Big Banks Justified in Hiking Interest Rates

Christopher Joye

In The AFR I argue that the big banks are absolutely justified in hiking home loan rates after APRA's recent decisions, and are definitely doing the RBA's dirty work for it on the liability side of the household balance-sheet by helping cauterise financial stability risks. The mere fact that the RBA is not jumping up to offset the banks' politically demonised hikes with a cash rate reduction is also a tacit admission that its 2016 cuts were terrible mistakes. But increasing home loan costs does nothing to normalise Australia’s 1.5 per cent cash rate, which equates to a negative real return after living costs and is, therefore, forcing savers into dysfunctional portfolio decisions. Indeed, by not raising its cash rate the RBA has effected a massive transfer of wealth from bank depositors to bank shareholders. Read free here. Excerpt enclosed:

"It is beyond time that we sought to neutralise the productivity sapping “search for yield” dynamics whereby rational investors are forced, through central bankers’ “financial repression”—or artificially low cash rates—to chase risks they would never ordinarily assume to eke out an income that satisfies their retirement needs. This is one of the key drivers of demand for investment properties: incredibly low gross rental yields of 4 per cent look enticing when at-call deposit rates are around half that level. (Especially if you can leverage your equity 10 times through ultra-cheap debt and top-up with capital gains!) Since 1991 the RBA's cash rate has, on average, furnished savers with a real return above inflation of about 2.5 per cent annually. This made deposits and bonds viable investments with low risk. Today that is no longer true for many retirees. By distorting asset-allocation decisions in this way the RBA is funnelling capital into leveraged sectors of the economy to the detriment of more productive areas. In the short-run employment and growth are artificially elevated by the ensuing building boom. The cost is a misallocation of resources that undermines long-term productivity and living standards. It’s a fool’s paradise. Investors would be wise not to get over-excited about bank profits improving through superior net interest margins. The recent rate hikes are likely responses to our banking regulator, APRA, lifting capital requirements for investment and interest-only home loans, which dilutes the profitability of these assets. Improved margins may only offset the skinnier RoEs flowing from APRA’s imposition of lower leverage. On this note, institutional investors are increasingly asking me why APRA is persisting in setting its new “counter-cyclical capital buffer” at zero at a time when every man and their dog agrees financial stability hazards have never been more acute. This buffer was introduced in 2016 on the basis APRA would pre-emptively coerce banks to build first-loss equity reserves during periods when asset prices and credit were climbing sharply. You could not find a better case study than the years since 2013. Yet in January APRA argued that it has “not observed a change in the level of systemic risk that would necessitate a change in the level of the countercyclical capital buffer”, which is a joke. The only way APRA can rationalise having no buffer at all when the household debt-to-income ratio and house price-to-income ratio have soared to record highs is by claiming that current credit growth is benign compared to rates observed since 1980. We only care about credit growth in respect of what it tells about indebtedness. When indebtedness is modest, as it was between 1980 and 2000, we could sustain fast credit growth without great anxiety. But when the debt-to-income ratio surges to unprecedented levels and credit creation continues to run at 3 to 4 times, it’s time to take action. I was recently asked by a major banker why more people aren’t making these points. My response was that APRA’s ultimate beneficiaries, depositors (or bank creditors), have no coordinated voice, or organised lobby group, representing their interests. In contrast, APRA’s adversary in this regulatory game, leveraged bank equity owners, are incredibly well coordinated via a potent lobbyist in the form of the Australian Bankers Association. The profound asymmetry in influence between these two constituencies cruelled APRA in the past with chairman Wayne Byres’ predecessors captive to the oligopoly in a perverse case of financial Stockholm Syndrome. How else could APRA have permitted banks to leverage their home loan books 65 times? Even today we have a former RBA governor and a Treasury Secretary sitting on major bank boards advocating their agendas (one told my mum that I write mean things about him!). There nevertheless remains hope that the notoriously independent Byres crafts a new legacy that strikes a better balance between the competing interests of debt and equity."


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