This is not a trick question, but what is the primary purpose of a retail (AKA commercial) bank?
Assuming it’s not been nationalised, like RBS and other 2008 basket cases, presumably the main function of a bank is to make money for its owners, i.e. the shareholders. Sure, the corporate mission statement might waffle on about helping customers through the key milestones on their life journey, blah, blah, blah, but if they don’t increase the shareholder’s value, they’re dead.
Australian retail banks have performed this task very well over the years. CBA’s share price and dividend history is shown below as an example, the other 3 major banks are not dissimilar;
That the dividends barely missed a beat following the minor difficulties in the banking world in 2008 is amazing. Of course, this masks a slightly inconvenient fact that they were supported by an implicit government guarantee of a bail out should one be required, allowing investors to remain calm and not rush for the exit like in other jurisdictions.
Gifts rarely come without an expectation of a quid pro quo, however. In the Australian case, the banks are expected to “do the right thing” by the public, by which we mean, “help the government”.
On the way up, when values are increasing and there’s a wealth effect to the public, or at least those exposed to the upside of property ownership, these two purposes (shareholder value and public service) are reasonably well-aligned.
On the way down, as property values decrease and regular members of the public start to experience financial pressure, the two purposes diverge. If the government of the day would like the bank CEOs to show some forbearance to those in distress or even take a haircut on the margin between borrowing and lending costs, the bank shareholders are going to suffer.
What might this mean in the short to medium term?
There’s a few factors at play currently which may provide us with an indication of how the next year or two might play out.
- The Royal Commission in to the financial sector has unearthed some unpleasantness by most major institutions. There will be ramifications for the sector in terms of increased oversight and regulation.
- Macroprudential restrictions on lending has resulted in a cooling of the housing market with prices down around 10% from the 2017 peak and perhaps, conservatively, 1 in 10 owner occupier mortgages being in negative equity (more, according to some sources).
- A likely change of government in May and the possibility of the removal of some tax breaks for new owners of investment properties.
- Costs of borrowing from overseas sources (currently about 60% of mortgage funding) has increased and looks likely to continue to do so, albeit mildly, during 2019.
- A halving of the number of foreign (by which we mean Chinese) property investors buying in Australia since the peak in 2014.
Predictions are notoriously difficult, especially about the future, but this combination of factors suggest that the decline in values is unlikely to halt during the next 12 months.
Whichever flavour of government is in power, and let’s face it, there’s little difference between the two parties other than one group is more competent at being corrupt than the other, won’t really matter; neither of the major parties are going to enjoy governing during a -15% or perhaps -20% property crash.
The calls to “do something, do anything” are going to become deafening.
The professional economic troll, Stephen Koukoulas, and the “Chief Economist” of My Property Market (i.e. the only employee), Dr. Andrew Wilson, are already flooding social media with pathetic begging of the Reserve Bank to cut rates.
God only knows how many more vested interests will come out of the woodwork over the coming months.
Obviously, the government is going to call in the favours owed. At the very least, banks are going to have to take a hit on margins. The banking regulator, APRA, may find itself under political pressure to ease the responsible lending restrictions that have been put in place and then banks will be “encouraged” to open the spigots again. Friendly State Governments may be under pressure to reverse restrictions on overseas ownership.
None, some or all of this might “work”.
Regardless though, shareholders of the banks are going to take one in the chops.