Melbourne Money and Finance Conference 2012: Financial Regulation: Global trends and domestic policies
An international financial regulatory agenda that continues to pick up pace, and to which Australia is committed, adds to a host of domestic regulatory changes affecting all parts of the financial sector. Experts have mixed views on the value this plethora of changes will add to Australia’s financial system. Such was the mood at the 17th Melbourne Money and Finance Conference hosted by the Australian Centre for Financial Studies (ACFS).
The conference, first held in 1987, has provided a forum for Australia’s foremost financial experts to discuss the key issues facing the financial services industry. The latest instalment saw approximately 60 invited delegates freely express their views on the likely outcomes of a suite of impending regulatory changes. The diverse audience included members of industry, regulatory bodies and academia.
The specific implications of the post-GFC shift toward increasing faith in regulation were contested throughout the event, with the trend toward global standard setting of regulatory requirements, led by the G20, an issue of some concern. The benefits of the Basel III liquidity capital ratio, the implementation of Central Clearing Parties for Over-the-Counter (OTC) markets and the proposed regulation of Dark Pools all faced intense scrutiny.
Opinions were more divided when discussing the Future of Financial Advice (FoFA). While there was general consensus that ensuring fees correspond to the level of service being provided is important, there was concern that there is nothing in the FoFa reforms to suggest that the overall quality of financial advice will improve. One delegate noted that any superannuation reform that did not address this issue could not constitute, as Bernie Ripoll suggested, a revolutionary and “once-in-a-generation change to our financial services sector”. Views toward MySuper were generally positive, however the continued similarity of asset allocation and hence market risk involved in pre and post-retirement superannuation products was highlighted as a problem that is yet to be addressed and is an increasing threat given the impending retirement of the baby boomer generation.
The event closed with a discussion on the proposed mandatory periodic disclosure of Superannuation Fund asset holdings, a change that almost all delegates agreed would be beneficial. It was argued that while strict disclosure requirements would require Superannuation Funds to implement more sophisticated reporting systems, the opacity of Australian Superannuation holdings is archaic and undesirable. The example of US funds which have been required to disclose complete portfolio holdings since the 1940s provided evidence to this claim. Almost all delegates agreed that the benefit to members of greater fund transparency would outweigh any additional costs associated with providing the disclosure.
The 17th Melbourne Money and Finance Conference was held on 16 – 17 July 2012, sponsored and supported by APRA, Finsia and the Reserve Bank of Australia. Papers presented at the conference will be available on the website and in Issue 3 and 4 of JASSA, Finsia’s quarterly Journal of Applied Finance.
Notes taken by Martin Jenkinson, ACFS
Australian Centre for Financial Studies
T: +61 3 9666 1050
Past MMF Conferences:
- 2011 – 16th Conference: Retail and Household Finance: Current Issues
- 2010 – 15th Conference: Assessing the Impact of Changes in Financial Regulation
- 2009 – 14th Conference: Financial Globalisation: Implications for Australian Financial Institutions and Markets
- 2008 – 13th Conference: Recent Developments in Australian Debt Markets
- 2007 – 12th Conference: Wealth Management: Trends and Issues
- 2006 – 11th Conference: The Future of Australian Banking
Submission to the Senate Economics Committee
The post-GFC period has been one of significant regulatory change for the banking sector, both internationally and domestically. The period has been marked by volatility, uncertainty and instability with further regulatory change still in the wings. The likely effects of these impending regulatory changes are yet to be fully discerned.
In a recent submission to the Senate Economics Committee, the Australian Centre for Financial Studies highlighted a number of issues relevant to the Committee’s Inquiry into the post-GFC banking sector.
The recommendations that were made in the submission are summarised below.
Recommendation 1: The degree of competition in the financial sector and the extent to which undesirable barriers to entry exist warrant review as part of a major review of the workings of the financial sector. One aspect of that review should include an assessment of the extent to which implicit and explicit government support conveys competitive advantages to particular financial institutions.
Recommendation 2: Consideration should be given to whether the systemic importance of the Big Four Banks (or any other financial institutions) warrants some form of special regulatory treatment.
Recommendation 3: (a) the deposit guarantee cap under the FCS should be reduced; (b) consideration should be given to charging a fee for the deposit guarantee on competitive neutrality grounds.
Recommendation 4: Consideration, on grounds of competitive neutrality, should be given to allowing any fee imposed for the deposit guarantee to be paid in the form of either cash or debits to franking account balances.
Recommendation 5: As part of a suggested review of the Australian financial system and its regulation, a substantive cost-benefit study of the impact of recent and proposed regulatory changes on the economy should be undertaken.
