dDiscussion of a tax on super profits has focused on energy companies, which have enjoyed huge windfall gains thanks to the invasion of Ukraine. But why hasn’t a similar tax been asked for the banks, which benefit from the increase in interest rates? While energy company earnings are highly cyclical, Australian banks are consistently among the most profitable in the world.
Rising rates widen the margin between what the bank charges borrowers and what it pays depositors. Lending rates closely track Reserve Bank rate hikes, but deposit rates often lag. In addition, low policy rates over the past decade have squeezed banks’ margins as they have been unable to reduce deposit rates sufficiently due to regulations requiring them to maintain a minimum level of retail deposit funding. As long as borrowers don’t default in droves, the lender’s profits should increase with higher interest rates.
Over the past year, Australia’s big four banks made $28.5 billion in profits. Their return on investment was 10.6%, well above the global average. Banks are large relative to the size of the overall economy at 160% of GDP, about twice the global average.
Several factors influence this performance. As mortgages make up around 60% of Australian bank lending – one of the highest percentages in the world – they benefited from the period of abnormally low interest rates and resulting high property prices, which boosted home loan volumes.
The sector is dominated by the top four banks, which make up around 72% of the market. Deregulation has not increased competition. The sector has consolidated through acquisitions and mergers. Foreign banks have largely withdrawn or redirected their attention to wealthy clients and multinational corporations.
Implied support from the Australian government and taxpayers, illustrated during the 2008 crisis and pandemic, ensures profitability. There are more subtle factors. Major banks zealously control the payment system, which means that competitors have to pay banks for access.
Over the past four decades, the profits of banks reflect their role, not only in providing vital services, but also the industry’s trend towards oligopoly. Profit maximization has reduced access to banking services, especially in regional and remote communities, and has led to financial exclusion. There are also well-documented cases of predatory behavior and outright fraud.
We need structural reforms. While seemingly attractive, a windfall tax has problems: What is a normal return? Does the state subsidize industry when profits fall? A better approach would be a fundamental reform of the sector.
The 2017 limited bank withdrawal could be expanded. It currently only applies to banks with more than $100 billion in specified liabilities. The current rate of 0.06% could be low when compared with the benefits of implicit government support which is estimated to reduce bank lending costs by 0.22 to 0.34%, although the number is disputed.
Given the need for financial services, banks should have an obligation to provide accessible access to basic banking services. This is similar to the obligation for energy, water and telecommunications companies to provide essential services.
We need more competition. Opening access to qualified participants on fair terms is one element. A basic, state-owned bank, perhaps based on Australia Post, providing simple services mostly to the financially excluded is an option. However, the long-forgotten Australian state-owned banking debacle suggests that caution is warranted.
Critical financial infrastructure, such as the payment system, should be under national control, with access to a wider variety of qualified entities, other than banks.
Such proposals will arouse fierce, well-tested and well-funded resistance, with changes described 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 to the economy or cause house prices to fall. Precipitous action, it will be argued, could damage international perceptions of banks, which play an important role in channeling foreign funding to cover Australia’s financing needs and jeopardize the functioning of monetary policy.
Lobbying efforts will exploit the fact that many people and businesses are both customers and investors in the banks, which make up over 30% of the Australian stock market. Tough rules, it is said, would hurt bank share prices, as well as reduce profitability and dividends, affecting around 14 million Australians. Banks will be represented as the largest employers and tax payers.
Indeed, such “the sky will fall” arguments are specious. For example, much of the substantial taxes paid by banks are effectively reimbursed to investors through the dividend imputation system, limiting the gain to government revenue.
Australia requires a diverse, competitive and affordable financial sector that provides a secure payment system, safe deposit of savings, affordable financing and simple and effective risk management tools. Current arrangements may not provide these results for all Australians.