Big bank subsidy worth > $5bn pa

Christopher Joye

Coolabah Capital

In The Australian Financial Review I show that the big Australian banks benefit from taxpayer subsidies worth more than $5bn per annum, or more than 10x what the car industry received in 2013, and excoriate those self-proclaimed libertarians and centre-right commentators who think the government should not be putting a price on the too-big-to-fail subsidy to mitigate moral hazard risks. Click on that link to read the column for free via Twitter or AFR subs can read here. Excerpt below:

"So Standard & Poor's has confirmed that Scott Morrison's gutsy budget saved Australia's coveted AAA rating, which all the major banks thought improbable back in December. Only a few weeks ago CBA reconfirmed its forecast that there was a "high probability" Australia would be downgraded to AA+ after the budget. Let there be no doubt about Morrison and Malcolm Turnbull's true motive. Losing the rating was never going to impact the government's cost of borrowing. The reason the Treasurer and Prime Minister were personally invested in taking "every step and every action…to retain it", as they declared before the budget, was to defend the major banks' coveted AA- ratings. As a small, capital-importing economy, the government believes it is imperative that the four banks that control more than 80 per cent of our financial system are "unquestionably strong" on a global basis. A downgrade of the sovereign rating automatically triggers a one-notch reduction in the majors' ratings to A+, which would have instantly increased their senior borrowing costs by about 0.10 per cent annually. The majors would have also fallen out of the exclusive cohort of only 20 banks rated AA- in S&P's list of the top 100 global banks...If Morrison and Turnbull stay the course with prudent fiscal consolidation and the housing market continues to decelerate, there's a good chance Australia will remain a member of the 12-nation AAA club for the foreseeable future. But you cannot logically extend the big bank levy to foreign banks, as Labor reportedly wants to do, because our government does not implicitly vouchsafe their solvency. Advocating this case means you favour applying the levy to all banks. Chris Bowen should stick to the policy proposal he carried to the last election, which was to put a 0.05 per cent annual price on the government's currently free guarantee of deposits. This is consistent with written advice from the Reserve Bank and Treasury. The budget disclosed that this guarantee covers $850 billion of sub $250,000 deposits, which means a five basis point levy would generate another $425 million in annual revenue on top of the $1.5 billion expected from the six basis points wholesale debt levy. What makes the hyperbolic opposition of both the banks' (save ANZ and every smaller rival) and centre-right observers, including John Howard and Peter Costello, so absurd is that eliminating or pricing government subsidies to private businesses is a foundation principle of modern public policy and an even more important tenet for libertarians that want to minimise government interference. According to RBA research in 2015, the "major banks have received an unexplained funding advantage over smaller Australian banks of around 20 to 40 basis points on average since 2000". While advisers say Morrison does not want to state on the record that the new levy is a tax on the implicit government guarantee of the big banks' wholesale debts for fear of fuelling moral hazard, he cited exactly the same 20 to 40 basis point subsidy on Insiders on Sunday to rationalise it. This accords with our estimates that the artificial increase in the majors' senior bond ratings by two notches from A to AA- on the assumption they will always be bailed out lowers their current cost of capital by 17 basis points annually. (Macquarie's rating gets upgraded from BBB+ to A using the same logic.) The RBA further found that the "funding advantage for the major banks is significantly larger for subordinated debt, perhaps due to the greater potential for losses in the event of a default", which our research also confirms. Even in the savings market, where ratings are less salient, a simple comparison of the six- and 12-month term deposit rates offered by AMP, Bank of Queensland, Bendigo & Adelaide Bank, and Suncorp, which all sit in the A band, reveals that they are on average forced to pay 26 basis points more than the majors for this money. The RBA's 20 to 40 basis point estimate of the too-big-to-fail funding advantage implies that the majors capture an annual taxpayer subsidy worth more than $5 billion from their implicit government guarantee (using the wholesale liabilities identified in the budget). This makes the majors by far the most publicly subsidised companies in the country, receiving benefits that are more than 10 times larger than the $415 million of support the car industry (a favoured political target) received in 2013. And none of this analysis accounts for the subsidies inherent in the $200 billion-plus of emergency liquidity all banks can tap in a crisis at a staggeringly cheap rate of just 1.9 per cent via the always-generous RBA...If you think my analysis is off-base, consider this emailed comment from the former head of funding at a major bank: "Your explanation of the fairness of the levy given the direct financial benefit to banks via the implicit guarantee making their liabilities cheaper and the value of the equity put option paid by the taxpayer to the benefit of bank shareholders is spot on". 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 over $8 billion with a team of 40 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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