The Financial System Inquiry’s interim report is more than 400 pages long but if one area sticks out as a focal point for overhaul it is the perception of the special status of Australia’s “big four” banks – ANZ, Commonwealth, NAB and Westpac – and the free ride they receive in the financial system because they are perceived as “too-big-to-fail” .
Too-big-to-fail (TBTF) simply means that there is a recognition, or at least a perception, that the financial and economic impacts of a collapse of a financial institution would be too great for any elected government to bear and so taxpayer money would be used to bail the bank out.
It’s a topic addressed specifically in the inquiry’s interim report, and FSI chair David Murray spoke about it again in his speech today in Canberra, and took questions on the issue afterwards.
The interim report said investors can “rationally surmise” the rescue by government of systemically important institutions because:
Global history records governments of all political persuasions using taxpayer funds to support distressed institutions. As undesirable as it may be to put taxpayer funds at risk to support financial institutions, in the midst of a crisis it is often the fastest and most certain option to stabilise the system and avoid widespread economic damage.
Think all of Europe – but particularly Ireland – which was the first sovereign to explicitly guarantee its banks during the Global Financial Crisis.
The knock on effect was guarantees in a number of countries including Australia which saw the Australian government forced at the time to guarantee every dollar of deposits within the Australian financial system and also provide wholesale guarantees to some Australian institutions.
Up until this time Australia had never had any guaranteed deposits unlike other countries and certainly no explicit guarantees.
There is an asymmetry in this relationship in that the banks, the bankers, creditors and their shareholders get to profit when times are good while the government and the taxpayer bear the brunt of failure with no positive payoff.
As a refresher, the inquiry’s report spells out, in simple terms, why banks can sometimes be allowed to be treated differently to other businesses when they look like they’re going to the wall.
When a business fails, it would ordinarily enter corporate insolvency or administration procedures to be sold or liquidated, with any value returned to creditors. Generally, the value of the assets will not be enough to repay all creditors the whole amount owing, and some will take a loss. Achieving this in a manner that meets financial stability objectives is more difficult in the context of a financial institution. Critical services provided by the institution may need to be continued or wound down in an orderly manner outside normal insolvency processes. In addition, creditors are often other financial institutions — imposing losses on these institutions, especially in the middle of a financial crisis, can worsen the situation. Disorderly resolution of one institution can create instability through a loss of confidence and changes in investor risk appetite. In many past instances, both in Australia and elsewhere, this has led governments to intervene to restore stability.
The report then continues:
Introducing credible ways to impose losses on creditors in the event of failure assists in achieving orderly resolution with minimal use of taxpayer funds. This goes some way to addressing perceptions that some institutions have an implicit guarantee by reducing expectations of Government support, and encouraging investors to pay greater attention to risk.
This is about finding ways to make sure that when a bank fails, the institutions it owes money to take the full force of the hit, rather than having to call in the taxpayer.
It has variously been referred to since the GFC as giving bankers the ability to “privatise profits and socialise losses.”
It simply drips what’s referred to as “moral hazard”, Murray highlighted today at the Press Club when he said:
“The message is that while we cannot eliminate so-called moral hazard, there is much that could be done to reduce it. By moral hazard, I mean the risk that perceptions of government support will lead to behaviour that increases the likelihood of such support being required.”
That is, we are no longer willing to privatise profits and socialise losses. In his speech Murray said:
By reducing moral hazard we can also reduce the significance of so-called implicit guarantees. The view of the Committee is that it is better to try and address the root causes of moral hazard than its symptoms.
While in answer to a question after the speech, he noted that what the inquiry was doing was “trying to figure out, in those circumstances, just how we can make it likely that in a bad set of circumstances, the taxpayer might get drawn in, but would be back out of there at no cost.”
Which is where the bail in of creditors – bond holders and the like comes in – together with extra capital buffers that the banks may need to put in place.
Make no mistake: this is a shot across the bow of the major banks in Australia. It’s clear that Murray and his inquiry panel are actively looking for ways to liberate taxpayers from the burden of having banks that are too-big-to-fail.