Low Rates, Bad Debts and Record Profits: Adventures in Bankland / by Adam Howard

Most people would know I am an ex-banker, right?  And my Dad was a banker before that, for 40 yrs…so we have about 50 years of banking between us.  Impressive, huh?

Well, in certain circles it is.

Anyway, my Dad and I talk a lot, and we talk about banking.  Makes us sad, boring geeks.  I get that.

He talks about the good old days, and the bad old days.

Long lunches at The Mediterranean, having a driver pick you up from said long lunches and State and Regional Managers being able to approve deals under their own signature (no credit department in those days).

And the flip side.  Interest rates of 20%+, tonnes of bad debt in the wake of the late ‘80s bust and WA Inc and having customers in tears on their knees on the floor of his office begging him not to foreclose.

I talk about the pressure to hit a million different sales targets, the stupidity of the bureaucracy and the inconsistency of credit managers and the impossible task of helping business owners manage their banking, while also making as much profit for the banks as possible.

Not surprising that we are both out of Big Corporate now…

One thing we DO find ourselves talking a lot about these days is, it’s not quite as much fun to be a banker now as it used to be.

Why is that? you ask.

Well, first of all there’s the almost universal scorn and derision the wider community feel towards bankers.  That hurts.

Unfortunately banks can have all the ad campaigns they want.  You know, stuff like:


“We live in your world”

“More give, less take”

“Its about more than money”

“Happy Banking”

But they just can’t hide the fact that banks are ALL about making money.  Especially when the Big Four make a combined $20 Billion to $30 Billion net profit between them each year.

And employees of the banks – bankers – bear the brunt of a little of that discontent.

Secondly, credit is tightening the leash, meaning it is a lot harder to get a loan approved right now than it has been for a long while.

The economy isn’t performing very well, unemployment is rising, wages are falling, house prices are falling, so amidst all this uncertainty, the big banks have made their qualifying levels for all types of loans a little tighter.

One of the most enjoyable parts of being a banker, maybe the only enjoyable part, is lending money.  You get to meet people, listen to their story, do a bit of analysis and turn it into a package the bank will look at and feel is acceptable.

And when you deliver, the people are happy. 

But at present, credit departments across our wide, brown land are making it more difficult to get to that happy place.

And, the final reason why banking isn’t what it used to be is, the regulators have come to town…in a big way.

For those fortunate not to know, the regulators of the finance sector include the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC).

From now on I will simply refer to APRA and ASIC as “the police”.

The police have been around for a long while but up until late 2014 they had regulated with a little “r”.  Softly, quietly, in the background.

Then, BANG!

Someone coins the phrase “too big to fail” and the police start looking at the banking sector and thinking to themselves, “There could be some risk in there…”

Since late 2014 that little “r” has turned into a Godzilla-sized R.  And that has meant, for bankers, the party is over.

Some of the tools used by the police to slow down lending have included:

-          Enforcing a limit of 10% per annum growth of a bank’s investment lending book;

-          Requiring our banks hold more Tier 1 capital (cash) in the bank as a percentage of their overall loan book.  This is called capital adequacy and was around 8% until 2 years ago and is now creeping up to 11%;

-          Regularly requiring the banks to audit their loan books to determine if they are incorrectly classifying property investment or development debt as business debt;

-          Insisting the banks increase the minimum level of living expenses included for households in a loan servicing test to more realistic levels;

-          Requesting the banks review their policies regarding lending to non-residents or expatriates, resulting in almost all the banks no longer allowing the inclusion of foreign earned income in a servicing test; and

-          Encouraging the banks to insist all owner-occupied home loans are on Principal and Interest repayments, rather than Interest Only.

All this has been in response to the absolute EXPLOSION in household debt that has happened in Australia between 2009 and 2014.

It wasn’t even a property bubble; just a debt bubble.

Australian households appeared addicted to credit and the concern for the police was we were living beyond our means; using our houses as ATMs to fund our lavish lifestyles.

And now we have the rather perverse (but almost intuitively reasonable) scenario where interest rates are at ridiculous lows, but it is actually quite difficult to borrow from a bank.

So, what will and won’t banks do right now?  Well…

·       A lot of banks won’t lend for investment purposes;

·       All bar 2 or 3 banks won’t consider income earned overseas, and if you are a foreign national, forget about it…;

·       And only 1 of all the major and regional banks will lend to a self-employed expat;

·       If you earn rent, less of it can now be included in a servicing test;

·       If you have a business loan, you need to apply a rate of 8% or more to it in a servicing test; and

·       If you own vacant land and want to borrow against it you will be lucky to be able to borrow more than 50% of the value.

Now, we haven’t actually experienced a financial calamity yet.  This is just a result of the police thinking if one did occur, our big banks are so large and dominant, that they are too big to fail.

