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Banking Royal Commission and the Credit Crunch - October 2018

Proposition 1: "There is a significant risk that, either as a result of the findings and recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry or as a result of the financial institutions' response to those findings, credit will become less readily available to Australian households or businesses."

Proposition 2: "Assuming credit becomes less readily available to Australian households or businesses, this will in turn have adverse consequences for the performance of the Australian economy."

Collaborator credits: we would like to thank Saul Eslake and Rod Maddock for their assistance in framing this poll question and expert overviews of the results.

Background information

Overview of poll results by Saul Eslake

Saul Eslake

Saul Eslake

This month’s ESA Monash poll was prompted by the Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the ‘Banking Royal Commission’) which was released at the end of September.

Read more

Overview of poll results by Professor Rodney Maddock

Rodeny Maddock

Professor Rodney Maddock

The most recent Economic Society survey of leading Australian economists throws up some important challenges to financial market commentary.

Read more

Proposition 1

Proposition 2


Responses (24)


 

Rachel Armstrong

1 - Disagree

2 - Agree


 

Garry Barrett

1 - Agree

2 - Disagree


 

Alison Booth

1 - Disagree

2 - No opinion

1 -

2 - I strongly dislike the wording of these propositions. Clearly the RC was important and showed how much banking requires reform. How this reform can be achieved is what we should be focusing on next.


 

Matthew Butlin

1 - Agree

2 - Strongly disagree


 

Lisa Cameron

1 - Uncertain (neither agree nor disagree)

2 - Disagree

1 -

2 - In the medium to long term a more sound and ethical financial system should work for the benefit of the economy and society.


 

Fabrizio Carmignani

1 - Uncertain (neither agree nor disagree)

2 - Disagree

1 - Uncertain here is the average between two considerations of opposite sign. First, yes there is a risk of credit becoming less readily available to Australian households and business. (But) Second, I do not think that the Royal Commission is the main factor driving this "credit crunch". The borrowing capacity of property investors was declining well before the publication of the interim report. Also, the report points to very important misconduct issues whose correction will have long-term benefits. The possible tightening of credit conditions in the short term is the price to pay for this necessary correction. Finally, part of the short term decline in the volume of credit available from banks might be offset by an increase in credit from other (non-bank) financial institutions.

2 - Following from my answer above, I do not see how the report in itself can have major, long-lasting negative effects on the performance of the Australian economy. This does not mean that the outlook for the Australian economy is without risks, but these are not primarily arising from the report.


 

Ken Clements

1 - Strongly agree

2 - Strongly agree


 

Deborah Cobb-Clark2

1 - Strongly agree

2 - Agree

1 -

2 - This would have adverse consequences for some sectors (individuals) in the economy; though not necessarily adverse consequences across the board.


 

Janine Dixon

1 - Uncertain (neither agree nor disagree)

2 - Disagree

1 - It's possible that credit will become less readily available as a "first round effect", but to take a balanced view, we should also consider that having a better-behaved banking sector will also have positive repercussions for the economy.

2 - Presumably credit was readily available to sub-prime mortgage lenders leading up to the GFC. More credit isn't always a good thing!


 

Uwe Dulleck

1 - Uncertain (neither agree nor disagree)

2 - Uncertain (neither agree nor disagree)

1 - This question has several aspects to consider. In general better regulation of banking services should increase the quality of service, thus increasing demand for the service and potentially leading to better investments. If we do trust our institutions, it may actually lead to better outcomes and maybe even more funds being available. If the regulation is implemented poorly, then yes this will increase costs to customers and credit will become less readily available ... but that this risk is larger than that new trust in the sector increases the supply of funds, is uncertain to me.

2 - I struggle with the premise. If currently the banking system is inefficient and (at least in some segments maybe even fraudulent) then getting this right may have a lot more benefits than costs to the economy. A more efficient banking system may even balance out the assumed drop in credit availability.


 

Saul Eslake

1 - Agree

2 - Uncertain (neither agree nor disagree)

1 - There's no particular reason to think that credit should become less readily available to business as a result of anything that has (thus far) surfaced at, or because of, the Royal Commission. But in the area of mortgage lending, the Commission has called out the failure of lenders, in many instances, to properly assess and verify customers' expenses in determining their borrowing capacity, relying instead on 'benchmarks'. Assuming that lenders now become more diligent in this area (as the law requires), mortgage finance may well become less readily available to prospective borrowers whose actual expenditures are higher than the previously used benchmarks assume (all else being equal).