Recommendation 6: The merits of allowing banks (and other lenders) to adopt mortgage loan arrangements giving them complete discretion to adjust interest rates on existing loans should be examined.
Recommendation 7: A wide-ranging review of Australia’s financial system and its regulation is warranted.
Professor Kevin Davis
Research Director, Australian Centre for Financial Studies and
Professor of Finance, University of Melbourne
W: +61 3 9666 1050
The Australia-New Zealand Shadow Financial Regulatory Committee releases Statement No. 10 exploring whether the systemic importance of the big four Australasian banks warrants their being subject to special regulatory treatment.
The Australia-New Zealand Shadow Financial Regulatory Committee (ANZSFRC), an independent group of senior finance academics, today released its latest statement. It addresses the question of whether the big four Australasian banks warrant any special regulatory treatment by virtue of being systemically important banks (SIBs). International regulators have recommended additional capital requirements for 29 international banks (but not including our big four) because of the negative social externalities which failures of such institutions cause.
The Big Four are Regional SIBs (R-SIBs), dominating the financial markets of Australasia. Given likely spillovers and contagion should either an Australian parent or its New Zealand subsidiary get into financial trouble, Trans-Tasman arrangements for dealing with a troubled R-SIB are important. While there are quite striking differences in resolution policies in the two countries, these do not appear to pose insurmountable problems. But greater clarity from the Australian government on how it would deal with a troubled SIB would assist.
- the fact that the big four would likely be “too big to swallow” by other banks, if in trouble, means that a different regulatory approach is appropriate compared to other smaller institutions where regulators can arrange smooth exit via takeovers (or allow failure)
- requiring additional contingent capital (which are hybrid securities which convert into equity when a bank is in distress) for the big four has merit
- there is merit in considering making a relatively simple leverage ratio the primary bank capital requirement instead of the increasingly complex and costly risk weighted capital requirements which the Basel Committee favours
- while Australian and New Zealand policies for resolution of troubled banks are quite different, and the Big Four are SIBs in both, those differences do not look to pose insurmountable problems in dealing with potential failure of either the Australian parent or subsidiary. A requirement for conversion of operations to Non-Operating Holding Company (NOHC) structure (where both Australian and New Zealand operations were separate subsidiaries of the NOHC) would reduce direct spillover effects. But, in the absence of greater clarity from the Australian Government on how it would deal with a troubled SIB, risk of Trans-Tasman contagion and runs would remain.
For the full statement and more information on ANZSFRC, please visit our website at:
The Australian Centre for Financial Studies facilitates industry-relevant and rigorous research and consulting, thought leadership and independent commentary. Drawing on expertise from academia, industry and government, the Centre promotes excellence in financial services. The Centre specialises in leading edge finance and investment research, aiming to boost the global credentials of Australia’s finance industry; bridging the gap between research and industry and supporting Australia and Melbourne as an international centre for finance practice, research and education.
The Centre provides access to and links between academics, finance practitioners and government and draws on expertise and experience from across these groups, to facilitate and disseminate knowledge creation and transfer throughout the greater finance community via its various activities.
The Australian Centre for Financial Studies (previously known as the Melbourne Centre for Financial Studies) is a not-for-profit consortium of Monash and RMIT Universities and Finsia with Affiliated Universities of Deakin and Melbourne, having commenced in 2005 with seed funding from the Victorian Government.
Media contact details:
Professor Kevin Davis
Research Director, Australian Centre for Financial Studies &
Professor of Finance, University of Melbourne
T: +61 3 9666 1050 M: +61 409 970 559
February 20, 2012
In this Australian Centre for Financial Studies Financial Regulation Discussion Paper, Professor Kevin Davis looks at Australian bank capital and bank profitability. The evidence regarding whether banks are making excessive profits is mixed, although high market to book ratios for the major banks (stock market value of equity relative to its accounting book value) are indicative of some inadequacies in competition. In order to generate the returns that shareholders require on the value of their investments, high market to book ratios (averaging around 1.5) mean that the major banks need to target accounting returns in the order of 15 per cent p.a. or more. The majors compete with each other within that constraint.
But that leaves unanswered the question of why other competitors who should be able to operate with lower target accounting returns are not exerting a restraining influence on bank pricing and profitability. It also leaves unanswered the question of how market to book ratios for the major banks evolved to such levels – with inadequate competition over many years being a prime suspect. This FRDP provides an overview of the issues, but more detailed research is needed to evaluate whether calls for greater regulation or special taxation have merit.
