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Romesh Wijeyeratne discusses the simple economics behind ongoing bank corruption scandals and government inaction.

THE COMMONWEALTH BANK'S treatment of CommInsure customers is another in a long line of banking scandals which leaves many Australians pondering why politicians won’t take decisive action against banks, despite overwhelming public support.

It didn’t take much convincing for the Coalition Government to call a Royal Commission into unions, so why is it so difficult to do the same for the banks?

Politicians are very hesitant to take any punitive action against banks, that may interfere with the bank’s profitability and lending capacity. Political parties are judged by their performance at each election on issues their constituents feel are important at the time.

One such issue that emerges regularly is the economy and its effects on the wealth of Australians, especially with regards to property prices and the sharemarket. Therefore, when deciding on the merits of political intervention into recent banking scandals, politicians must consider the possible unintended consequences of any such intervention to the broader economy.

The consequences of taking action against banks

Consider that nearly half of the companies that comprise the ASX200 are financial sector related companies. Many retirees rely on the dividends that these shares pay. This may give politicians considering banking reform a moment of pause given that their constituents who invest in the ASX200 have a vested interest in the share price of banks continuing to rise.

Similarly, constituents who own property feel greater wealth when their home equity rises. The cost of owning property often figures prominently as an election issue and we have recently been through an important example of how banks can use this issue to dissuade politicians from taking effective action against them. The banks can simply use their leverage over something dear to the hearts and minds of nearly all voting Australians - mortgage rates.

Example of influence over government policy

In 2014, the (then) Minister for Small Business Bruce Billson announced a review into unfair contract term protections for small businesses. The intention of this review was to address the allegedly unconscionable contract terms that the supermarket giants Coles and Woolworths were using to gain unfair advantage over their suppliers. To the credit of the Minister, this review was subsequently extended to look into unfair contract terms in financial contracts.

During the public consultation phase, the Head of the Australian Bankers Association Mr Steve Munchenberg commented to the media that the legislation changes proposed by the review would “influence the price of credit”.

This is the banks’ way of telling politicians, 

if you change the laws, we will raise interest rates.

Soon thereafter, the draft Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Bill 2015 legislation was produced with a clause limiting the effect of these unfair contract protections to contracts with a value of less than $250,000 — later increased to $1 million by the Greens and Labor. This clause was never discussed as part of the public consultation process.

As most Australians aren’t aware of this watering down of the legislative protection, the banks can then claim this watered down legislation as a victory for customers — problem solved.

At the recent Loan Impairment Inquiry into constructive defaults, ANZ deputy group CEO Graham Hodges stated that the new unfair contract term protections

“will prohibit contract terms that are unfair or cause a significant imbalance in the rights of a small business, including farmers and their financiers.”

 

However, he conveniently omitted telling the committee that these protections don’t apply to customers with loans greater than $1 million. Therefore for the majority of complainants who are farmers or small business operators, these legislation changes are of no practical assistance. The bank’s strategy worked, having diluted the legislation to the point that it is ineffective for the majority of complainants.

This strategy of subtly threatening interest rate hikes will always be effective because most Australians of voting age are also mortgage holders whether they are owner-occupiers, retail investors, small business, or farm mortgage holders. If any political party tries to take action against a bank, the banks can simply suggest they will reprice credit.

The banks can then rely on the media, some of whom may have significant financial shareholdings, to suggest that the increase in interest rates is a direct result of economic mismanagement of the incumbent political party. This has maximum impact on the voting public and can influence government.

The cost of doing nothing

We are now at a time where there has been so much misconduct in the financial industry that it simply cannot be ignored. All sides of government are now at a point where they must decide if the cost of doing nothing outweighs the cost of taking action. Profitable small businesses are being shut down, productive farmers are being evicted from their land, and employment generating entrepreneurs are being bogged down by lengthy litigation. This all has flow-on effects to employment growth, tax receipts and economic growth.

The banks continue to report record profits while Australians are being warned of the risk of a recession approaching. This disparity can’t continue and most voters and political parties are coming to this realisation.

With an election around the corner, it would be remiss of any political party to ignore serious bank reform in the form of legislation changes and punitive action. Indeed, ASIC’s recent, uncharacteristically tough stance on the rate-rigging scandal may signal a change of attitude, by regulators at least. In the meantime, if the unions wish to avoid a Royal Commission they may do well to apply for a banking licence.

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