
SJ is spot on, there needs to be more emphasis on alleviating the debt obligations (interest payments) for the productive assets in our economy. Not homeowners, who shouldn't have taken out a mortgage if they couldn't afford many multiples of the interest rate at time of purchase.
By doing this we reduce the unemployment rate, adding to wages spending and therefore consumer spending, further increasing productivity that is not necessarily debt fuelled.
The banks are not without blame however, they should have cut borrowing long ago rather than continue to source additional foreign investors for mortages. A little too rememniscent of the CMO and CDO debarcles in the US. Both of the mid '80 and the GFC.
I agree with Matty that the problem is not enough saving and that the solution is through the tax system. The problems that you are pointing out arise from the fact that the tax system in Australia currently incentivises people to generate wealth in ways that are detrimental to the country (borrowing is encouraged, saving is discouraged so our current account position worstens).
If we get the tax system incentives more in line with what we need as a country, then savings go up and borrowing goes down. That would be good for the country (though probably not for banks and their shareholders).
I think the tax system could be better. However, I think it is in the minority of Australians that really consider the tax on their savings. Most have little enough disposable income to be able to save sufficiently to gain from any tax advantage. With the exception of retiries (sp?), though a majority could well be below the tax free threshold anyway.
By incentiving savings through tax all it would really do is provide the higher income brackets with a lower tax option for their investments, rather than assisting the middle and lower income brackets to save more. This would increase national savings, but sufficiently for a dramatic change in availability of funds? Probably not, there are higher yield investments available that are tax free until the capital gains are realised.
I agree that Australia should be saving more, but this must correspond with a reduced level of borrowing or increased earnings/productivity. Otherwise, the repayments on borrowings outway the ability to save.
Also, from a savings perpective there is the consideration of public savings. While the govt maintains a large deficit as it does currently public savings are depleted, exacerbating the problem. To reduce the deficit they will either require higher tax income or reduced expediture on public services. Both reduce economic productivity, slowing growth.
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