There is currently much heated debate over whether Australian banks are exploiting a privileged position to make excessive profits. The major banks (to varying degrees) have been announcing record high dollar profits, while at the same time increasing loan interest rates and reducing employee numbers. With memories of government support to the banks during the Global Financial Crisis still relatively fresh, there have been a range of calls for regulation or taxation targeted at preventing “excessive profits”.
To determine whether the major banks are making excessive profits it is important to be clear about the interpretation of profit rates and rates of return, and to recognize the different perspectives arising from differences between the book value of equity (shareholders funds) and its share market value. Those differences help explain why CEOs of the major banks believe they are engaged in a highly competitive game, while others point to their high profit rates as evidence of inadequate competition.
An analysis of bank market to book ratios and alternative measures of rates of return is suggestive of past and present inadequacies in banking competition, and of accounting profit rates of 15 plus per cent being somewhat higher than is needed to meet shareholder demands. But this is a complex topic where assumptions can be disputed and more research is required. Moreover, even accepting those conclusions, no simple, politically palatable, policy conclusions are readily apparent.
Understanding rates of return
It is important to note that profit rates reported by banks (and other firms) are accounting measures, which relate accounting profits to the book value of equity. Thus, for example the CBA’s recent announcement of a half year profit of $3.6 billion for the six months ending December 2011, was reported as a return on equity of 19.2 per cent p.a. on (the book value of) shareholder equity of $38.9 billion. But at the end of 2011, CBA had some 1.6 billion shares on issue which at a share price of around $50 gave it a market capitalization of around $78 billion – approximately twice the book value.
For shareholders who had bought CBA shares at around $50 (the level they have hovered around for two years) the half yearly earnings of $2.31 per share would, if repeated in the second half year, give earnings of $4.62 for the year, which is an annual return on their investment of around 9.2 per cent. That does not seem like an excessive rate of return, and a similar gap between accounting and shareholder rates of return prevails if the latter are measured as dividends received plus capital gains relative to the share price!
How is this vast gap between the accounting and economic (shareholder) rates of return reconciled and explained?
Financial accounting academics have developed a relatively simple framework (known as the residual income model) within which to study this type of issue. It posits that market value (MV) and book value (BV) of equity at any date t are related as:
MVt = BVt + Present value of expected future abnormal earnings.
In turn, abnormal earnings at any future date τ are given by (roeτ – rτ)BVτ-1, where roe is the accounting rate of return achieved and rt is the required rate of return of shareholders, both applied to the book value at the start of that period. The formula includes the expected value of such abnormal earnings into the distant future, and these need to be discounted to a present value to allow for the delay and risks.
The intuition is straightforward. If investors think that managers will be able to use the financial resources (book value of capital) available to them to generate a return (roe) greater than that required (r), they will be willing to bid up the share price (market value) above its book value. In an efficient market, the share price (market value) will settle at a level which investors believe is consistent with their receiving just their required rate of return.
Market value, Book value and Bank CEO’s: Between a rock and a hard place?
While the precise relationship between accounting rates of return and shareholder equity returns and book and market values is complex, the message should be clear. Bank CEOs need to deliver profits (or confirm expectations of future profit growth) which are sufficient to meet the rate of return required by their shareholders on the market value of their investment. If the market to book ratio is greater than unity, the required accounting rate of return on book equity will exceed the required return of shareholders. If accounting profits (both current and forecast) are not sufficient to deliver the required return for shareholders on the market value of their investment, the share price will fall.
It is somewhat difficult to feel sympathy for highly remunerated bank CEOs but, with high market to book ratios they are caught between a rock and a hard place. Unless they deliver apparently excessive accounting profits and incur political and social wrath, they will not meet the demands of their shareholders for a fair return on their investment. And with most Australians being bank shareholders (through superannuation if not directly) that alternative would not be a popular outcome either.
For the major banks this is the situation they face. Table 1 presents recent figures for the market to book ratio for Australian banks, and shows that the four majors have ratios well in excess of unity. It also highlights a significant dichotomy between stock market valuations of the four majors and the other banks –which have market to book ratios well below unity. Whether those numbers indicate excessive profitability and market power of the major banks is returned to shortly. But first, it is worthwhile to examine how bank shareholders have fared recently, what rate of return shareholders require from banks, and what accounting rate of return is consistent with that.
TABLE 1: Market to Book Ratios of Australian Banks; February 2012
Source: http://www.investsmart.com.au (15 February 2012)
How have Bank Shareholders Fared?
