Australia needs a super profits tax – on banks | Satyajit Das

DThe discussion of a super-profits tax focused on energy companies, which reaped huge windfall profits thanks to the invasion of Ukraine. But why wasn’t a similar tax imposed on the banks that benefit from rising interest rates? While energy company earnings are highly cyclical, Australian banks are consistently among the most profitable in the world.

Increased interest rates increase the spread between what the bank charges borrowers and what it pays depositors. Lending rates closely follow Reserve Bank rate hikes, but deposit rates often lag behind. In addition, low policy rates over the past decade have squeezed banks’ margins as they have been unable to lower deposit rates enough as they are required by law to maintain a minimum level of deposit funding for retail customers. As long as borrowers don’t default en masse, lender profits should rise with higher interest rates.

Last year, Australia’s big four banks made $28.5 billion in profits. Their ROI of 10.6% was well above the global average. Banks are large relative to the size of the overall economy at 160% of GDP, about double the global average.

Several factors affect this performance. With mortgages accounting for around 60% of Australian bank loans – one of the highest shares in the world – they benefited from a period of unusually low interest rates and the resulting high property prices, which boosted the volume of home loans.

The industry is dominated by the big four banks, which account for around 72% of the market. Deregulation has not increased competition. The industry has consolidated through takeovers and mergers. Foreign banks have largely withdrawn or refocused their focus on wealthy clients and multinational corporations.

The implicit support of the Australian government and taxpayers, evident during the 2008 crisis and pandemic, guarantees viability. There are more subtle factors. Big banks eagerly control the payment system, which means competitors have to pay the banks for access.

Over the past four decades, banks’ profits have reflected not only their role in providing essential services, but also the sector’s tendency towards oligopoly. Profit maximization has restricted access to banking services, particularly in regional and remote communities, and led to financial exclusion. There are also well-documented cases of predatory behavior and outright fraud.

Structural reforms are needed. A windfall tax, while attractive on the surface, has problems – what is a normal rate of return? Does the state subsidize industry when profits fall? A better approach would be fundamental reform of the sector.

The 2017 capped bank levy could be expanded. It currently only applies to banks with over $100 billion in committed liabilities. The current interest rate of 0.06% may be low compared to the benefits of implicit government support, which is estimated to reduce banks’ borrowing costs by 0.22% to 0.34% – although the figure is debatable.

Given the need for financial services, banks should be required to provide affordable access to basic banking. This is comparable to the requirement for energy, water and telecommunications companies to provide indispensable services.

It needs more competition. Opening up access for qualified young professionals on fair terms is one element. A simple state-owned bank, perhaps based around Australia Post, offering basic services, particularly to the financially excluded, is an option. However, the now-forgotten Australian state bank debacle suggests caution is warranted.

Key financial infrastructures such as the payments system should be under national control, with access to a wider variety of qualified parties other than banks.

Such proposals will provoke fierce, well-rehearsed, and well-funded opposition, with changes being portrayed as undermining confidence in banks and the financial system and creating unwanted instability and economic damage.

Banks will argue that such measures will threaten the economy’s credit supply or lead to falling house prices. Hasty action, it is claimed, can damage international perception of banks, which play an important role in channeling foreign funds to meet Australia’s funding needs, and jeopardize the functioning of monetary policy.

Lobbying efforts will take advantage of the fact that many people and businesses are both clients and investors in the banks, which make up more than 30% of the Australian stock market. Stricter regulations are said to hurt banks’ share prices and reduce profitability and dividends, affecting some 14 million Australians. Banks are portrayed as major employers and taxpayers.

In truth, such “heaven-will-fall” arguments are flimsy. For example, much of the substantial taxes paid by banks are effectively reimbursed to investors through the dividend credit system, limiting profit to government revenue.

Australia needs a diverse, competitive and cost-effective financial sector that offers a secure payment system, a safe depository for savings, financing at reasonable prices and simple and effective risk management tools. Current regulations may not deliver these results for all Australians.

Satyajit Das is the author of Fortune’s Fool: Australia’s Choices (March 2022) and A Banquet of Consequences – Reloaded (March 2021).

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