Why our small banks are under pressure: Kohler

While America could come out of the financial crisis with nothing but smaller banks, Australia looks like coming out of it with nothing but big ones. Just watch loan margins expand then.

Australia’s smaller banks are being crushed by a cost of capital disadvantage, ironically exacerbated by the Government guarantee that was designed to save them last year.

First, Basel II banking rules have altered the risk weighting regime to provide lower weightings for residential mortgages owned by “accredited” banks. The regionals haven’t yet got accreditation, so their cost of capital is much higher.

Second, the so-called Rudd Bank – the Australian Business Investment Partnership – is a big four club that is only going to make matters worse; it is designed to replace foreign banks with loans on commercial property from the big four banks only, bolstered by money from the Government to lower the cost of funds.

And third, the Government’s scheme to protect the smaller banks’ deposit bases has unwittingly improved the competitive position of the big banks because the price of the guarantee is based on credit ratings – the lower the rating, the higher the cost of the guarantee.

So while the Government’s action prevented any deposit runs on the smaller banks last year at the height of the crisis, a slower competitive death was put in place by the cost of funds disadvantage that went with it.

As a result, the regional banks that remain, which is really just three of them – Bendigo & Adelaide, Suncorp and Bank of Queensland – are slowly bleeding.

The two Queensland ones are up for sale, but ACCC chairman Graeme Samuel seems to be leaning towards stopping them being taken over. He told The Australian Financial Review this week that with the demise of the non-bank lenders over the past 18 months he is worried about bank competition and is inclined to oppose further mergers.

In fact there is probably no need to worry because there is no need for the big four to buy them – they are gradually plundering their businesses because of the greater than usual cost of funds advantage that they have now, which is overwhelming the regional banks’ traditional other advantages (loyal, local customer bases).

The only viable long-term solution was suggested this week by commentator Christopher Joye;that the Government guarantee the mortgages rather than the institutions. It would be more complicated than simply selling credit-rating-based guarantees to the banks, but far better for competition in the long term.

The basic problem is that the same mortgage over the same property taken out by the same person requires significantly more capital behind it if the mortgagor is Bank of Queensland than if it’s, say, Commonwealth Bank. That’s because both the Basel II risk weighting rules and the Australian Government’s guarantee effectively require it.

And the ACCC needs to push this idea as well. Merely preventing the regional banks from being taken over is not enough – with an inherent cost of funds disadvantage they will eventually simply disappear.

This article first appeared on Business Spectator