Banks Behaving Badly

in trouble hiding behind keyboard
Reddit

Aussie banks are in the spotlight again, and rightly so.

Last week, Prime Minister Malcolm Turnbull had a go at the banks over their poor behaviour. Over the weekend, Labor leader Bill Shorten promised a Royal Commission into the banks if he wins the election.

In addition, there are a number of articles in the mainstream media about the financial system, bank debt and bank profits.

That shouldn’t surprise you. I spent most of last week talking about Australia’s financial issues…high levels of private sector debt, high stock market exposure to the financial sector, and significant reliance on the banks for foreign funding.

Shorten’s potential Royal Commission into the banks will cost taxpayers around $53 million. As if the banks haven’t already made enough ‘moola’ from us, all while enjoying implicit taxpayer support, we now have to fund an enquiry into their behaviour? An inquiry that will do nothing to stop the sort of cultural deterioration you’re seeing in the industry…

The simple fact is that cheap money has a corrupting effect on those closest to the source of it.

Banks create credit. When you walk into a bank and apply for a loan, they assess your credit worthiness. If they deem you worthy, they credit your bank account with the loan amount. This money never existed before. But now that you’ve decided to monetise your credit worthiness, the money exists and you spend it.

When this happens on a massive scale, you get an idea of how powerful the banking system is. But that’s not all. When there aren’t enough lenders wanting to borrow money, the central bank lends a hand. It deposits new money into the banks’ reserve accounts, which has the effect of pushing down the cost of credit.

The aim is to encourage more people to borrow. This enables banks to create more credit. The money gets spent into the economy and economic activity increases.

But the banks also own the wealth management businesses. So they have a side business in advising people how to manage the money that they previously created! What a gig!

It goes without saying that when there is a lot of money flying around the economy (thanks to low interest rates), lending and ethical standards inevitably slip. The more profit the banks make, the higher the remuneration of those individuals driving the  profit growth.

And don’t forget that the banking sector is one of the few that has the implicit support of the government. That is, if things go wrong, taxpayers will ultimately bail them out.

This implicit support has huge ramifications. It allows banks to take on significantly more risk than they otherwise would. They know that if things go pear-shaped, they won’t have to foot the bill.

So what’s the Royal Commission for? To tell us that human nature is flawed? That an industry offering massive monetary rewards attracts morally corrupt psychopaths, as well genuinely decent people?

What’s there to discuss? Time and time again, history has proved that easy money corrupts. The incentives to flout the rules are just too great.

Of course, the call for a Royal Commission is just good politics. Shorten is taking advantage of the fact that Malcolm Turnbull isn’t doing anything….about anything.

Turnbull kicked off the attack against the banks but it was just rhetoric. Shorten wants to take it up a notch as we head into election season.

The politics are plain to see, as Chris Joye points out in today’s Financial Review:

Bill Shorten’s proposal for a $53 million royal commission into illegalities in the financial services sector smacks of political opportunism after Labor repeatedly rejected calls from experts and its own Treasury to investigate the banks between 2009 and 2013.

In every cycle, banks behave badly. And in every cycle, politicians feign outrage about this behaviour. Whether they want to do anything about it depends on whether they are in government or opposition. 

Greg Canavan,
For The Daily Reckoning

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.
Reddit

Leave a Reply

Be the First to Comment!

Notify of
avatar
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au