Royal Commission Duds Bank Depositors...

Christopher Joye

Coolabah Capital

In the AFR today I argue that nobody seems to have noticed that the royal commission's mandate is biased in favour of the imprudent over the parsimonious. It has spent most of its time agonising over the tiny number of "bad" borrowers who defaulted on their interest and/or principal repayments and none contemplating the plight of the millions of depositors who underwrite these loans. Every borrower who fails to meet their obligation to service a loan threatens the safety and security of Australian depositors' hard-earned savings. And since a large bank's equity capital is typically leveraged 19 times, it does not take many loans to go foul before they risk blowing up these institutions, as we learned during the global financial crisis (click there or AFR subs can read directly here). Excerpt below:

The recent Australian political impulse to push banks to be softer on bad borrowers – an artefact of the absence of any recession, and hence near-death banking experiences, for 27 years – transfers wealth from the prudent majority to this spendthrift minority while also raising the probability of banks going bust.

The Labor Party's brain-explosion in the form of its 2009 "responsible lending laws" – which irresponsibly sought to shift accountability for repaying loans from the borrower to the lender (yes, that should sound bizarre!) – fundamentally undermined the integrity of Australia's otherwise world-class financial system.

Politicians who have never worked in the real world decided it might be popular to allow borrowers to wriggle out of loans they have defaulted on if the lender has not verified their ability to repay it.

That's like saying the courts cannot prosecute burglars if the owner of the stolen property cannot prove they tried to protect it. Finders keepers!

It's a slippery legal slope that is fraught with "moral hazard" by incentivising borrowers to behave irresponsibly knowing they can blame the big bad banks ex post facto if their investment does not work out while ignoring the consequences for the poor folks funding these loans (ie, depositors). BankWest anyone?

Thank heavens the regulator, ASIC, wittingly or unwittingly made the responsible lending laws nebulous and non-scalable, which means that how they apply varies on a case-by-case basis.

This make it practically difficult to prove a lender behaved irresponsibly (as demonstrated by test cases finding in favour of lenders) and almost impossible to run an effective class action litigation across scores of borrowers with varying circumstances.

After decades of highly providential prosperity, Australians appear to have forgotten that the GFC was brought about by loose lending standards – as manifest by the boom in sub-prime lending – and the ability of US borrowers to walk away from their "non-recourse" loans with zero personal accountability as a result of political populism.

It was the "anti-deficiency" statutes in states like California that prevented lenders from pursuing bad borrowers personally through bankruptcy processes that led to default rates on US loans that were literally 20 times higher than what has historically been evidenced in Australia.

And of course this, in turn, necessitated trillions of dollars of taxpayer bail-outs of failing financial institutions.

Aussie banks have legal recourse to both the property that serves as collateral protecting a loan and any other financial resources the borrower possesses outside their home.

It is precisely because domestic mortgagors have so much downside risk if they miss repayments (in contrast to their US peers) that they have been so diligent in satisfying these obligations.

The (defaulting) property developer donors who convinced some in the Coalition to help Labor establish the royal commission hope they can engineer a shift in the balance of power away from depositors towards borrowers.

Read the full column here or here.


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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