The Game of Bank Bargains

Last week at a lunchtime speech on leadership, the Commonwealth Bank chief, Ian Narev, told his audience that Australia needed “largescale financial institutions” to confront challenges ahead and take advantage of opportunities.

Mr Narev didn’t mention the four pillars banking policy, which the banking sector has been chafing about since 1990. However, it is difficult to visualise the emergence of large-scale institutions so long as the four pillars policy remains unchanged.

According to Mr Narev: “The country needs vibrant competition. It needs entrepreneurship. It needs smaller companies as well, but it needs large-scale institutions. They are and will be a critical part of the economic prosperity of Australia”.

Considering the devastation we have witnessed during the last eight years across the global financial landscape, especially among the ranks of the mega banks, Mr Narev’s vision of the financial future may well be built on shaky foundations.

Had Australia’s financial system gone down the same path of consolidation as the US and UK after 1990, it is highly likely that our damage would have been all the greater.

As it is, and was before the GFC, Australia has a justifiable reputation for running one of the world’s best banking systems.

The Global Financial System

There are many metrics that can be deployed to measure the comparative performance of the 117 banking systems that have been defined as functioning members of the global system.

A magisterial study of global banking published late last year, “Fragile by Design”, ranks national banking systems by stability and credit generation since 1970.

The authors are Charles W. Calomiris, Professor of Financial Institutions at Columbia Business School and Stephen H. Haber from the Hoover Institution at Stanford University.

Only six of the 117 countries they surveyed - Australia, Canada, Hong Kong, Malta, New Zealand and Singapore - met the author’s threshold of being both credit abundant and crisis free.

What do these “very successful six” countries have in common? Three of them - Hong Kong, Singapore and Malta - are city-states or small islands rather than large countries. Their economies are not as diverse as countries with larger systems.

The authors argue: “There is simply too much at stake for the economic and political elites, and too few other interest groups lobbying for alternative uses of the banking system, to divert the society from a path that leads to stable and abundant credit”.

The three other countries on the list of the “very successful six”, Australia, Canada and New Zealand, share two features.

First, they were all part of the British Empire. Indeed, all six are former British colonies. Second, they are among the world’s most stable and long-lived democracies.

The authors then deploy a metric, known as the polity score, to measure the extent of democracy and autocracy in a given country.

From 1925-2010, Australia, Canada and New Zealand all scored the maximum, 100. The average polity score worldwide for the same period was 52.6.

The authors identify what they see as something else that Australia, Canada and New Zealand share. The structure and political histories of these three countries tended to mitigate the ability of populists and bankers to form coalitions that disadvantage everyone else.

Banking and politics

As the text above suggests, there is a rare pre-occupation about the role of politics for a book about banking. The authors put it bluntly: “Banking is all about politics and always has been”. In fact, the 570-page book is subtitled: “The Political

Origins of Banking Crises and Scarce Credit.”

Politics penetrates every nook and cranny of banking. This ubiquitous presence, banking’s universal consecutiveness, the relations with governments, business, the layers of conflicted interests, the shifting coalitions and its latter-day role as a sanctions broker are what makes banking so fragile, so unpredictable.

Reading the case studies of Calomiris and Haber leaves one with the realisation that the expression “safe as a bank” is actually ironic.

For instance, the Worlds Bank’s Financial Structure database shows that only 34 out of the 117 nations that make up the global banking system were crisis free from 1970 to 2010. 62 countries had one crisis, 19 had two crises.

The 19 countries included Chad, the Central African Republic, Cameroon, Kenya, Nigeria, the Philippines, and Thailand. Turkey, Bolivia, Ecuador, Brazil, Mexico, Colombia, Costa Rica, Chile, Uruguay, Spain, Sweden and…the United States.

How did the United States find itself in such bad company? Politics, in many different forms, is what did it.

The era of mega banks

In the early 1990s, state laws in the US encouraged the consolidation of existing banks leading to what became the emergence of mega banks.

The incentives to become a mega bank were many.

The advent of powerful IT platforms able to deliver potential economies of scale at low marginal cost was a powerful incentive.

In addition to making conventional banking more efficient, IT investment enabled mega banks to launch their own range of “products”.

The bailing out of the Continental Illinois bank in 1984 on the grounds that it threatened a financial contagion created a new category of “too big to fail” banks which, in effect, provided free insurance cover from the Federal Reserve.

To gain clearance for a US banking merger, it was also necessary to qualify under the “good citizenship” rules of the Community Reinvestment Act (CRA). This had been around since 1977 as a political inspired subsidy to borrowers who had been red-lined by the banks.

President Clinton boasted in a July 1999 speech: “CRA was pretty well moribund until we took office. Over 95 per cent of community investment … made in the 22 years of that law have been made in the six and a half years that I’ve been in office.”

Clinton embraced the idea of CRA commitments as part of his belief in the “third way” to promote the economic wellbeing of disadvantaged Americans without harming other individuals or business interests.

In order to rack up good citizenship points, merger-driven banks formed coalitions with urban activist groups. These coalitions committed more than US$850 billion in credit to be channeled through the activists.

In addition, the banks directly committed an additional US$3.6 trillion in CRA lending to under-served areas or low-income communities.

Bill Clinton’s “third way” may not have caused the sub-prime crisis, but it was a significant contributing factor. American banks, including Citibank, AIG, Merrill Lynch, Bear Stearns, Lehman Brothers, Wachovia, Washington Mutual, and

Countrywide Financial either failed or had to be rescued by the government.

Within a few years of the Riegle-Neal Interstate Banking and Branching Efficiency Act that knocked down the last barriers to interstate banking, the US banking system was consumed with merger mania.

JP Morgan Chase, for example, was created out of the merger of 37 banks, forming a mega bank with 220,000 employees and US$2 trillion in assets. Banking systems are political, complex and evolving by nature.

As the global crisis demonstrated, size can be as much vulnerability as a defensive asset. Commonwealth Bank’s Ian Narev may have donned the cloak of super-banker, but he will have to come up with more than saying “trust me

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Max Walsh


Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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