2 - The fact that mortgage finance may be a little less readily available is not necessarily a Bad Thing. No-one's interests are well served, in the long run, by imprudent borrowing or lending - so if there is less of that, then that's a Good Thing, even if it also means less upward pressure (or in the short term a bit more downward pressure) on property prices. And if less readily available credit does threaten to have more serious adverse consequences for the broader economy, the RBA is likely to take that into account in setting monetary policy.


 

Allan Fels

1 - Agree

2 - Agree


 

Gigi Foster

1 - Agree

2 - Uncertain (neither agree nor disagree)

1 - Both due to changes in regulatory requirements and due to banks' strategic incentives (as distinct from economic necessity), there is a reasonable chance that lending restrictions will become tighter.  Banks of course are shouting loudly about the negative impact the Royal Commission's review will have on Australians, because that argument makes them look like stewards of our welfare rather than businesses that have been spoilt by a sweet sham called "industrial self-regulation" under whose banner they have abused the trust and reduced the welfare of Australians for years. The Royal Commission's report intends to cast light on this latter concern, which is far, far more economically important in the medium and longer run than the credit tightening that the banks are tsk-tsking about.

2 - To the extent that credit is allocated more efficiently (i.e., to borrowers who will produce more with it, pay it back with higher likelihood, and so on) as a by-product of less of it in total being given out, this may have positive longer-run economic consequences for the country.  Certainly one must expect a clean-up of Australia's financial industry as a whole, of which the Royal Commission's review is a first step, to have positive long-run economic consequences.


 

John Freebairn

1 - Disagree

2 - Strongly disagree

1 - Hopefully, a revised set of better applied simpler and more transparent rules, as suggested by BRC, will reduce low value products now provided via information asymmetry market failures. Apart from some short term fines, costs of providing valued services will not rise.

2 - Disagree that valued credit will become less available or more costly as argued for Proposition 1.


 

Paul Frijters

1 - Strongly disagree

2 - Uncertain (neither agree nor disagree)

1 - I have to say 'no' for two distinct reasons. The first is that corruption in the banking industry is so entrenched and politically protected (as I detail in my co-authored book Game of Mates of April 2017), that there is virtually no chance of the recommendations of the Royal Commission truly being taken seriously. The second reason is that if the recommendations were to be taken seriously, then in the long run the cut that banks take on mortgage loans and business loans would reduce, which reduces the price of  credit and hence increases access to them. I detail that too in 'Game of Mates'. However, it is indeed perfectly possible for the banking industry to inflict a recession on Australian households as revenge for uncovering its corrupt activities. The RBA of course has been remiss in banking oversight for many decades and has impure incentives in terms of its response.
I find the question itself somewhat loaded. It is of the form "Is exposing crime going to lead to a problem because the criminals who remain in charge might take it out on their victims?".

2 - In the longer run it is probably better for the economy to reduce the reliance of the economy on debt. Yet, short-run effects of credit reductions would be negative on the economy.
Again, I find this question very leading.


 

Geoffrey Kingston

1 - Agree

2 - Agree

1 - Yes, there is indeed a risk of reduced bank credit. In particular, the banks will be wary about class-action litigation, and stricter court interpretations of the responsible-lending laws.

2 - Households and businesses alike look to the banks for funds to acquire assets, especially property.


 

Michael KNOX

1 - Agree

2 - Uncertain (neither agree nor disagree)

1 - I have been surprised at the number of business and individual investors who
have asked me if the decrease in business and home lending that they observe is caused by the Banking Royal Commission.  That the two are related to each other seems  to be commonly believed by many members of the Australian public.

This may simply be because the public sees house prices moving down at the same time as the Banking Royal Commission is in session. The increase in bank reserves that have been implemented under supervision of the RBA since January 2015  do have the effect of a moderate tightening of monetary policy even though the cash rate has remained unchanged. This may be a better explanation for the tightening of lending since  that time.


Could the advent of the Royal Commission result in banks becoming more risk averse? It would be reasonable to expect that it might.

2 - This depends upon the RBA reaction.  Should the RBA react to a reduction in bank lending by further cuts in the cash rate, then the two effects might be expected to cancel each other out.


 

Tony Makin

1 - Agree

2 - Agree

1 - Credit availability has already tightened for property purchases in particular, especially for investors, which is contributing to the downward pressure on property prices in Sydney and Melbourne.

2 - Tighter bank credit will adversely affect private investment and hence the economy's rate of growth, other things equal. This is macroeconomically analogous to the classic risk-return trade-off from finance.  Lowering risk by tightening credit implies a lower, albeit safer, return in growth terms.  

