Banks may be asked to absorb more than their contractual share of the economic fallout of the Coronavirus

We have already seen signs that the Australian banks recognise that they need to absorb some of the fallout from the economic impact of the Coronavirus. This commentator writing out of the UK makes an interesting argument on how much extra cost banks and landlords should volunteer to absorb.

Richard Murphy on tax, accounting and political economy
— Read on www.taxresearch.org.uk/Blog/2020/03/04/banks-and-landlords-have-to-pick-up-the-costs-of-the-epidemic-to-come-if-the-the-economy-is-to-have-a-chance-of-surviving/

I am not saying banks should not do this but two themes to reflect on:

1) This can be seen as part of the price of rebuilding trust with the community

2) it reinforces the cyclicality of the risk that bank shareholders are required to absorb which then speaks to what is a fair “Through the Cycle” ROE for that risk

I have long struggled with the “banks are a simple utility ” argument and this reinforces my belief that you need a higher ROE to compensate for this risk

Tony

Author: From the Outside

After working in the Australian banking system for close to four decades, I am taking some time out to write and reflect on what I have learned. My primary area of expertise is bank capital management but this blog aims to offer a bank insider's outside perspective on banking, capital, economics, finance and risk.

2 thoughts on “Banks may be asked to absorb more than their contractual share of the economic fallout of the Coronavirus”

  1. Richard Murphy’s views are irresponsible. There is a rental contract between tenant and landlord. If the government can come in an alter that willy nilly or by extension of force majeure clauses it undermines the whole contract legal system and ultimately leads to a decrease in housing prices and an increase in rents as landlords will need to price for this risk that the government imposes “rent holidays” on them. It is also inconsistent with the treatment of mortgages as mortgage holders don’t get a “mortgage holiday” they simply get to capitalise payments. How the banks deal with this should be left to the banks. It is very costly both economically and reputation ally for banks to repossess homes. It is an absolute last resort for a bank, but every case is different. If the bank believes the home-owner can ultimately catch up on any arrears then of course they will exercise forbearance, but this needs to be balanced with the risk the mortgage holder will ultimately default and the bank will be left with a bigger loss than it would suffer through an early repossession. “Guidance” from the government seems the most appropriate step; looking to profit in anyway from people’s hardship or increase it will be looked upon in a very dim light and looking to be generous and understanding where they can will be looked upon favourably

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    1. Moray. Points all well made. I am very much with you on the importance of not rewriting contracts after the fact. Part of what I was reflecting on when I drafted the post was that the banks chose to translate the full effect of the RBA rate cut into a reduction in lending rates. Note I did not say “pass on” as I don’t see how banks can be profiting from not “passing on “ the rate cut if their Net Interest Margin is at best flat and more likely declining as it has over the past few years while banks refused to “pass on” rate cuts.

      My main points is that choosing to extend some forbearance, as we have already seen happen in response to the bushfires, is to some extent expected of the banks. This obviously creates more pain for bank shareholders but I raised the hope that maybe the cost might be defrayed somewhat by helping to rebuild trust. It also reinforces the point that bank shareholders are very exposed to the cyclical downturns that we have seen play out across economies over centuries and the return they receive should reflect that. Banks are often compared to utilities like power, water and telecommunications. The analogy has some substance in the sense that all the companies operating in these areas keep the wheels of the economy turning over. The exposure of a bank to these cyclical downturns is I think much higher than a true utility and that should be reflected in the “through the cycle” ROE that a bank targets.

      The odds of Australian landlords being expected to offer forbearance are I think about zero so I did not focus too much on that. The banks however are subject to a different set of expectations.

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