Few subjects in the public debate are more emotive than banking. Bankers’ actions, pay and profits have been ferociously dissected in the wake of the Global Financial Crisis (GFC). In Australia, we were fortunate that our banking system and broader economy survived the crisis in good health. But banks’ behaviour here continues to attract scrutiny.
This report examines our banking debate through the prism of market design. It analyses the major faultlines, identifies enduring market failures and proposes a policy response. There are three main points of tension: 1) whether the banks should follow the Reserve Bank of Australia (RBA) in setting interest rates; 2) whether rising funding costs have necessitated the banks' rate increases; and 3) whether banks are too profitable relative to the risk they face.
On the first two points, the report finds in favour of the banks – they are rightly the arbiters of their own rate settings, and rising funding costs have indeed led banks to raise rates. On the third point, we find that the Big Four banks are more profitable than the risk attached to their equity would justify, thanks to implicit insurance provided by the state and a market structure which makes their operations more capital intensive than necessary.