How long can the banking community starve the business sector to feed the housing beast?; Australia’s obsession with mortgage lending isn’t an accident: Breaking the big four’s bad habits
Tweet Topic Started: 7 Oct 2014, 11:44 AM (1,795 Views)
Australia’s major banks are getting desperate. The Murray Inquiry threatens to corral their dodgy lending practices and misleading accounting, prompting a last ditch effort by senior management to convince members of the inquiry that additional regulation is not required.
We shouldn’t sugar-coat the situation: the Murray Inquiry poses a serious threat to the business model of Australia’s big four banks. That might sound dire, but don’t be fooled, this is a business model that should be threatened.
The inquiry itself -- the first into the financial sector in 17 years -- will be released in November. At the centre of the inquiry are two fundamental issues: the major bank’s low capital ratios and the government’s implicit guarantee of Australia’s financial system.
Those two factors go some way to explaining why three Australian banks -- almost entirely irrelevant outside our shores -- are currently among the biggest 20 banks in the world in terms of market capitalisation. The big four also sit in the top 50 global banks as measured by total assets.
Australia’s obsession with mortgage lending isn’t merely an accident. It’s an entirely rational (albeit short-sighted) and inevitable consequence of a financial system that perceives mortgage lending as less risky than business or personal lending.
Under the current regulatory regime, favouring mortgage lending allows the banks to effectively lend more, leverage themselves higher and generate greater profits. Christopher Joye at the Financial Review provides an excellent recap on how the system works. As long as house prices keep rising the banks can’t lose.
It’s a model that has been embraced by the banking community. Mortgage lending now accounts for almost 61 per cent of total outstanding domestic credit (compared with 45 per cent in 2000 and 24 per cent in 1990). Mortgage lending has accounted for almost 100 per cent of credit growth since the beginning of the global financial crisis.
But higher mortgage lending isn’t without its costs. An obvious implication has been higher house prices, while elevated land prices have created a significant cost -- and in some cases a barrier to entry -- for Australian businesses.
It’s also a business model that is built on unsustainable foundations. How long can the banking community starve the business sector – particularly small and medium-size enterprises – to feed the housing beast?
We should remember -- and the banks should bear in mind -- that it is the business community that underwrites the Australian housing market. They pay the incomes that become the mortgage repayments that enable the banks to post record profits year-after-year.
By starving the business community, our major banks are compromising productivity and income growth. Eventually that will put their mortgage holdings and business model at risk.
It’s rational in the short-term due to higher profitability and a stronger share price but it’s easy to see that it isn’t in the long-term interest of Australian shareholders or the business community.
The Murray Inquiry determined that “housing is also a potential source of systemic risk for the financial system and the economy.” The inquiry noted that “a large enough disruption to the housing market could have significant implications for household balance sheets, financial stability, economic growth, and the speed of recovery in housing spending and broader economy activity following a shock.”
Where the story becomes more concerning is that the taxpayer will be on the hook if it all goes belly up. The federal government’s implicit guarantee of the Australian financial system creates a situation where it’s heads they win and tails you lose.
The guarantee -- which has effectively lowered the cost of bank funding -- has come with no strings attached. It didn’t come with a government equity position, nor was it received with an expectation that banks would reduce their risk exposure.
According to a report by The Australian, “one source close to the inquiry suggested it was mulling more than doubling the big four’s charge for being ‘systemically important’ from an additional 1 percentage point of common-equity tier-one capital to 2.5 percentage points”. If that is realised, it will be a big victory for Australian taxpayers and the stability of the Australian financial system.
The major banks won’t accept this lying down and even once the inquiry is released they will direct their considerable influence towards the federal government. But make no mistake, the bank’s concerns warrant little attention and are entirely short-sighted and self-serving.
The Australian economy will benefit from a more diversified financial system -- one that not only finances housing speculation but also small- and medium-sized businesses. The system will also be improved by forcing the banks to bear a greater degree of the financial risk they create. Hopefully the Murray Inquiry will deliver on both fronts.
I agree with you Peter. Money being lent for housing eventually finds its way into the hands of businesses. If anything, the problem may lie with encouragement for start ups and entrepreneurs.
I agree with you Peter. Money being lent for housing eventually finds its way into the hands of businesses. If anything, the problem may lie with encouragement for start ups and entrepreneurs.
My point really was that if a business asks a bank for a loan and they have security to offer and either a good history of income or good prospects of income, then the bank will probably lend, but if there are no applications from business owners then what can a bank do - they can't go around forcing businessmen to take loans they don't want.
It's at least as easy to get business finance now as it ever has been, probably easier.
It's not as though a bank will refuse a loan to a good business to 'save" their money for a home loan - we all know that doesn't happen. If a bank can see a buck in a deal they will lend to any sector of the economy.
Any expressed market opinion is my own and is not to be taken as financial advice
To add to Peter & b_b's comments - remember if you are a small business after a loan, the cheapest way to get finance is to use residential property you may own as the security. Why would you pay more than you have to for finance?
