Colin Heath - PwC Banking and Capital Markets Leader
The Budget had the most far-reaching implications for the financial services industry of any Budget this century.
New regulatory powers to approve and disqualify executives and board members, mandatory deferment of pay, $200 million fines for breaches of misconduct rules, the establishment of the Australian Financial Complaints Authority to deliver binding outcomes in disputes - individually, any of these measures would have sent a shock through the industry. Together, they represent a paradigm shift in the legislative treatment of the sector.
But clearly the most attention grabbing element is the 0.06 percent levy on the liabilities of Australia’s five largest banks.
As we begin to digest the implications of the levy, equivalent to circa five percent of the banks’ net profits, it’s worth considering some of the views about how we ended up here.
The Government cited budget repair as the rationale, and the community quite rightly expects the banking sector to contribute to resolving this challenge, and to meet its obligations regarding a social licence to operate.
However, economists will tell you there are two levers to pull in managing a budget; reducing spending or increasing revenue. If spending reduction isn't possible, the focus must be on increasing revenue, including stimulating growth in those parts of the economy that contribute to tax receipts.
Initial PwC modelling suggests that if the bank levy is passed on to individuals and businesses as higher borrowing and transaction costs, and to consumers as higher prices, the average loss in GDP will be approximately $650 million every year, with 6000 fewer jobs on average annually. Increasing the cost of doing business clearly acts as a drag on growth, which doesn’t bode well for tax receipts over the longer term.
As to the levy itself, there are only three possible sources of funding; customers, shareholders, or employees, the latter through lower pay or headcount reductions.
With the move to ask the ACCC to monitor mortgage pricing decisions, lower shareholder returns are a possibility. This will mean lower returns in superannuation accounts, hitting the hip pocket of retirees.
Another view suggests the levy will stimulate competition, and help break up a perceived oligopoly in the sector. Yet the numbers would indicate competition is as fierce as it has ever been. For example, the combined net interest margin of Australia’s major banks at the half year to March was 2.01 percent, its lowest level since 2008. Margins have been consistently contracting for the last six years.
There is also some suggestion that the Government has called in the favour owed for guaranteeing the banks during the financial crisis and the fact this guarantee implicitly remains in place.
Shareholders are already experiencing reduced total returns as a result of the requirement to hold more capital and be ‘unquestionably strong.’ Whether it’s reasonable for the banks to compensate the Government beyond this will undoubtedly be a point of ongoing debate.
There's also a view that, by charging for it, the government has made an implicit guarantee explicit. If the markets interpret it this way, it's possible an explicit guarantee will reduce bank credit spreads, which would go some way to softening the impact. Indeed, since the budget, the banks wholesale funding costs have come down a couple of basis points.
When you look at the history of taxation of specific segments and sectors, it becomes clear unforeseen events and unintended consequences can combine to make them less effective and more distortive than hoped. Directionally, we should be moving our tax regime towards being simpler, more efficient, and less reliant on taxes that remove incentives to invest, transact, and hire and retain the best talent. Targeting one segment of one sector on ‘golden goose’ grounds could erode confidence in the assumption of a level playing field for taxation.
The United Kingdom introduced a similar levy in 2011 with hopes it would raise £2.6 billion in each year of operation. However the assumptions of its revenue raising potential were optimistic, leading to nine rate rises and a tripling of the original rate in order to hit its target.
Domestically, the closest approximation would be the mining tax, introduced in Wayne Swan’s 2012 budget. It was predicted to raise $3 billion within its first year, but slumping commodity prices saw this forecast downgraded to just $200 million within 12 months of it being announced. By 2014 it was scrapped.
None of this is to detract from the need for balance. The CEOs of the smaller banks have a legitimate point about relative competitive disadvantage to the majors on ‘too big to fail’ grounds. And the Government can point to a substantial tax windfall to fund public services, at least in the short term. But do these justify such a substantial shift away from the principle of a level playing field for taxation?
Judging by the soundbites on the evening news, the big banks won’t get much sympathy in the community. And the banks will be the first to admit there are areas where they absolutely need to improve. However, the sector has constructively and openly engaged with regulators and other stakeholders, and there is now an unprecedented level of transparency around their decisions.
Regardless, some in the community remain angry. But sooner or later we are going to need to have a serious conversation about what we want from our banks, both in an economic sense and as a society. Do we want a strong and stable sector that stimulates growth and delivers wealth into superannuation? Or do we want a more regulated, utility-like sector, that produces ongoing tax receipts, but does little to boost the wider economy?
All Australians support good policy, because good policy solves important problems and contributes to our national prosperity. We will need to wait and see how effective the bank levy is on both counts.
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