Complacency is the enemy of Australian prosperity and softens up businesses, workers and the economy and leave the nation vulnerable to shocks, especially from without.
According to Satyajit Das, a former banker and specialist in finance and risk management, dangers from within loom large as well.
Das, whose latest Bloomberg article appears in the AFR this morning, says that even though Australian banks have reformed themselves since the “near-death experience in the 1990s”, with returns on equity of 15% well above the “single digits” of US bank stocks, and whose dividends have risen strongly over the past decade, risk remains below the surface.
“In fact, though, this ruddy good health masks some deeply worrying trends. The balance sheets of the biggest banks – Commonwealth Bank of Australia, National Australia Bank, ANZ and Westpac – are far more vulnerable than they may seem on the surface — and that means Australia is, too” he wrote.
Das recognises he might sound a little alarmist given the reforms undertaken after that awful experience 25 years ago which almost saw Westpac collapse. He also recognises that the Big Four “face little competition in their home market and have benefited tremendously from Australia’s strong growth, underpinned by China’s seemingly insatiable demand for the country’s gas, coal, iron ore and other raw materials”.
But he says the banks, like federal treasurers before them and many Australians, “have made the same fundamental mistake the rest of the country has, assuming that growth based on ‘houses and holes’ — rising property prices and resources buried underground — can continue indefinitely”.
I think Das undersells the banks and the Australian population vision of what has happened and is going on in the world. His reference to “houses and holes” is a well worn frame by which many view this country.
Like the fund manager overlooking New York’s Central Park who threw me out of her office in 1999 for having the temerity to suggest Australia was becoming a well-diversified services-based economy – like the United States – Das is making the same call to arms that local bears have been making for almost two decades now.
It doesn’t mean he won’t be right eventually. But neither does it reflect the changed structure of the economy.
Indeed, no-one expects the good times to roll on forever. We’ve heard from both the RBA and Treasury on numerous occasions that 25 years into an economic expansion the good times won’t last forever. Das recognises this and is clearly worried by the potential for lending to miners to become bad debts.
“Despite a recent rebound in Chinese demand, commodities prices look set to remain weak for the foreseeable future. Banks’ exposure to the slowing natural resources sector has reached nearly $70 billion in loans outstanding — worryingly large relative to their capital resources,” he writes.
A $70 billion writeoff – the implication in his case – would seriously undermine the Banks and the Australian financial system if it came come to pass. But as we have seen recently, the rules of constant disclosure and half yearly accounts mean the banks, APRA and no doubt the RBA, are all watching closely.
But Das doubles down on his fears about the banks saying, “their exposure to the property sector is even more dangerous. Mortgages make up a much bigger proportion of bank portfolios than before — more than half, double the level in the 1990s. And they’re riskier than they used to be: Many loans are interest-only, while around 80 per cent have variable rates”.
Das’s fear for the banks seems to rest on his notion that “with a downturn likely — everything from price-to-income to price-to-rent ratios suggests houses are massively overvalued — losses are likely to rise, especially if economy activity weakens”.
Again, it’s hard not to agree with Das that his views “might sound alarmist”.
The question clearly hinges on whether of not a “downturn is likely” and then the severity of the economic slowdown when it comes.
Das has a reasonable concern about offshore funding as a result of any slowdown and the nation’s large current account deficit, which the banks largely intermediate on behalf of Australia.
“If Australia’s economy or the financial sector’s performance falters, or international markets are disrupted, banks’ access to external funds could be threatened,” he says.
This is true. And it is one of the reasons the RBA has sponsored the establishment of committed liquidity program which allows the banks, including the regionals and mutuals, to convert home loans on thebalance sheet into assets they can lend to the RBA for access to cash.
It’s Australian banking’s self-insurance policy, underwritten by the RBA.
Das is worried that both the economy and banks are in need of diversification. He highlights that:
Pundits have been saying for years that Australia needs to diversify its economy, boosting services exports — primarily tourism, education and health — rather than continuing to depend on resources and debt-fueled property growth.
Banks need to do the same, reducing their exposure to the housing market and the mining industry.
The good news for the economy is that the upside of the downside of the end of the mining boom and the fall of the Australian dollar is exactly that diversification.
But the path is not as clear for the banks and Das says “they should move swiftly to shore up their balance sheets, aggressively increasing bad-debt reserves, raising capital and gradually trimming dividends. Even their otherwise enviable luck can’t last forever”.
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