daytrade diaries... january 23/24 weekend, page-26

  1. 16,565 Posts.
    http://www.theaustralian.com.au/business/banks-to-be-in-firing-line-for-election-year/story-e6frg8zx-1225822693254

    Banks to be in firing line for election year
    Jennifer Hewett, National affairs correspondent
    The Australian January 23, 2010 12:00AM

    BE careful what you wish for. Kevin Rudd's proud boasts about the strength of the Australian banking system will quickly change in tone, with both bank profits and interest rates certain to rise during an election year.

    The Rudd government is unlikely to go anywhere near as far as US President Barack Obama, or even as British Prime Minister Gordon Brown, in unveiling radical new punitive measures against the big banks and their bulging bonuses.

    The popular fury of US and British voters against the immediate and shameless return of greed has been less evident here because of the strength of the Australian economy and a tradition of (relatively speaking) less eye-popping bonuses.

    The Obama White House is also trying to limit the power of the US's "too big to fail" financial giants in some ways that will make the largest US banks look more like Australia's big four, and regulated accordingly.

    That includes resurrecting some discarded curbs on banks to restrict their ability to take huge risks investing and trading their own capital, and to prevent them dabbling in the more speculative end of the market through hedge funds and private equity firms.

    Instead, such high-risk activities will probably be spun off, supposedly safely away from the prospect of taxpayer support.

    None of this will run to plan, of course.

    The details will also be much changed if and when the White House agenda gets through congress.

    It was still enough to give Wall Street severe jitters as investors contemplated suddenly reduced profitability for the big banks as a corollary of reduced risk.

    It also sent Australian financial stocks into a sympathy swoon yesterday, made worse by yet another outbreak of concern about how much China will tighten lending. Australian nervousness of banking stocks may be overdone because the circumstances are very different to the US and Europe, but there's no doubt the politics of banking will become more difficult here as well this year.

    The next big test will come if the Reserve Bank raises interest rates, as many economists expect, at its February 2 meeting.

    Sensitivity about rising rates is already acute, particularly if banks continue their recent pattern of mostly increasing rates above the official number set by the Reserve Bank. Just ask Gail Kelly at Westpac, who attracted so much ire from Canberra and the public by raising rates by 0.45 percentage points last month rather than the approved 0.25 percentage points.

    This compared with 0.37 percentage points by Commonwealth, 0.35 by ANZ and a politically clever 0.25 by NAB.

    The real debate behind the scenes will be the banks' effective threat to the government that they will slow access to credit if they are criticised by Canberra for pricing it too high. This will cause trouble for all sides.

    The banks' argument that higher rates are necessary to counter their higher cost of borrowing -- whether from domestic deposits or offshore funding -- may be commercially logical, but it is not politically persuasive, particularly in view of the increased dominance of the major four banks and growing evidence of a surge in their profitability as bad-debt provisioning falls.

    With the big four now accounting for more than 90 per cent of all new home lending and more than 80 per cent of all existing loans, it also puts a sharp local edge on the "too big to fail" argument. Banking, in that sense, is more concentrated here than in the US.

    What really matters is how this plays out politically in a changed environment.

    The basic rule of thumb is that the banks want their net interest margins to sit at about 2 per cent no matter what the headline profit numbers say.

    To the extent they need to pay more for funds -- up, on average, about another 1 per cent over the 90-day bill rate since before the crisis -- they will pass that on to customers. Australian customers don't have so many alternatives these days.

    The catch is that pressure on the cost of funding will steadily increase over the next couple of years because of the finite limits in growth of the Australian retail deposit base and the growing need for governments internationally to borrow to cover all that public spending.

    That is quite apart from what the RBA does with the cash rate, now at 3.75 per cent.

    There is always plenty of double talk in this debate in Australia. The most acute political focus is always on home mortgage rates, for example, but it is really business customers who have borne the brunt of increased rates.

    For most of the global financial crisis and the subsequent recovery, the banks effectively protected mortgage holders while quietly slugging their business customers harder.

    That was because the business market was regarded as a higher risk of going bad -- in contrast to Australian home owners who, unlike their US counterparts, remained very good bets. It was also because banks could get away with it more easily.

    As the RBA pointed out in December, net interest margins on variable housing loans are still about what they were before the crisis -- and that has only been achieved after the three increases in interest rates in the last quarter of the year. "The recent widening in the net interest margin has been largely due to wider margins on banks' business lending," deputy governor Ric Batellino pointed out in a speech just before Christmas.

    "Margins on businesses loans, however, are now substantially higher than they were immediately before the crisis."

    To the extent that these margins on business lending did fall temporarily at the height of the crisis, this was offset by a virtual freeze on new lending.

    The banks blamed lack of demand rather than reluctance to lend to small and medium business but they certainly tightened standards considerably, even for existing customers.

    That sense of caution is still pronounced, meaning lending to business is actually falling -- not a promising sign for economic activity not bolstered by massive resources projects.

    In the residential market, both Westpac and Commonwealth are now rubbing up against constraints on their decision to aggressively pursue growth in the residential market last year.

    This was quite different to the strategy of NAB and ANZ, which were far more subdued.

    Last year Commonwealth wrote about $45 billion worth of new mortgage business, Westpac about $35bn, NAB about $7bn and ANZ almost none.

    The greater the growth, the greater the need for funding. As this tension became obvious, Westpac focused on increasing deposit rates while Commonwealth tightened mortgage credit.

    It also meant NAB was able to get plenty of kudos last month for sticking to the 0.25 lift in rates delivered by the RBA. The size of its book meant that it cost it far less than it would have done Westpac or Commonwealth.

    Knowing it will be aggressively targeted if it raises rates again above the RBA increase, Westpac is deliberately pulling back on growth in its lending to the mortgage market.

    It is tightening credit standards as well as making its rates relatively less attractive. Be prepared for a renewal of hostilities next month.
 
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