Bank Levy is Cheap

Christopher Joye

Coolabah Capital

In The Australian Financial Review I explain using objective bond market data that the government's new 0.06% bank debt levy is actually very cheap and only about 35% of what they could have forced the largest banks to pay if they wanted to fully price the immensely valuable taxpayer subsidies flowing from their "too-big-to-fail" status, which explicitly lowers their cost of borrowing by 0.17% annually to say nothing of the free government guarantee of bank deposits they receive---Treasury and the RBA previously advised the government they should pay 0.05% annually for this second form of insurance (click on that link to read the column for free). Excerpt below:

"Exactly the same math applies to Macquarie: if you normalise the rating on its senior bonds back to its BBB+ stand-alone credit profile, its borrowing costs increase by 0.17 per cent annually. Requiring banks to pay a price for the implicit too-big-to-fail subsidy is universally regarded as best practice because it minimises the significant moral hazards of having government-backed private sector institutions that can leverage off their artificially low cost of capital to engage in imprudent risk-taking behaviour. During the global financial crisis the government took the unprecedented move of offering to guarantee the safety of all banks' deposits and senior bonds. While the bond guarantee has expired, the government continues to guarantee all deposits up to a $250,000 cap for free. Treasury and the Reserve Bank formally advised the government to force banks to pay for the benefit of this separate subsidy, advocating a price of around 0.05 per cent annually. Former Treasurers Joe Hockey and Chris Bowen both embraced this idea, which was then oddly rejected by the chairman of the financial system inquiry, David Murray. In an otherwise outstanding root-and-branch review, this was one recommendation that never made sense. The reality remains that all banks get the benefit of free government insurance of their biggest source of capital (deposits), which taxpayers are not being compensated for. Theoretical best practice here would be to impose a 0.05 per cent levy for sub-$250,000 retail deposits, which would raise about $500 million annually, combined with the too-big-to-fail levy the government has just introduced. This is the equitable quid pro quo for having the government eliminate the downside risk of banks going bust. (And why this is technically a levy and not a tax.) Make no mistake, smaller bank bosses think the too-big-to-fail charge is a terrific idea, despite the Australian Bankers Association's understandable opposition to it. For years they have been calling on the government to level the competitive playing field by removing or properly pricing the too-big-to-fail crowd's subsidies, the latter of which is why we have such a concentrated financial system dominated by four of the largest banks in the world. Another way of rationalising the levy is that it is crucial to ensuring the government retains a credible commitment to delivering a budget surplus in the early 2020s, which has been vital to keeping Australia's AAA rating. If Australia is downgraded one notch, the majors' credit ratings will all fall from AA- to A+. This would directly increase the cost of their senior bonds by 0.08 per cent annually, which is, again, more than the cost of the levy. No matter which way you slice and dice the numbers, the banks are still the beneficiaries of a generous net taxpayer subsidy that is not being fully priced." Read for free via Twitter here.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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