The announcement of a royal commission into the much-reviled banking industry will please a lot of voters, but it will also cost many of them money.
Not the $75 million Prime Minister Malcolm Turnbull said the 12-month commission will cost, but the additional funding pressures the banks are likely to try to pass on to mortgage borrowers next year.
Few economists currently see the Reserve Bank raising official interest rates in 2018, but the cost of global borrowing is expected to tighten in the months ahead as the central bank-induced era of cheap money draws to a close.
Banks have long expected to pay more for the third of their funding sourced in those global markets, but they will now face an additional cost – investors will want a higher return for lending to Aussie banks, given the government’s now explicit lack of faith in the sector.
That increase in borrowing costs will not be large in percentage terms, but it either has to be passed on to borrowers or shaved off the profits and dividends paid to bank shareholders.
The latter, you might think, would be the wiser option given the anger in the community felt towards the big banks.
On the other hand, how much worse could it make them look to have another out-of-cycle rate rise early next year? When you’re in the mud, it’s hard to fall further.
A last hurrah for the banks
Banks have been reporting record profits in recent years, but not because of charging high rates for their loans.
It’s quite the opposite. Mortgage rates were kept low as the big banks competed in pursuit of market share, and profits have instead flowed from expanding their mortgage books far more rapidly than the economy has expanded.
During that phase, the banks’ net interest margin – the difference between what it pays for funds and what it charges for loans – has continued to slide lower, from 2.5 per cent in 2011 to around 2.2 per cent today.
That’s not a problem for the banks while their stock of loans is growing fast, but a mini lending boom over the past four years is now winding down.
As the chart below shows, annualised bank credit growth has slipped from 8.9 per cent in January 2016 to 5.7 per cent today.
That’s still growing faster than the economy – nominal GDP is forecast to grow 4 per cent in 2017-18 – but is likely to slide further in the next couple of years.
That’s for a number of reasons – higher mortgage rates mean each new borrower can afford to service less debt; the Australian Prudential Regulatory Authority has been busy tightening up lending regulations; and now the royal commission will likely tighten things further.
While slap-dash lending practices are unlikely to take up much of the commission’s time, there is little doubt that the banks will emerge for the royal commission process chastened, and less profitable on a number of fronts.
Hopefully we’ll never again see them dishing out shonky financial advice, mis-selling financial products or ripping off insurance policy holders.
Put all that together, and what do bank shareholders have to look forward to? Slowing credit growth, funding cost pressures, possible fines and prosecutions and tighter regulation.
Against that backdrop, it will be very tempting for the bank boards to look to exploit the swollen mortgage books they already have with an out-of-cycle rate rise next year – to make a bit of hay while the sun’s still shining.
If it happens, the banks will be excoriated by politicians – but again, will that change anything?
They copped numerous angry outburst from former treasurers Wayne Swan and Joe Hockey, and did customers rush out and take their business to the smaller banks? Hardly.
To be clear, a bank royal commission had to happen – the instances of malfeasance already uncovered suggest there are more nasties to come.
But most people will have assumed that such an inquiry would have taken place only when the next Labor government came to power.
Now that it’s happening much more quickly, the upside is that wrongdoing will be identified and punished sooner.
The downside, though, will be more pressure on cash-strapped mortgage holders while the economy is still struggling towards better levels of growth.
For that, the Turnbull government may lose some of the praise it’s due for getting on with cleaning up the banks once and for all.