They are so interconnected that if one fell, it could likely have a flow on effect that saw another fail…and then another, etc.

Here are some numbers that display the size and importance of our banks, particularly the Big Four.

-          Their combined market capitalisation is 25% of Australia’s GDP:  $400 Billion against $1.6 Trillion.

-          Their combined Net Profit is about 2% of Australian GDP; the same approximate size as our defence budget.

-          In 1990 they controlled 40% of the home and investment lending market, and today that is 80%.

A quick sideline here.  The bit about the above numbers that kills me is the percentage of the debt market owned by the Big Four now, compared to 1990.

Every time one of the Big Four wanted to buy a smaller competitor (Westpac buying St George and CBA buying Bankwest are the two most obvious examples), the Australian Competition and Consumer Commission would rule that the acquisition wouldn’t represent a decrease in market competition.


Now, the above numbers put the lie to that.  40% market share to 80% market share in 26 years.

Four massive organisations owing a market is called an oligopoly.  We in the democratised west make fun of other nations with critical markets dominated by a few big players, but that’s exactly where we find ourselves.

Maybe we could go further and say it’s a cartel.  They have the same products that are priced within a few points of each other and all move their prices in lock step with each other.

Remember a few years ago when NAB launched their advertising campaign saying they had broken up with the other banks??  That was NAB basically saying they were leaving the cartel and moving their home loan rates outside the previously agreed cycle.

But then remember…

“Too big to fail.”  “Posing a systemic risk.”

As a government you can’t bust a cartel that forms the bedrock of the economy, even if it’s selling a drug that appears more addictive than cocaine.

Now, back to the chances of bank failure.

Don’t worry about your home loan debt.  That’s not what’s at risk here.  Your home loan is an income producing asset.  If one bank failed, it’s loans would be sold to another investment entity.

Failure would impact cash and transaction banking, and that means domestic trade and commerce grinds to a halt.

THAT’S what Hank, Tim and Ben over in the USA were afraid of in the wake of the GFC; that trade, buying goods and services, payments, would grind to a halt.

That’s ultimately what caused the failure of Bear Stearns and Lehmann Brothers, and then the GFC.

The assets they held as security for the debt they had used to fund their operations was all of a sudden deemed worth a lot less than a few days earlier.

This caused a dramatic loss of confidence in those institutions, resulting in plunges in their share values.

Frightened by this plunge and the media coverage, investors asked for their funds back, but were told they could not redeem their funds.

Then, it became apparent they were insolvent and they had no choice but to:

-          Be bought for cents in the dollar; or

-          Declare bankruptcy.

It was an investment banking version of a good ol’ fashioned run on a bank.

A bank run is where depositors turn up en masse to withdraw all their savings due to concerns about either the stability of a bank or the value of their savings.

Once a bank holds cash below a certain threshold it is also insolvent and it then fails, just like Northern Rock did during the GFC.

The above is unlikely to happen in Australia…but it’s not impossible.

If bad debts incurred by a bank rise too high, and depositors get worried enough, there could be a run, but the bad debts would need to happen suddenly.  Suddenly enough to really scare the sh#t out of a lot of people.

Remember what I’ve said before, it’s not the size of change that causes the damage, it’s the speed at which it occurs.

That’s enough scaremongering.  As I said, a run is exceedingly unlikely.  Recent media reports have declared Australian banks the most profitable in the world.


Read the reports.  Be sceptical.  Read between the lines.  Listen to the talking heads and pay attention to what we have been discussing here.

ANZ have just announced a fall in net profit for the 9 months of their financial year to 30 June 2016, driven in large part by a 25% increase in bad debt provisions.  Specifically, a part of their bad debts referred to as home loans 90 days past due.

That means home loans that have gone into regulatory default.  No payment made in the past 90 days.

And THE LAST bill Australian households will allow to go unpaid is their home loan.

CommBank have also announced a record net profit of about $9.5 Billion, but they too have announced an increase in bad debt provisions.  The first in almost a decade.

The good times for our banks and bankers are over, particularly in Western Australia which has been the engine room of growth for our banks for almost a decade.

In winding up, I would make a point I make when talking face-to- face all the time.

My reference point for the risk free rate of return is the RBA cash rate, currently at 1.5%.  Our banks lend it out at between 3.5% and 4%.

Yes, they make stupid amounts of profits, but theirs is a volume game.  They have so much of the market that they can’t help but make that much money.

But with a net interest margin of about 2%, our banks ARE NOT INTERESTED IN RISK.

They will not support entrepreneurs.

They will not “think outside the square.”

And they do not like it when you show them stuff that’s even remotely risky.

Tough times for borrowers, AND bankers.