The Australian, June 1, 2018
After much anticipation, the Hayne royal commission has turned its spotlight on small business — the often forgotten sector that is regarded as the engine room of the Australian economy.
And it hasn’t been pretty for our major financial institutions.
Small and medium-sized enterprises have long been ignored by the big four, especially during the good times.
Political economist Benjamin Friedman made the point that modern society is like a bicycle, with economic growth being the forward momentum that keeps the wheels spinning.
As long as the wheels are spinning rapidly, the bicycle is a stable vehicle, but when the wheels stop as a result of an economic downturn, social tolerance flies over the handle.
Australia has not reached this nadir but we are certainly in a radically different place today than during the heady days of the mining boom, when profits were soaring, capital was readily available, and people were making fortunes overnight.
In such a “sales driven culture”, there is plenty of evidence of lax credit standards in assessing the robustness of household income and expenditure, including what have been described as “liar loans”, which may total as much as $500 billion. This and other recent examples illustrate a decline of professionalism across the industry.
Here are the four reasons why it was inevitable we’d end up here:
A power imbalance
The big banks hold all the cards, particularly in respect to small and medium-sized businesses. No sector has been more adversely affected by the structure of and culture within our banking industry.
Small businesses are hugely reliant on the major banks because they account for about 85 per cent of all SME lending.
All the evidence suggests that in the absence of meaningful competition, the banks have leveraged their power to maximise profits — and everything else is secondary, especially service.
SMEs are forced to enter into a Faustian pact with the big banks, which, according to the Financial Ombudsman, goes like this: “We are lending you money today … but we can call a loan at any time for any reason … If you do not repay it immediately, we will take all of your secured property, your personal property, including your home, from you and bankrupt you under the director’s guarantee. Sign here.”
Refusal to change
Since the financial crisis the major banks have appeared before 51 inquiries, investigations and reviews.
So many inquiries raise serious questions about the social licence granted to the banks. They also suggest that the big banks are less than willing to take public responsibility for their actions.
The reality is that, culturally and operationally, our major banks are locked on a path. Therefore, the royal commission is a review of their social licence, but it doesn’t and can’t address the core problem.
Rather than providing capital to support SMEs, our banks have had an unhealthy bias towards household lending, now at $1.6 trillion — truly eye-watering levels. By comparison, lending to SMEs is roughly about $250bn.
This bias to property lending has also resulted in about 90 per cent of all SME lending being secured against collateral of either commercial or residential property.
When the science and craft of banking was governed by professional standards, collateral was just one of the Cs of lending. The other three — character, cashflow and capital — are now largely shelved as banks have industrialised their operating models in the quest for economies of scale, cost reductions and the de-professionalising of their customer-facing staff to nothing more than sales agents or “order-takers”.
This trend is now set in concrete and difficult if not impossible to reverse.
Barriers to entry
While there is much legitimate disquiet on the culture problem within our major banks, culture is only part of the reason the banking sector is on the nose.
The core problem is a powerful oligopoly industry structure, protected by special privileges, where our dominant banks earn close to double their risk-adjusted cost of capital.
Peter Costello answered this recently, describing the major banks as “absolutely immune from market discipline, living in a highly profitable cocoon; they think all these high returns are from their own brilliance, but what they haven’t understood is they have a unique and privileged regulatory system which has delivered this to them”.
The government needs to follow the example set by the British and support competition by making material regulatory changes and dispelling the self-serving myth that there is a trade-off between healthy competition and stability.
There is nothing more cleansing or more regulating than real competition to correct poor conduct, encourage professionalism and foster economic growth.
It is the collapse of meaningful competition, outside selected consumer products such as mortgage lending, that is at the root cause of the reputational damage and societal mistrust plaguing the banking industry. The mystery is why have we tolerated this for so long, particularly in SME banking.
Joseph Healy is an adjunct professor at the University of Queensland Business School and a member of the Chartered Institute of Bankers (Scotland), He is a former senior executive at NAB and ANZ and a co-founder of Judo Capital, a financial institution established to service SMEs.