Investments, Regulation

High price we all pay for questionable practices

The royal commission into misconduct in banking and financial services is the judicial inquiry we had to have. Everyone agrees, even the coalition government that fought tooth and nail to prevent it. Today there isn’t a politician in the land who’s not lauding what the inquiry has unveiled.

There’s no doubt it’s been a cathartic exercise, especially for the many victims of the banks’ and other financial institutions’ malevolent behaviour. Even if they haven’t had their Andy Warhol moment at the hearings, no doubt they have enjoyed watching senior executives squirming on the stand. Royal commission counsel have been forensic in exposing atrocious corporate cultures that have seen clients fall victim to overcharging and poor and often conflicted advice, as well as regulators often being misled. Criminal charges could follow.

That’s the upside. But there is a downside; a tangible real cost to holding this royal commission. And, ironically, it’s likely many of those paying the price are those very same victims of these financial institutions’ excesses, as well as all Australians and the wider economy.

It’s my contention the revelations from this inquiry have probably been one of the main contributors to the fall in the Australian share market over the past month. While acknowledging there has been a global sell-off driven by technology stocks and now being fuelled by energy companies that has influenced investor sentiment, in relation to the ASX 200, it’s been the selling of the index’s heavily weighted banks and financial services companies that has dragged the market down.

No doubt many of the victims hold these stocks, especially SMSF trustees with their penchant for shares offering fully franked dividends.

But of greater concern is the credit squeeze now gripping the Australian economy as banks have reacted to the intense scrutiny they are under by tightening credit. It is worrying not only to the housing market, although that’s getting the lion’s share of the media attention, but also to businesses (especially small to medium-sized enterprises) and property developers.

Loans that were readily signed off are now getting the third degree. Overseas, credit margins are widening, especially those associated with junk bonds, which is going to make it just that much harder for business and banks to borrow offshore as well.

The most obvious impact of this credit squeeze is weaker housing prices. And when housing prices fall, people simply don’t feel as wealthy as they do when they are rising, irrespective of whether they are sellers or not. The result? They reduce their spending and investing activities.

The first casualty is often retail sales, but it also affects people’s appetite to take risk and invest. This reduced appetite for risk has amplified the sell-off in the small-cap sector of the Australian market.

Obviously, the banks’ share prices are also victims of this credit squeeze. Analysts are rightly asking if they are not lending money at the same rate as they were a year ago, where will their earnings growth come from and will this flow through to smaller dividend cheques, another potential cost to investors.

Add the uncertainty surrounding possible legal action arising from the royal commission, increased compliance costs and a falling house market, and it’s no surprise local bank shares are being sold off.

Since the beginning of this year, NAB and Westpac are both down around 18 per cent, Commonwealth Bank of Australia has lost 12 per cent of its market value, with the ANZ being the ‘best performer’, down only 10 per cent. The biggest loser is AMP, having more than halved its value with a 53 per cent loss.

Not even the fact the employment market is healthy will do much to dampen this negative sentiment as it has gone hand in glove with slow wages growth, leaving aside the increase in the minimum wage, so even if there were no credit squeeze, there is no great appetite for more debt, whether it be for consumer spending or investment.

Unfortunately, lowering interest rates is not an appropriate option, and even if they were lowered, their stimulatory effect would in all likelihood be negligible. Certainly, at the current level, rates are no disincentive to borrow.

No doubt Justice Hayne’s final report, due early next year, will contain a sea of recommendations. That is what royal commissions do, despite the fact there is no shortage of evidence to suggest the biggest issue enabling these abuses to occur was the failure to enforce current laws – not their absence.

And with an election due in May, all political parties will be falling over themselves to appear more gung-ho than their rivals on implementing any recommendations. While that may produce better consumer outcomes in the long term, in the short term we are all going to pay a real cost as many people find credit that much harder to get.

George Lucas is managing director at Raiz Invest.

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