One way to determine whether bank shareholders have enjoyed excessive returns on their investments is to compare their returns to those on the stock market more generally. Figure 1 does that for the period since early 2007 using rolling quarterly rates of return (in order to smooth the graphs). The solid line is the return on the S&P/ASX 200 Accumulation Index (an index of returns on the top 200 stocks which incorporates both capital gains and dividends). The dashed line is the (equally weighted) average return on the four majors (again incorporating both capital gains and dividends).
Figure 1 suggests that returns to bank shareholders have, over the period since just before the start of the Global Financial Crisis, been relatively similar to those on the ASX 200.
Figure 1: Bank and ASX 200 returns*
* The figure displays the average monthly rate of return over the preceding three months.
An alternative method of examining the returns to bank shareholders is to use the market model, relating monthly bank equity returns against returns on the market index (ASX 200). Results of such regressions (in which returns are measured in excess of a risk free interest rate proxy) are given in Table 2. There are two main features of those results. First, the regression intercept (α), which can be interpreted as measuring abnormal returns, is insignificantly different from zero in all cases. Second, the betas for all banks are around unity, which the Capital Asset Pricing Model (CAPM) implies that shareholder required returns would be approximately the same as the required return on the overall market.
Table 2: Market Model Results
This table gives results of estimating rit-rft = α+β(rmt-rft) where rit is the monthly return on stock i in month t, rmt is the monthly return on the market (ASX200) in month t and rft is the return on a 30 day bank bill for that month. Figures in parentheses are t statistics for a test of the null hypothesis that the parameter is significantly different from zero. Monthly data from February 2007 till November 2011 is used.
Required Shareholder Returns on Bank Equity and Accounting Returns
The required return is generally defined as that rate of return which compensates the investor for systematic (non-diversifiable) risk, and can be estimated using an asset pricing model such as the Capital Asset Pricing Model (CAPM). It is also often described as an expected rate of return, in the sense that market equilibrium requires that the share price adjusts until the expected future cash flows from the investment mean that the expected return equals the required return. (If the expected return was below the required return, investors would sell shares, pushing the price down and the expected return up).
Applying the CAPM is complicated by Australia’s dividend imputation tax system, because a significant component of returns to shareholders takes the form of franked dividends. However, it is well established that the effect of this complication on the CAPM is primarily to require that shareholder returns be measured by “grossing up” the cash dividend component of returns for the value of attached franking credits. While there is much debate about the average value of franking credits, they are certainly fully valued by domestic investors such as superannuation funds. For simplicity and, I would argue, appropriately in this case, the following analysis will assume full valuation – although that will no doubt be challenged by some.
Using a theory such as the CAPM, it can be argued that investors in bank shares currently require a ball park rate of return (including franking credits) of around 11-12 per cent. This ball park estimate is based on a risk free rate of 5-6 per cent, a market risk premium of 6 per cent and a beta for bank stocks of around 1.
How does that match up with accounting rates of return on (book value) of equity such as the 19.2 per cent reported by CBA, or the 15 per cent rate more generally thought of as being achievable by the majors in the post-GFC world?
The average market/book ratio for the major banks is in the vicinity of 1.5, suggesting (as outlined above) that investors believe that banks can generate a higher return on the equity funds available to them to use than that required by shareholders. Does this mean that a 15 per cent accounting return on equity is consistent with the shareholder required rate of return on the market value of equity or around 10-11 per cent p.a.?
Quite possibly! However, the accounting return on equity is an after-company-tax rate of return, and the dividends provided to shareholders as part of their return include valuable imputation credits. The arithmetic is a thus a bit messy. But it goes as follows and is set out in Table 3.
Suppose the book value of equity is $100 and the market value is $150. Suppose that the accounting return on equity is 15 per cent (ie profit after tax of $15) of which 80 per cent is distributed as franked dividends giving a $12 franked dividend which grosses up to a $17.14 dividend before personal tax. To that must be added the effect of the $3 retained earnings on the share price which can be expected to create a capital gain. Assuming that the retained earnings are fully reflected in the share price, there is a $3 capital gain, giving a total grossed up shareholder return of $20.14 which, on a market value of equity of $150, is a fully grossed up, pre-investor tax, rate of return of 13 per cent. (Also shown for information is the after tax return for a superfund for which the full valuation of franking credits implied in the grossing up is realistic).
Table 3: Relating accounting and shareholder returns – an example
This ball-park calculation suggest that a 15 per cent accounting return on (book value of) equity is at least, or more than, adequate to provide shareholders with their required rate of return of 10-11 per cent on the (higher) market value of equity. And for superfunds, the tax benefits from receiving franking credits mean that this is a very pleasant after-tax rate of return.
