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Government backing encourages banks to take more risks – research

October 31, 2017 Business News No Comments Email Email

Government protection and a perception that they are too big to fail has encouraged Australia’s four major banks to take risks and this has contributed to strong credit growth in recent years, according to a leading researcher at the University of Sydney Business School.

Associate Professor Dr Eliza Wu, a banking expert in the School’s Discipline of Finance, says that government support has led to excessive lending by the banks, particularly to home buyers and property investors leading to high property prices in the major capital cities.

“With government backing, the banks have been able to access more deposit funding, lower their cost of funds, and hence are more inclined to lend in larger volumes and at cheaper rates in order to increase their market share,” says Dr Wu. “This in turn, has forced other finance providers to follow suit just to remain competitive.”

“Under these circumstances, a significant downturn in housing prices could lead to household defaults and widespread losses throughout the banking sector,” she said.

Dr Wu’s research indicates that banks in developed countries like Australia and the United States started taking risks in the aftermath of the 2008 Global Financial Crisis when government’s offered “a whole vast and unprecedented array” of support.

“Governments bought toxic assets, injected new capital into the banks and provided liquidity support programs of all kinds,” she said. “There was also a range of implicit and explicit government guarantees benefitting the banks.”

“In November 2008, the Australian government introduced the wholesale funding guarantee scheme for Australian banks which covered their borrowings from creditors internationally. Essentially, if the banks were not able to repay that debt, the government was up for the bill.”

While the wholesale funding guarantee no longer exists, Dr Wu points to the Financial Claims Scheme, which protects retail deposits up to $250,000 and the Reserve Bank’s emergency liquidity facility as examples of continued government support for Australian banks.

“Then there is the ongoing implicit support for the banks based on the perception that they are Too-Big-To-Fail,” says Dr Wu. “They hold around 90% of all banking assets in Australia and despite the recent political tensions between the banks and the state and federal governments, they are viewed as too systemically important to be allowed to collapse.”

Despite their recent behaviour, Dr Wu believes that another financial crisis can be averted if the shareholders demand that the banks retain “larger capital buffers over and above the minimum capital requirements”.

“Our research shows that the banks that are better capitalised seem to do better in that their risk taking behaviour is more restrained. This comes from shareholders essentially having more skin in the game, so they’re more interested in keeping an eye on what the bank managers are doing and what kind of risky activities they’re engaging in,” Dr Wu concluded.

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