Is our banking system a major threat to financial meltdown or will it see us through?
Last month’s crisis triggered by a brace of sudden bank collapses -- including the once highly regarded Credit Suisse -- has perhaps highlighted flaws, weaknesses in the banking system that needs reformation, while also amplifying strident calls from some economists for central banks to take a step back from their quest to stamp out inflation with rising interest rates.
Firstly, set the scene and take comfort from Christine Lagarde’s recent IMFC statement from the IMF Meetings in Washington DC, 14 April 2023.
“The global economic outlook has improved on the back of a gradual easing of global supply bottlenecks, declining energy prices, and the recovery of the Chinese economy. Global inflation has also been declining since it peaked in summer 2022. However, the recovery prospects for the global economy remain fragile amid continued uncertainty…as inflation is projected to remain too high for too long, the Governing Council of the ECB decided in March to raise the key ECB interest rates by 50 basis points”
Importantly the euro area banking sector is resilient, with strong capital and liquidity positions.
Economic activity - “Growth in euro area GDP slowed progressively …..and stagnated in the fourth quarter. Employment growth also slowed in 2022, but remained resilient in the fourth quarter despite the moderation in economic activity.
Risks to the growth outlook are tilted to the downside. Persistently elevated financial market tensions could tighten broader credit conditions more strongly than expected and dampen confidence”.
Inflation -…”, food and core inflation rates continued to rise. At the same time,….employees demanding compensation for the loss in purchasing power amid tight labour markets has translated into higher wage growth, while many firms in sectors facing constrained supply and resurgent demand raised their profit margins……, historically high wage growth, related to tight labour markets and compensation for high inflation, will support core inflation. This outlook remains surrounded by considerable uncertainty”.
Supporting international cooperation and strengthening the global economy - “Recent global shocks and geopolitical tensions have advanced the debate about reconfiguring global supply chains… a less integrated world economy also entails costs. It weakens the diversification of global production and, in particular, the efficient allocation of resources globally, which has an adverse impact on welfare across the world.”
In Australia the Reserve Bank of Australia (RBA) obliged on 4 April with a pause after 10 successive rate increases – although predictions are rife more rises could be in the offing, perhaps as early as next month.
What went wrong last month?
Credit Suisse was in a mess long before last month, embroiled as it was for years in scandals including charges of aiding cocaine smuggling. Share value had recently declined about 70%. And shares of the three collapsed US banks had dropped because mismanagement was patently obvious. Unsurprisingly, depositors of all four banks aware of these failings, formed queues to withdraw their money.
Reasonably you’d think it would be up to American regulators and not depositors to sound the alarm. However, realistically you could also expect regulators to (as they’ve done) insist the system is stable, because to say otherwise would be an admission they weren’t doing their job properly. Be that as it may, at Macks Advisory we were appalled to discover that only last year Credit Suisse passed a US Federal Reserve stress test with flying colours.
Which makes us a tad nervous about what might be the actual state of Australia’s banking system. The RBA recently declared “Australian banks are unquestionably strong”.
Whilst comfort can be taken from much written about the strength of the Australin banks we note that Anat Ruth Admanti, Professor of Finance and Economics at Stanford Graduate School of Business, once listed by TIME Magazine as one of the world’s most influential people, says regulators should require banks to reduce leverage from the currently apparently acceptable 20 and often 30-plus times, to something closer to 10 (in other words half that generally believed to apply in Australian bans).
The root of the problem - A free-market system allows markets to establish the worth of stuff. The system under which banks flourish is directly opposed to that.
Ms Admanti says many US banks can’t survive in a free market and many are still functioning only because of government-backed guarantees and subsidies that tend to encourage bankers to have much less regard for the rigours of risk management than they should.
Research by a group of economists from Stanford, Columbia and other top American universities has discovered the market value of US banks’ assets is now a gut-wrenching $2 trillion lower than the book value on their balance sheets, because of interest rate increases of the past 12 months.
This means that based on market-to-market valuations almost all the capital of America’s banking system has already been wiped out.
So, what’s to be done?
Aussie Banks telling insight from the current proposed takeover by ANZ of Suncorp
Mr Keogh (ACCC deputy Chair) said the ACCC’s concerns stemmed from observations in past inquiries “that there is not evidence of strong competition between the four major banks”.
The ACCC founds its assessment on where competitive forces in the banking market are coming from that is that “ANZ is a member of a powerful oligopoly, where major banks don’t inflict too much pricing pressure on each other” interestingly “anecdotal evidence from senior bankers. say the current cutthroat competition in mortgage markets has been created by major banks”.
“The ACCC’s view is that it would be better for two of the regional banks (Suncorp & Bendigo) to get together and lift pressure on the majors, in the way it set up the subjective “counterfactuals” that are part of a merger analysis”.
We concur with that view - Watch this space!
JobKeeper and ‘excessive’ stimulus to blame for high inflation - Australia was one of just five OECD countries to provide too much fiscal stimulus.
Modelling by Australian National University visiting fellow Chris Murphy reveals that Pandemic-era government stimulus measures such as JobKeeper dramatically overcompensated for lost income and, when combined with rock-bottom interest rates, pushed inflation 3 percentage points higher than it needed to be, new research shows.
“Overall, while the macroeconomic policy response made unemployment and inflation less variable during the COVID era of 2020 and 2021, the excessive nature of that response makes unemployment and inflation considerably more variable during the post-COVID era from 2022 to mid-2025,” Mr Murphy said.
Mr Murphy concluded JobKeeper was too generous with these hindsight lessons.
- “It should only be available to businesses that are not able to operate normally because of social distancing.
- “Payments should not extend beyond the duration of social distancing. The payments should be redesigned to reduce the great unevenness in compensation for lost profits.”
Accordingly, the RBA should take more account of how much government stimulus has been injected into the economy to avoid keeping interest rates too low for too long.
So, hold on and buckle up, 2023 is going to be a rough economic ride for many Australians and businesses alike.
Neither side of politics could do much to avoid what is afoot. That’s where the real political debate needs to be had: what impact does governmental decision-making have on what’s already unfolding?
What is on Foot is a very delicate balancing act, because once that process properly starts (the evidence so far is that it hasn’t in any meaningful way) the decline in consumer spending will slow down the economy. When that happens people will lose their jobs and, depending on exactly how it happens, bad things will flow from it.
The RBA is trying to cause economic pain in order to lower inflation, but it doesn’t want to cause a recession, which could inflict severe economic pain.
The upside to such outcomes is that either way they put the inflation genie back in the bottle.
Nonetheless we believe that unless worthwhile reforms to the system are forthcoming, the world will soon be a much more dangerous and difficult place than it is now, to be in any kind of business anywhere.
Australia’s best shot at long-term economic success is to pursue an aggressive growth agenda built on a more diversified economy.