Thus a 15 per cent accounting return on equity (which excludes franking credits) looks easily sufficient to meet investor expectations and maintain share prices (although precise calculations are more complex – and this should certainly not be taken as investment advice!).
Of course, the calculation is not quite this simple. Some part of earnings is paid out as franked dividends and franking credits have zero value for some (overseas) investors. While retained earnings increase the bank’s capital base and should generate capital gains for the shareholders via an appreciation of the share price, there are many other influences upon share prices including expectations of future performance.
Approaching the question from another direction, the cash dividend yields of the major banks have been in the region of 6.5 to 8 per cent in recent years, with not much in the way of capital gains (and losses in some cases). Since a fully franked 8 per cent dividend grosses up to around 11 per cent, these numbers are roughly consistent with recent accounting returns being at least sufficient to meet shareholder required returns.
The Market/Book Value Problem and Competition
But even if the major banks were only just generating the returns that their shareholders demand, the question remains of why investors are willing to bid bank share prices up to a multiple (well) in excess of unity. As outlined earlier, this suggests that banks are able to earn abnormal returns on the financial resources (book value of equity) available to them. Why is it that the banks can achieve this?
One possible answer can be found from examining bank pricing practices and the nature of competition in banking/financial markets. Banks obviously price loans and other financial products to reflect both their operating costs and their cost of funds – one component of which is their cost of equity funds. Stated alternatively, pricing is done to try and achieve the target rate of return on equity. Thus, all of the majors will be pricing to achieve an accounting return on (book value of) equity of around 15 per cent or more. That type of return is thought to be required to keep shareholders satisfied with the resulting returns on the market value of their equity investment in the bank.
Major bank CEOs and management thus perceive themselves as engaged in fierce competition with other banks, because all are constrained in their pricing by similar 15 per cent (or higher) accounting return targets. Higher return targets imply (ceteris paribus) higher product prices which will see them undercut by the others and lose business (unless they are more efficient and have lower operating costs than their competitors). Pricing is constrained on the downside by the target accounting return – which is needed to keep share prices from falling.
But this self imposed constraint only applies to the four majors, because of their elevated market to book ratios. Any new competitor not suffering such a “handicap” and starting with a market to book ratio of unity, would be able to target an accounting return equal to that demanded by shareholders (of around 10 – 11 per cent on the ballpark calculations done earlier), and undercut the major bank prices. Indeed, for the non-majors, as shown in Table 1, their market to book ratios below unity should give them a competitive edge in this regard – other things constant.
Of course, other things undoubtedly are not constant. Smaller banks or new entrants may face higher deposit or debt funding costs (or higher required returns of shareholders). That may reflect market realities or perceptions of implicit government guarantees for banks which are “too big to fail”. Scale, such as the four majors have, may enable them to operate with lower operating costs. And potential economies of scope, due to the pervasiveness of the majors’ activities across the entire financial sector, may also bring operating cost or revenue benefits. The higher market to book ratios of the majors may thus reflect a franchise value built up over time which generates such operating cost advantages.
The dilemma which policy makers must face is to ascertain why the majors have elevated market to book ratios. Is it because they have operational or funding cost advantages over other existing or potential competitors – such that lower return aspirations of the latter would be offset by lower operational efficiency and thus bring no net pricing benefits to customers?
If so then, with one caveat, the only rationale for policy intervention would seem to be if those cost advantages reflect distortions in the system – which suggests policy prescriptions directed towards removing such distortions. (Arguably, banning mortgage exit fees and policies aimed at making it easier for customers to switch banks fall into this category, as would be measures to remove any perceptions of implicit guarantees for large banks enabling them to achieve lower funding costs).
The caveat arises because we have reached the current situation because the evolution of operating/funding cost efficiencies over time was not fully reflected in lower customer prices via competition, but rather in higher stock market prices reflecting the resulting higher accounting profits. It might then be argued that “forcing” lower product prices or returns to shareholders (such as by special taxation) would rectify that historical lack of competition. However, it would be at the expense of driving down bank share prices and imposing substantial losses on current banks shareholders (who are not necessarily the ones who benefited from the historical experience).
An alternative explanation for the high market to book ratios may be that there are barriers to entry which enable banks to make excess returns on the book value of their equity (even in the absence of cost advantages) and support a higher stock market valuation. One such barriers to entry could arise from the wide scope of bank activities across the whole financial sector, and a consequent ability to temporarily cross-subsidize particular market segments and prevent new entrants (even those suffering no cost disadvantage in that particular activity) from profitable entry? While the banks will, no doubt argue that they have not engaged in such practices, for a potential entrant the possibility that they may do so, can be a sufficient deterrent.
