The Rba Rightly Decides It Is Time For Shock Therapy

The Age

Wednesday October 8, 2008

Commercial banks ought to pass on most of the one percentage point rate cut to their customers.

AUSTRALIA's banks are among the most secure in the world, politicians of both parties routinely intone, and Australia's banking system is the best regulated. The second part of the claim is easier to justify than the first, as the Reserve Bank's decision yesterday to reduce the cash rate by a whopping 100 basis points to 6% testifies. Whatever else may be true of Australia's financial institutions, it is not true that they can be insulated from the global credit crisis and the threat of recession that comes with it. The RBA's announcement amounts to a recognition that the most crucial task ahead is to prevent any slowdown of economic activity.

The size of the rate cut - double what had been expected, and the biggest cut since 1992 - suggests that the RBA does not expect too much help in this task from the commercial banks. As the prospect of a rate cut increased in recent weeks, the banks had responded with warnings that they would be unlikely to pass on the full extent of any cut, because the credit crisis emanating from the US was making their own borrowing from foreign banks more expensive. It is a reasonable surmise, therefore, that the RBA board decided on a hefty rate cut partly in the hope that the banks would go further in dropping their own rates than they might have done if the cut had been the expected 50 basis points.

The extent of the crisis was appraised soberly enough by the RBA's governor, Glenn Stevens, in his statement accompanying the rate announcement. "Conditions in international financial markets took a significant turn for the worse in September," Mr Stevens said, alluding to the nationalisation of failed banks and mortgage lenders in the US and Britain, the $US700 billion bail-out of troubled investment banks by the US Treasury, and the wave of panic on world financial markets that ensued despite the passing of the bail-out legislation by the US Congress. A turn for the worse indeed.

The day before, market indicators around the world had plunged, with Australian shares following the global trend and the Australian dollar dropping to its lowest value against the US dollar in three years. A cheaper dollar is not necessarily a bad thing, because it makes Australia's exports more competitive, but in the context of the global crisis there was also another lesson in the dollar's fall, which the RBA did not ignore. The weakening of the currency is an indication of a loss of confidence by investors - and when confidence erodes, economic regulators have a problem, no matter how high the estimation of Australia's big four commercial banks may be in global markets.

The banks are stating a fact when they point to the increasing cost of their own borrowing abroad, borrowing that is necessary to keep their own businesses going. But that fact is not the whole story.

The big four remain highly profitable institutions, and they are about to swallow some of their remaining regional competitors. The Commonwealth is poised to take over BankWest, lest it lose its status as the country's leading mortgage provider to Westpac, which is absorbing St George Bank. Suncorp's banking business, too, is expected to be hived off and sold, with three of the big four bidding to acquire it.

If the big four are in a confidently expansionist mood when their international rivals are fearful and in some cases faltering, arguments that the greater part of the RBA's rate cut cannot be passed on to consumers need, at the very least, a more cogent justification than the commercial banks have yet cared to offer. It was no surprise, therefore, that the RBA's announcement yesterday was followed quickly by Westpac's decision to lower its variable home-loan rate by 80 basis points - an amount larger than the 50-point cut the banks were so apprehensive about only days ago. The Commonwealth matched Westpac's cut and a non-bank lender, Aussie Home Loans, announced a 75-point cut. Late yesterday ANZ and NAB eventually matched the other big banks' 80-point cut.

If Australia comes through the global crisis comparatively unscathed, it will be because of the continued strong demand for this country's commodity exports and the effective regulation of the financial system. But the economic landscape will have changed, and one of the most notable features of it is likely to be that the big four banks will have grown even bigger. And the argument for maintaining an effective regulatory system will have grown along with them.

© 2008 The Age

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