The global financial crisis has highlighted the flaws in the financial system and has spread around the world, from market to market from sector to sector with the increasing swiftness of a locomotive running down a hill.
Indeed, the size of the problem is so vast that it’s difficult to comprehend the scale of what faces Australia’s bankers and the Australian Government in the years to come.
Let’s look at this way; economists and governments treat banks as special. In part because they know the important role they occupy in the psychology of a nation – but also in part because they know that banks play a central role in the growth and health of an economy.
The role they play is to create a forum in which savers can store their wealth and through the mechanism of a bank this money then can be lent, usually prudently through a series of Government and bank controls to home buyers and entrepreneurs.
At least that’s the way it used to be, yet in the past five years those controls appear to have evaporated in pursuit of market share.
In the spring of 2003, China, one of the great savings nations of the world awoke, and in its determination to be part of the world financial system began shipping its savings abroad.
Instead of being a lender nation China did this differently. Used to central control and overly sensitive to the idea of capital outflows and the effect it could have on its currency China simply exported its savings and government profits, rather than creating Government debt and running a current account deficit.
The amounts that were exported by the Asian saving nations to the western debtor nations are simply staggering. According to the International Monetary Fund and forecaster Consensus Economics between 2000 and 20008 America alone absorbed $US5.7 trillion approximately 40% of its entire 2007 GDP.
This inflow of money had to go somewhere and it was the job of the financial system to recycle it into debt, financial instruments and investments and of course it did so with its usual ruthless efficiency, creating housing booms, investment booms and consumption booms all over the world.
Of course by embracing that debt naturally means savings ratios across the debtor nations plummeted – by 2005 the USA had a savings ratio of just 1% – down from 10% just a decade earlier.
To understand the size of the gap emerging in the market and the potential size of the problem that is wrestling with, it’s worth trying to understand the size of the current account deficit (CAD) as a percentage of GDP.
Fundamentally, this is an accurate picture of the effect of the borrowing – the measurement of the CAD as a % of GDP gives an accurate indication of its relative size to national output over time and therefore a country’s economic position.
General economic theory holds that if the deficit reaches more than -5% of GDP most economists consider it to be unsustainable since it represents a constraint to domestic economic growth.
If the economy is growing at say 4% and the CAD reaches -5%, then the economy cannot grow faster without spending more on imports which in turn will increase the goods deficit and the CAD.
Right now the idea that Australia has been sheltered from the worst of the global financial crisis is effectively shattered by understanding our economic position.
Consensus Economics estimates Australia will have a CAD in 2009 of about -5.5% slightly worse that the USA and Ireland but significantly better off than Spain which binged on overseas debt like few other nations.
What Does It Mean To Australia?
The short answer to this is no one really knows – estimations for the clean up for this mess vary from an optimistic 2 years to Bill Gates’s estimation of a decade. Even Alan Greenspan has called the current financial crisis a “once in a 100 year event.”
Whatever the case and who ever is right the news is grim – we have had the first run on a bank in the UK since Benjamin Disraeli was Prime Minister and hundreds of thousands of people have lost all or part of their savings in failures which have been spectacular – with single funds like Bernie Madoff’s collapsing and destroying $50 billion of investment, not to mention local examples like Storm Financial.
In Crisis There Is Opportunity
The first wave of the crisis cleaned out the mid-tier of Australia’s retail banks with both St George and Bank West being swallowed whole by Westpac and CBA respectively – and indeed in the home lending sector Aussie Home Loans, flush with cash after a part sale to CBA gobbled up Wizard Home Loans.
That apparently isn’t the end of the takeovers – industry rumor has at least four other takeovers of various sizes mooted as the big four banks scramble for market share at a time when their competitors are weak.
They are using this time too to clean out some of the hangover of the past five years of aggressive competition for share – re-writing the commission structures of businesses and mortgage brokers and returning some of their third party business divisions to profitability.
To a certain extent Australia’s big four have been immune from the overseas collapses – and the failure of some of the worlds’ biggest banks has seen them leap up the league tables as their overseas competitors simply collapse. ( This is called the Bradbury approach – named after the Australian Olympic Speed Skate Stephen Bradbury – who won Australia’s first ever Olympic Gold Medal – when his competitors in the speed skating race simply fell at the last corner – allowing him to cruise to a surprised gold).
In fact it is the aggressive second tier players – Macquarie Bank and now all but defunct Babcock and Brown businesses which imported the cheap debt laden, mathematical model driven valuation techniques that have shouldered much of the burden of the collapse – Australia’s big four banks had through either good luck or good management only relatively limited exposure to the disasters overseas.
Financial probity of the banks aside it’s clear that we are going to enter an era of newly straightened banking models where aggressive market growth is not going to be the order of the day.
Quaker Banking Starts To Re-Emerge
The idea of Quaker banking – that is simply lending only a percentage of what you have in deposits have already emerged in the home loan and business lending market – non complying home loans and easy business credit have all but disappeared and the market is awash with anecdotes of project finance pulled in the middle of building and experienced importers being refused credit.
The market – ever sensitive to the peril that the system faces – has responded and household deposits, a core measure of the savings of average Australians, started to accelerate in July last year.
Source APRA
This chart tracks the APRA recorded household deposit amounts – including the effect of the takeover of St George by Westpac and Bank West by CBA – it should be noted that the sudden jump in deposits by ANZ in May 2008 was from a reclassification of assets not an instant new source of funds.
The chart also shows that while Westpac may be the biggest bank by market capitalization in Australia, CBA is enjoying the lion’s share of the household deposits market and appears to be growing faster.
CoreData research shows the growth in CBA’s deposits is at least in part being driven by the idea that the CBA brand is the safest in the market.
At a time when consumers are valuing security over anything else in the market – then that’s a distinct advantage.
The other thing that this chart shows is that even within this small group there may be a two-tier banking system emerging – with Westpac and CBA enjoying substantially better growth rates than NAB and ANZ – an issue worth watching as the effects of this crisis on consumer behaviour become clear.
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