The poorer than otherwise performance of big 4 bank shares, a key asset in superannuation portfolios, also has direct wealth effects.  This will likely raise the cost to the federal government of future age pensions, with negative budgetary implications.


 

Margaret Nowak

1 - Agree

2 - Uncertain (neither agree nor disagree)

1 - The Financial institutions can be expected to respond to the public airing of some of their recent actions in respect of customers by adopting a more conservative approach to providing credit. However, there is also already evidence that the financial institutions are restricting credit in response to the regulatory authorities concerns relating to overextension of lending in the housing sector, especially in relation to housing investment in Sydney and Melbourne.

2 - The impact on the performance of the economy from credit being less readily available is dependent on both what else is happening in the economy at that time and on where and for whom the demand for credit is not being met. In the long term a reappraisal of borrower eligibility may strengthen the credit system and support financial stability.


 

John Quiggin

1 - Agree

2 - Disagree

1 - It would be better to say "probability" rather than "risk" since the latter implies a positive answer to Prop 2.

2 - Debt/income ratios are dangerously high, and reducing them would be beneficial.


 

Rana Roy

1 - Uncertain (neither agree nor disagree)

2 - Disagree

1 - Any major reform that aims seriously to move from a suboptimal equilibrium to a more optimal equilibrium is likely to be disruptive and to carry the risk of unintended consequences. Consider for example the reforms that put an end to the rule of the Mafia in the Mezzogiorno or that of the drug cartels in Colombia. In principle, the same would apply to any major reform that aims seriously to put an end to the unethical, and prima facie criminal, practices exposed by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. In the present case, however, the timetable for major changes to the governance and regulation of the finance sector is likely to be overtaken and overwhelmed by more powerful events: the deepening of the downturn in the housing cycle; a global tightening of liquidity with global QE scheduled to turn negative in early 2019; a global downturn in asset prices and in the real economy in 2019 and 2020. This is why I find it difficult to be certain of the impact of any follow-up to the Royal Commission: it may be that reforms resulting from its findings and recommendations will amplify the impact of other and more powerful events on the availability of credit to Australian households and businesses; it may be that such reforms will not happen early enough to have any discernible independent impact; or it may be that the requisite reforms will be delayed by the relevant decision-makers as part of their response to the downturn. My vote for “uncertain” should be read as the outcome of the above reflections.

2 - The Torah instructs us in Exodus 20:15: “Thou shalt not steal”. If the attempt to implement this instruction in response to the findings and recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry were indeed to result in a discernible independent impact on the availability of credit (notwithstanding my doubts on this point as expressed in my previous answer), I would respond, paraphrasing Paul Keating, “This is the correction that Australia had to have.”


 

Jeffrey Sheen

1 - Strongly agree

2 - Agree

1 - An overly severe credit squeeze is already underway. It will worsen further until ‘Goodhart’s Law’ eventually prevails since financial institutions invariably find ways to beat  over-bearing regulatory and supervisory constraints.

2 - In the short to medium term, the economy’s performance will be weaker as a result of the current credit squeeze. In the longer term, it is possible that the Royal Commission will help to deliver a more stable, fairer and safer financial system that in turn will mean less volatility about the economy’s trend.


 

Julie Toth

1 - Agree

2 - Uncertain (neither agree nor disagree)

1 - Credit costs and availability are already changing due to global credit market machinations and rising US Fed rates etc. Changes to bank policies and practices in Australia as a result of the royal commission will affect credit costs and/or availability, in addition and concurrent to these background trends. In practice, it is likely to be difficult to untangle exactly why any individual credit arrangement changes, unless the bank in question explicitly says that it is in response to the royal commission.

2 - I am very confident that I don't agree or disagree on this one! Availability, conditions and cost of credit change frequently, in response to many variables (e.g. perceived risk, cost of capital, asset price trends, bankers' bonus arrangements, regulatory requirements). Reduced availability of credit is not necessarily always a negative influence on economic performance. The effect on households and businesses depends on when/why/how credit tightening is happening. And whether or not the availability of credit is a constraint on investment or output.


 

Joaquin Vespignani

1 - Agree

2 - Disagree

1 - I agree but preventing unscrupulous lending and bank misconduct is a priority for a sound financial system and strong economy.

2 - Even if some additional regulations are introduced to restrict credit,  this will only have a moderate effect in the Australian economy. Any additional restrictions will somehow be compensated with easier monetary policy (lower interest rate).