The analysis of this paper suggests that profitability of the major Australian banks, which many have claimed to be excessive, may be marginally higher than required to provide bank shareholders with a fair, required, return on their shareholdings. Underpinning this conclusion is the fact that the market valuation of bank equity far exceeds its book value for the four majors, requiring product pricing to be based on target accounting profit rates which appear unreasonably high to the outside observer.
But that, by no means, is the end of the story. Why are market to book ratios for the major banks well in excess of unity – or is this a “normal” state of affairs in banking? Is it because barriers to entry prevent effective competition from others not suffering such a “handicap” and who would thus be able to price products off a lower target accounting rate of profit? Or is it because the majors have inherent competitive advantages which have emerged over time and become reflected in higher share prices rather than in lower product prices? If so, to what extent do those advantages reflect inherent efficiency advantages versus market distortions which policy actions might target? And why didn’t competitive forces lead to the alternative outcome of more of the efficiency gains being passed on to customers in the form of lower product prices rather than finding reflection in higher bank share prices?
While the analysis of this paper suggests that returns may be somewhat higher than consistent with fierce competition, the important message is that by focusing on accounting returns the debate may be looking in the wrong place. Instead, more attention should be paid to why market to book ratios for the major banks are (and have been for some time) at levels well in excess of unity.
This FRDP was prepared by Kevin Davis, Research Director, Australian Centre for Financial Studies.
The Financial Regulation Discussion Paper Series provides independent analysis and commentary on current issues in Financial Regulation with the objective of promoting constructive dialogue among academics, industry practitioners, policymakers and regulators and contributing to excellence in Australian financial system regulation. More in this series
Published in The Conversation, 15 February 2012
Last week, the Reserve Bank defied market expectations to announce the 4.25% cash rate would remain unchanged. But the surprise decision by Australia’s Big Four banks to act independently of the Reserve Bank and raise their standard variable interest rate- even as they announce record profits – has caused much ire among customers and Treasurer Wayne Swan. Are these interest rate hikes justified?
Professor Kevin Davis, Research Director for the Australian Centre for Financial Studies argues that although the banks are looking to protect their profits, the rising cost of funding – not to mention structural challenges in the sector – are driving the increases…
I think for the moment, what one can say, is that given the state of nervousness in international capital markets, the cost of raising funds has probably gone up. But at the moment, the banks also are in a situation where they’re rolling over a lot of the borrowing that they did during the global financial crisis under the federal government’s guarantee.
Could you elaborate on that guarantee?
Published in AFR, 17 January 2012
Despite their consistently good profitability and cost/income ratios which KPMG’s annual performance survey indicates are relatively favourable compared to their international peers, the announcements of staff reductions by the major Australian banks should probably not come as a surprise.
Three interrelated factors are driving bank attempts to cut labour costs. While one is perhaps cyclical, the others appear longer term in nature, and the interesting question is whether this will herald a downsizing of financial sector employment and activity as a whole, or a shift in its composition away from banks.
For historical context, total financial sector employment was a relatively constant share of total employment during the “noughties”, at around 3.7 per cent. This was despite the ratio of financial institution assets to GDP increasing from 2.5 to 3.5 over the decade and the finance sector’s share of value added (GDP) increasing from just under 9 to over 10 per cent.
In the 1990s, the employment share dropped from 4.7 per cent to 3.7 per cent, while assets/GDP increased from 1.7 to 2.5 times and share of value added increased from around 8 to around 9 per cent.
So, over the past decade, a rapidly expanding financial sector has not increased its share of total employment, and in the previous decade financial sector growth saw a declining share of total employment. If technological change has meant that high growth has just sustained sector employment, a slowing of growth seems likely to lead to reduced employment.
Thus, the first factor driving employment cutbacks in banking is the marked decline in banking sector growth rates following the Global Financial Crisis. Credit growth (including securitisation) has fallen from an average of 14.4 per cent p.a. in the four years prior to June 2008 to 2.9 per cent p.a. in the two years to November 2011.
Higher growth on the deposit side of bank balance sheets offset that effect for a while with M3 growth rate averaging 17.8 per cent p.a. in the two years to June 2009, as depositors returned to the major banks during the unsettled times and as banks tried to replace offshore funding with local deposits. But over the two years to November 2011 that growth rate dropped to an average of 7.4 per cent p.a.
