Dec 15, 2010

Not the right time for banking reform

I hesitate a little to put this out there because SURELY the men making the noise and the decisions know what they are doing and understand all this stuff better than us. Surely... Don't they? Oh that's right - they don't.

Background: Since the "end" (huh!) of the GFC, Australian banks have been moving their interest rates [on loans not deposits!] "independently" of the Reserve Bank. This mostly means that when the RBA raises the cash rate by a certain amount (usually 0.25%), the Big Four banks are these days raising theirs anywhere from 0.10 to 0.50 above the "official" rise.
This has caused shock and anger and there has been a lot of talk about banks gouging customers and price signalling, and the fact that there is limited competition in Australia among banks.
So first the opposition shadow treasurer and then the actual treasurer have proposed various measures to reform the banking system and force banks to be nicer.

All of which are wrong-headed in my mind and doomed to fail.

Now speaking personally, we have a hefty mortgage, which we have made precisely NO headway in reducing, and we are feeling the rate rises - but here's my view.

Yes no doubt the banks are taking advantage where they can - it's in their nature, plus they probably feel compelled to "catch up" for the low interest rates during the stimulus period of the GFC.

Banks face increasing funding costs due to the GFC and tighter credit in the global markets, blah blah blah insert bank press releases here - which is true but it is equally true that the funding processes provide a nice cushiony less-than-transparent way for banks to add a little extra without exposing this to their customers.

Those rate rises get smaller again - at some point the GFC will pass or abate, banks will get less jittery and the normal competitive urges between the banks [limited as they are] will re-assert themselves.

The GFC is a total, global, unprecedented, once-in-three-generations event which has had eye-popping and massive impacts which are still playing out like the ripples from a stone thrown in a pond (or a meteor slammed into the sea). Not a good time to legislate as a reaction to the fall-out.

Both our government finance ministers and the opposition ones are, well, somewhat new, shall we say, to
the worlds of banking and finance and perhaps are not quite qualified to make sweeping reforms...? (Though to be fair I will add that I don't think anyone can manage this very well)

We should keep in mind the law of unintended consequences here; on a small scale look at what happened when the Reserve Bank brought in the new ATM fee system which notified customers using a "foreign" ATM of the fee that would be charged. Transparency increased - but so did the fees. Where some banks decreased the fees or stopped charging them, they started charging others instead.

[I am reminded here of the story of a daycare centre related in the first Freakonomics book which increased late pick-up fines to try and reduce the number of parents running late to pick up their kids. The result of the increase was more parents running late more often - because once they were paying a premium to be late they no longer felt so guilty about it and were happy to "buy" the right to come later when it suited them].

If banks are legislated against applying certain fees, they will just apply others, or increase costs to borrowers in less transparent ways. Obviously. John Locke pointed this out back in 1692.

Banks are entitled to charge some fees. Switching mortgages, paying out a fixed loan earlier than the maturity date, going into overdraft, or basically doing anything that requires extra funding by the bank can reasonably attract a fee.
However there is no doubt banks take advantage. In the old days you couldn't easily go into overdraft - the bank would not honour payments. Now they honour them and charge you an overdraft fee. People are reasonably angry about this. Under pressure, the banks have reduced (and in one case removed) these charges, and to my mind a small (single digit!) charge is reasonable for this "service". But a better way would be giving customers an option when they set up their accounts: do you want payments honoured into overdraft for a small fee, or do you prefer the bank to dishonour any payment which would send your account into overdraft (for no fee). Even better, charge different fees depending on the amount into overdraft, time taken to bring the account back into credit, etc. Most clients would pay minimal fees (a few cents or dollars a time say). Banks have very sophisticated systems and it is not difficult to set up algorithms to manage this type of charge. There is little administrative burden and the charges are not really designed to discourage overdrafts - at least this way the charges would be honest and useful (larger fees for larger overdrafts would serve to discourage overdrafts as well as cover the bank's risk, where the customer had chosen this option rather than the option not to honour payments).

Similarly for switching mortgages - yes the charges to switch are outrageous, but the government is correct to look for adding ways to make switching easier, rather than outlaw the fees. (Some sort of fee is reasonable unless another aspect of switching allows banks to recoup costs from each other - as remember when you pay out a loan early you are [in theory if not always in practice] disadvantaging the bank which has borrowed money to fund your loan using a rate based on the value and time of the original loan life). As well as the amount of the fee, one of the big disincentives to switch is "bundling" - the process banks have of getting you hooked up to linked transaction, saving, credit and loan accounts at the same time as you get your mortgage. Switching would be easier if "unbundling" was as easy as the "bundling". There should also be easier options to set up a mortgage and retain transactional accounts at other banks (though this is not necessarily advantageous currently, what if same-day transfers between different banks were possible without the cost?)

I do believe there must be legislation and watchdogs over banking - but the legislation has to be fairly "light". You can't legislate fairness completely. And you can't concoct fake competition into a market that doesn't have much. New Zealand chose to set up a state bank to increase competition - I'm not convinced that's a solution (and obviously neither is our government as they have ruled it out); we all know how nimble and competitive state-run institutions are (not)!

We do have to accept that there will always be costs associated with banking. There must be minimum legislation to keep basic fairness and retain competition, but in general when it comes to rules and legislation around finance, the required basic rules are already in place. You have to think very carefully about any new ones as after hundreds of years of commercial banking and finance, there is not really anything new and new rules and legislation are seldom actually needed. (Similarly, repealing or removing existing rules is not always a good idea either - there are reasons for rules that have been in place for decades or more).

Here is a great quote to finish off, on the law of unintended consequences:

"The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it."
- Rob Norton, "Unintended Consequences", The Concise Encyclopedia of Economics - at:

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