The banks are strangling small business – and threatening the economy: Kohler

The only thing standing between Australia and the sort of catastrophic mess that Britain and America are heading into in 2009, and that Iceland is in now and that Ireland would be in if it wasn’t part of the euro, is the state of our banks.

The only thing standing between Australia and the sort of catastrophic mess that Britain and America are heading into in 2009, and that Iceland is in now and that Ireland would be in if it wasn’t part of the euro, is the state of our banks.

Most of their banks are quite broke; Australia’s are OK… so far.

But the distance between us and them may be less than you think. Without the Federal Government guarantee, the big four banks would be totally unable to raise funding from international markets, and since around 40% of bank funds in this country are supplied by wholesale markets, Australian banking would effectively shut down.

What’s more, the banks are playing with fire by not reducing small business lending rates with the cut in the cash rate.

Thanks to pressure from all manner of politicians, mortgage rates have been cut by almost as much as the cash rate (2.75% versus 3%) but business rates have not been reduced at all. This might well turn out to be a self-destructive margin play by the banks.

For the moment, as we reported on Friday, the banks are in taking their revenge on Australian business – but the Kevinless alternative is the hell being suffered on each side of the Atlantic. It has been a horribly dramatic few days.

On Friday analysts at Royal Bank of Scotland said that British banks were “technically insolvent on a fully marked to market basis”.

Also on Friday the Government of Ireland nationalised its third biggest bank, Anglo Irish.

Later the same day, the United States Government gave $US20 billion to Bank of America and guaranteed $US118 billion worth of its bonds to keep it afloat, after the bank announced a quarterly loss of $US1.7 billion.

And also on Friday, Citigroup announced its $US8.3 billion loss for the December quarter and a loss of $US18 billion for 2008 as a whole, and CEO Vikram Pandit announced plans to split the bank into two. Bloomberg’s headline on its story about this read “Citigroup’s Pandit tries to save the little that’s left to lose”.

After crunching Citigroup’s quarterly report, an analyst a Deutsche Bank, Michael Mayo, estimated that its tangible common equity is now $US28.9 billion, or 1.5% of its assets. Splitting the bank adds nothing to its equity.

Meanwhile in Iceland, where the banks took on liabilities 10 times the national GDP by betting on Britain’s property bubble, both inflation and interest rates are 18%, and rising. A calamity has been visited upon the people by their bankers. The Observer’s Will Hutton commented yesterday that Iceland’s only hope is membership of the euro, if it can be secured (he says Britain must now join the euro as well).

In Australia the banks did not gamble with financial derivatives, are not exposed to British and American real estate and did not lend much to sub-prime borrowers.

As we reported on Friday, they are now scooping up plenty of funds from international debt markets using the Government guarantee, as well as from retail depositors, and they have all raised new equity in the past few months and most have tier-1 capital ratios well above 8%.

But it’s not time to stop holding your breath. The Australian banks are exposed to Australian real estate, which did lend to plenty of sub-prime corporates.

It is a slightly disturbing fact that even though the banks are backed by the Government’s AAA credit rating, they are paying 150-200 basis points more than government for the same term debt (three to five years).

Nobody knows why that’s happening, but it suggests that without the Government guarantee Australia’s banks would be raising no funds at all from international wholesale markets. And since they are the only successful Australian borrowers on global markets at present, the credit system would otherwise shut down.

Meanwhile the banks are taking advantage of this market power handed to them by the Government by holding business lending rates steady in the face of lower cash rates in order to widen their margins.

This is going to lead to higher unemployment as businesses lay off staff to keep servicing their debt and avoid bankruptcy.

And every percentage point increase in the unemployment rate will increase the rate of defaults in the mortgage book and undermine house prices.

That’s why lowering mortgage rates to assist home lenders but paying for it by maintaining business rates will ultimately be self-defeating.

But at least the banks are still solvent and they’re still lending. Australia’s unemployment rate has only ticked up from 4.4% to 4.5% and house prices have not collapsed, even though they rose more than those in Britain and the US during the boom.

Maybe things will be okay in Australia. Maybe the fact that our banks are still solvent and functioning will keep unemployment down and house prices up, which will keep the banks solvent and functioning and keep unemployment down and house prices up, which will keep the banks solvent and functioning and keep unemployment down and house prices up… and so on.

Let’s hope so.

This article first appeared on Business Spectator