Bank operational structures based on anticipation of ongoing high growth rates obviously needed reassessment.
A second factor is regulation. Bank CEOs have pointed to an increased cost burden from recent regulatory changes, and it is hard to dispute that these must involve some increase in costs. But any employment effect is primarily indirect as attempts by banks to pass on those costs reduce customer demand for their financial services. And it seems more likely that the slowdown in credit and monetary growth reflects the effects of economic conditions and uncertainty on customer demand for financial services than increased costs of regulation.
Moreover, any regulatory induced decline in banking may be offset by growth elsewhere in the financial sector, eventually providing employment opportunities elsewhere for bank ex-employees. Even if banks still maintain their share of intermediation, they may find that regulatory changes make it preferable to adopt a production process which relies more on outsourcing some activities. Mortgage broking comes to mind, although offshoring of some other activities will not help newly unemployed bankers.
Ongoing technological innovation is, of course, the third relevant factor. In the late 1980s and early 1990s the major banks, responding to deregulation, advances in technology, and a massive decline in profitability which threatened the survival of some, reduced branches and employment and earned the wrath of the Australian public. Technological advances are again causing a reassessment of labour requirements, with ever increasing growth of internet banking and “apps” which enable customers to interact with their banks on a virtual basis.
But in an environment where banks remain relatively profitable and financial sector pay remains absurdly high, look forward to a resurgence of the “banks are bastards” grumbling, which the banks had worked hard to get rid of over the last decade.
This Commentary is written by Professor Kevin Davis, Research Director of the Australian Centre for Financial Studies.
Published in The Conversation, 7 October 2011
Professor Kevin Davis, Research Director at the Australian Centre for Financial Studies explains the concept of “living wills” – a basic plan of how a bank could be pulled apart without damaging the broader industry.
What do living wills mean for banks?
One of the things that came out of the global financial crisis was general recognition that the powers of the regulators to resolve a troubled financial institution are not as good as they should be, so that when large banks get into difficulty we find there are all sorts of problems in them making a smooth and graceful exit from the industry……
Presentation by Mandiri Investasi
Monday, September 5 2011
Event sponsor: AFM Investment Partners
Speakers from Mandiri Investasi suggested that Indonesia is one of the most misunderstood countries in the world. For instance, Indonesia has experienced continuous growth since 2001. There has been “no lingering crisis” rather just “growth and democratisation”.
Indonesia’s stock market is roughly ¼ the market capitalisation of the ASX. There is much scope for growth in financial services with the debt to GDP ratio at only 27%. This for instance represents a credit penetration rate little more than half that of China and Brazil. This low leverage is also seen as one of the reasons for Indonesia’s strong growth throughout the global financial crisis.
However, Indonesia’s future may be to become one of the largest Islamic Financial Services market in the world. Presently Islamic Syariah bonds account for only 5.3% of issuance in the AUD77bn Indonesian Government Bond Market. Two reasons were cited for the slow take off Sharia-compliant financial services. Firstly, the market is difficult to standardise given differing interpretations from Middle Eastern and Malaysian jurisdictions. And secondly, liquidity is low in such products because a prevalent view that trading may not be sharia-compliant.
Like any emerging market Indonesia has to address corporate governance and corruption issues. The establishment of a new Corruption Watchdog and a successful counter-terrorism campaign in recent years have allayed fears.
With continued high population growth and greater foreign investment inflow, Indonesia is expected to return to its pre-1998 trend of above 6%pa economic growth rates. It is expected to continue growing after China has slowed due to a younger more fertile population.
Inflation is significantly a function of food and oil prices which are capped by government subsidies, although government involvement in these two sectors is likely to be wound back over the next decade.
Major growth sectors are expected to be those that cater to growing population, higher intra-country trade and higher income levels. Being a massive archipelago, much infrastructure spending will go to building new ports.
Mr. Priyo Santoso, Chief Investment Officer of Mandiri Investasi suggested that for investors seeking a defensive source of alpha, Indonesia should be considered. With larger US pension funds now looking at funds devoted to China and India, Santoso foresaw a future trend for dedicated Indonesian-specialist funds.
Notes taken by David Michell, ACFS
About ACFS Boardroom Briefings
To promote excellence in financial services and boost Australia’s global credentials, ACFS draws on its international network of experts to present relevant and unique speakers to the Australian finance sector. Boardroom Briefings are invitation-only events run for selected stakeholders such as sponsors, partners and supporters, where they have the opportunity to interact more intimately with the speaker to conduct a more targeted discussion.