For big business (read public companies), generally equity is the cheapest and most readily available source of finance. And with Australia's large institutional capital pool (due to compulsory super) why would big business borrow from a bank at high rates for anything other than short-term/over-draft type financing nowadays? When there are literally billions of $ available from the capital markets? These are the main reasons for a structural decline in the propertonal of bank lending made directly to business.
Of course there are still reasons why business might seek direct bank financing, (including from overseas banks remember - not shown in Callam's charts), but I'm just pointing out how the desirability of this has changed over the past 20-25 years.
PS/EDIT: I don't recall ever hearing any storied in recent times of businesses unable to secure finance? So it certainly doesn't look like there is any "shortage" of capital for Australian business? Maybe a shortgage of opportunity to invest capital with good prospects for profit/growth, but that's an entirely different story.....
PPS: I really do wish that media economics commentators could get a better handle on the monetary mechanics that they often discuss - the RBA understands all this perfectly, I am certain.
The bottom line here is, to much money flowing into housing is the downfall of our economy, wheather it be business lending or otherwise .
The government and banks have encouraged housing ponzi lending standards and discouraged business lending. You know this better than anybody Peter.
Where buisiness lenders will normally only lend over 15 years, and yet we let housing lending go from 25 to 40 year mortgages, where the banks encourage interest only loans as to take more from people over much longer periods of time, practically all their working life, if they live that long, taking more money from the overall economy for much longer periods of time.
Where buisiness lenders want 20-25% deposit, yet only 3%/for a house. I know st.george was offering 97% lending last year, not sure now. And at one stage we had 100% lvr for houses and also 105% home loans at one stage. And then if I want to buy a second hand unit or house, investors pay no gst, yet if I buy a second commercial which is not leased, I am subject to gst.
This is the demise of our economy,even without the threat of modern tech, cheap asain labour and rising interest rates.
Its like a guarantee of serious economic decline for a very long time.
Where buisiness lenders want 20-25% deposit, yet only 3%/for a house. I know st.george was offering 97% lending last year, not sure now. And at one stage we had 100% lvr for houses and also 105% home loans at one stage. And then if I want to buy a second hand unit or house, investors pay no gst, yet if I buy a second commercial which is not leased, I am subject to gst.
The minimum home loan deposit is 5% not 3% but I do agree either way it's a small deposit (unless there is equity in another property that the borrower can use)
I can arrange 90% Low Doc loans for Commercial property through a bank. I have arranged loans that far exceeded any dollar for dollar security cover that the bank held - I can't do that for residential property. IE the loan was way above 100% - probably in the order of 125%
In the past decades that people point to as being somehow wonderful it was far harder to find business lenders who were willing to lend. In the Eighties and Nineties I was a business owner earning very good money, I had security, but it was impossible to get bank finance - and I knew the game and I had contacts. I would prefer to be in a business that needed finance now because funding is so much easier to find.
Callam bless his heart has written this article with this slant because he simply doesn't know - and nor do you Ted. He is just repeating the water cooler mantra that he has heard, as you are.
Anyone in business who has a good business or has good prospects with security will get a loan - that's a far cry from the good old days when it was damned hard to get business finance, and when you did the rates were so high they killed the deal.
Any expressed market opinion is my own and is not to be taken as financial advice
Where buisiness lenders want 20-25% deposit, yet only 3%/for a house.
That's because the security for the housing loan is far more substantial and stable than the small business, which can burn money and be dead in a matter of weeks.
That's because the security for the housing loan is far more substantial and stable than the small business, which can burn money and be dead in a matter of weeks.
That is simply a temporary error. Established businesses create profits, the house creates nothing. It's value depends entirely on the long term sustainability of an artificially created monopoly and a once in a lifetime windfall from emerging economies. If the Australian public lose their taste for immigration, for example, what is the value of the security then.
Sydneyite
For big business (read public companies), generally equity is the cheapest and most readily available source of finance.
Wrong on both counts. Equity is almost never cheaper than credit. Only a unique combination of low interest rates and irrationally exuberant equity prices makes equity cheaper and issuing equity dilutes your own, so CEOs and boards are reluctant to do it. Share buybacks have started in Australia now because interest rates are unusually low.
Sydneyite
Australia's large institutional capital pool (due to compulsory super) why would big business borrow from a bank at high rates for anything other than short-term/over-draft type financing nowadays? When there are literally billions of $ available from the capital markets? These are the main reasons for a structural decline in the propertonal of bank lending made directly to business.
Correct, compulsory super has made equity cheaper, but that is not the structural reason for the decline in business lending. The structural decline in business lending is due to the average age of our large corporations. Any business that is profitable will need less credit as the business gets older. That is, profitable businesses older than 20 years can largely fund operations and pretty much everything else out of profits, and are more inclined to do so if interest rates are low because the IRR > cash rate.
Elastic
If anything, the problem may lie with encouragement for start ups and entrepreneurs.
Startups and entrepreneurs are discouraged when the total return on housing exceeds roughly 8%, because the risk-weighted return on housing is too high to justify risking capital in a startup. Just go to the bank, lever up your savings and buy a house.
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