DTalk of a super profit tax has centered on energy companies, which enjoyed huge windfall gains from the invasion of Ukraine. But why has there been no call for a similar tax on banks, which profit from soaring interest rates? While energy company earnings are highly cyclical, Australian banks are consistently among the most profitable in the world.
Rising rates increase the margin between what the bank charges borrowers and what it pays depositors. Lending rates closely follow Reserve Bank rate hikes, but deposit rates often lag. In addition, low official rates over the past decade have squeezed margins for banks as they have been unable to cut deposit rates sufficiently due to regulations requiring them to maintain a minimum level of retail deposit funding. As long as borrowers do not default en masse, lender profits should increase with higher interest rates.
Over the past year, Australia’s big four banks have made $28.5 billion in profits. Their return on investment was 10.6%, well above the global average. Banks are large relative to the size of the overall economy at 160% of GDP, about twice the global average.
Several factors influence this performance. As mortgages account for around 60% of Australian bank lending – one of the highest proportions in the world – they benefited from the period of abnormally low interest rates and the resulting high property prices, which increased the volumes of real estate loans.
The sector is dominated by the big four banks, which account for around 72% of the market. Deregulation has not increased competition. The industry has consolidated through takeovers and mergers. Foreign banks have largely withdrawn or refocused their attention on high net worth clients and multinational corporations.
Implicit support from the Australian government and taxpayers, exemplified in the 2008 crisis and the pandemic, ensures profitability. There are more subtle factors. The big banks zealously control the payment system, which means competitors have to pay banks to gain access.
Over the past four decades, bank profits reflect not only their role in providing vital services, but the industry’s trend towards oligopoly. Profit maximization has reduced access to banking services, especially in regional and remote communities, and led to financial exclusion. There are also well-documented cases of predatory behavior and outright fraud.
Structural reforms are needed. Although seemingly attractive, there are problems with a windfall tax – what is a normal return? Does the state subsidize industry when profits fall? A better approach would be fundamental sector reform.
The 2017 limited bank levy could be expanded. It currently only applies to banks with more than $100 billion in specified liabilities. The current rate of 0.06% may be small compared to the benefits of implicit government support which is estimated to reduce banks’ borrowing costs by 0.22-0.34% – although this figure is disputed .
Given the need for financial services, banks should be required to provide affordable access to basic banking services. This is similar to the obligation for energy, water and telecommunications companies to provide essential services.
We need more competition. Opening access to qualified participants on fair terms is one element of this. A stripped-down public bank, perhaps based around Australia Post, providing simple services, especially to financially excluded people, is one option. However, the now forgotten debacle of Australian public banks calls for caution.
Critical financial infrastructure, such as the payment system, should be under national control, with a wider range of qualified parties, other than banks, having access to it.
Such proposals will elicit fierce, well-prepared and well-funded resistance, with changes described as undermining confidence in banks and the financial system as well as creating unwanted instability and economic damage.
Banks will say that such measures threaten the supply of credit to the economy or cause property prices to fall. Hasty action, it will be argued, could damage the international perception of banks, which play an important role in channeling foreign funding to meet Australia’s financing needs and undermine the functioning of monetary policy.
Lobbying efforts will exploit the fact that many people and businesses are both customers and investors of the banks, which make up more than 30% of the Australian stock market. Strict regulations, it will be said, would hurt bank stock prices and reduce profitability and dividends, affecting around 14 million Australians. Banks will be described as the main employers and taxpayers.
In truth, such “sky will fall” arguments are specious. For example, much of the substantial taxes paid by banks are effectively refunded to investors through the dividend imputation system, limiting the gain to government revenue.
Australia needs a diversified, competitive and profitable financial sector offering a secure payment system, safe deposit of savings, appropriately priced funding and simple and effective risk management instruments. Current arrangements may not produce these results for all Australians.
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