Australian Centre for Financial Studies
T: +61 3 9666 1050
Yesterday, ACFS held a Banking Panel with a number of industry heavyweights , in conjunction with the Economic Society of Australia and sponsored by PricewaterhouseCoopers.
The event was sparked by debate arising fom the long-running Senate Economics Committee Inquiry into Competition within the Australian Banking Sector. Over a hundred submissions were received by the Committee from a wide range of organisations and individuals. There were many questions that needed to be addressed.
Prof Kevin Davis, Research Director ACFS, led a panel discussion to shed some light on the debate. Invited panellists were key players of the industry with their own points of view:
- Michael Ullmer, Deputy Chief Executive Officer, National Australia Bank;
- Ian Harper, Director, Deloitte Access Economics;
- Steven Münchenberg, Chief Executive Officer, Australian Bankers’ Association; and
- Graeme Samuel AC, Chairman, Australian Competition and Consumer Commission.
The panel attracted a 150-strong audience from all strata of the industry.
Outgoing ACCC Chairman Graeme Samuel was passionate in expressing his thoughts on current commentary about the Commission’s recent decisions. He defended the proposed reforms for price signalling to remove any loopholes and technicalities in illegal cartel behaviours; and cited rigorous due diligence in granting permission for the takeovers of BankWest by CBA and St. George by Westpac during the GFC.
CEO of the Australian Bankers Association Steve Munchenberg was candid about the negative perceptions of banks and its impact on politics and regulation. He recognised as foremost importance that banks must step up to do things that would convince the public that banks are concerned about customer interests. He referred to recent heat on banks raising rates beyond the Reserve Bank adjustments to the cash rate.
Outgoing NAB Group Deputy CEO Michael Ullmer noted that his bank’s strong growth in new accounts indicated that competition between banks was alive and well. He challenged advocates of account portability to look at the cost-benefit trade-off of the implementation.
Prof Ian Harper of Deloitte Access Economics renewed his call for a new “root and branch inquiry into the Australian financial system”. This should be prerequisite to any major reforms to the banking industry. He also cautioned that effects of the GFC are still to be felt across the industry. This was agreed by Ullmer, referring to banks continuing at relatively high level of liquidity reserves compared to pre-GFC.
Australian Centre for Financial Studies
T: +61 3 9666 1050
Professor Deborah Ralston, Director, Australian Centre for Financial Studies, stated today that the ACFS-Finsia Banking and Finance Conference running Thursday and Friday this week in Melbourne is “a must attend for finance practitioners and academics to swap experiences and share knowledge, and to develop contacts across their disciplines.” She noted that the prac-academic conference, now in its 15th year, serves as “a rare interface between academics and professionals in the banking and financial services industry”.
Professor Kevin Davis, Research Director, Australian Centre for Financial Studies, added that “in an environment where financial markets are undergoing marked change, understanding recent developments in both theory and practice, and the results of applied research are crucial.”
There are many highlights of the event including:
1. Conference Dinner – with keynote speaker Steven Münchenberg, CEO, Australian Bankers’ Association speaking on Banking, for fun and profit on Thursday 30th September 2010 at the RACV Club 501 Bourke Street Melbourne.
2. Eight Morning Plenary Financial Services speakers over the 2 days, cover a breadth of industry critical issues:
- Ben Gray, Head, TPG Capital Aust: Private equity investing during & post GFC
- Prof Stephen Gray, University of Qld: How to use economic models in practice
- Mark Joiner, Executive Director Finance, NAB: Australian Bank Management in the wake of the Global Financial Crisis
- Greg Medcraft, Commissioner ASIC: Financial Services: What is on the Forward Agenda for ASIC?
- Colin Nicol, Partner, McGrathNicol: Current issues in Corporate Restructuring & Insolvency
- Dr Don Russell, Chairperson, State Super: Post-Cooper review, do super funds need to reconsider their investment strategies?
- Justin Wood, former Barclays Global Investors Australia: Retirement system development and implications for financial market participants
- Prof Kevin Davis, ACFS – on the Recommendations from Australia-New Zealand Shadow Financial Regulatory Committee meeting on Repairing Retailing Finance
3. Each afternoon there are 3 concurrent sessions of peer reviewed research, ACFS Research Grant papers and Finsia PD workshops. Research topics covered include:
- Bank Credit Rating
- High Frequency Trades
- Hedge Fund fees
- Contrarian Investment Strategies
- Networks in Financial Markets
- Rating Triggers in Loan Contracts
- Islamic Banks
- Consumer behaviour and Margin Lending
- Basel capital adequacy and Australian bank risk