Australian Stock Market to Murray…Meh

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A quick follow up on the release of yesterday’s Financial Services Inquiry. Of the many recommendations made, most centred on the need for the big banks to raise more capital and the levelling of the playing field between the big four and the second tier banks.

Well, whatever was in the report, the market didn’t see it that way. The big four bank stocks soared yesterday. Bank of Queensland [ASX:BOQ] meanwhile, fell nearly 2% and Bendigo and Adelaide Bank [ASX:BEN] fell 0.15%…although it is near record highs.

In other words, the market doesn’t believe the report’s recommendations will actually have much effect on the sector, or if so, it was already priced in. The general gist is that market fears of future capital raisings are overblown. The thinking goes that banks generate excess ‘organic’ capital (a nice little euphemism for high profits) and can therefore use these strong profits to boost capital levels as needed, rather than go to the market for extra capital.

The other issue is that the reforms still need to be implemented, a responsibility the government has put onto the bank regulator APRA. This means any change will likely take years, giving the banks plenty of time to adjust.

In the meantime, there’s an interest rate rise on the horizon. This is ‘great’ for the banks…but not so great for the economy as a whole, because the increase in debt levels that it fosters just adds to the underlying — and unseen — risk in the financial system.

David Murray’s recommendations seek to fundamentally change the structure of the financial system and attempt to place the burden of financial risk taking back on the bankers (and off the taxpayers — you and me).

That the market doesn’t seem to care or give due weight to the recommendations says a lot about either the ignorance or the arrogance of the market, brought about by years of ‘success’ and really believing that Australia has one of the strongest financial systems in the world.

No, we don’t. Our banks are just as leveraged and risky as any other banking system. It just depends on the risk they face. David Murray correctly points out that when the next crisis hits (and it will) there will be no mining boom to bail us out as it did in 2008/09. He knows that things will be much worse.

But as is the nature of financial crises, those providing the warnings and trying to prepare the system for stress are often ignored. The bankers simply don’t care about downside risks because they have no incentive to care.

So what if things go bad and it turns out the banks don’t have enough capital? They have the implicit backing of the Reserve Bank of Australia and the government (the taxpayer…you and me), and so their downside is limited.

But the upside? It’s all theirs. We don’t get to share in it in any way…we are only there for downside protection.

It’s this ‘asymmetry’ (all upside, limited downside) that David Murray wants to address. Will he be successful? It will be a long road, but it’s early days. So far, the market says the banks are still untouchable.

Regards,

Greg Canavan+
For The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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Mizou
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Re : “So what if things go bad and it turns out the banks don’t have enough capital? They have the implicit backing of the Reserve Bank of Australia and the government (the taxpayer…you and me), and so their downside is limited.”

In this scenario, aren’t we looking at “Bail ins” ?

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