In a conversation with a few friends a couple of weeks ago – and while we were all expressing collective dismay at the current state of banking in Australia and globally (as you do when the sticky wine is being served ahead of the cheese platter) – the topic turned to alternatives and substitutes to current banks.
The problem, as we saw it, was that the lack of access to capital for many businesses was having a direct impact on economic growth.
In my role, I see the evidence of this all too often. In fact, my partner, Nick, reckons that only one in fifty potential commercial borrowers (without real estate as security) that come to us will get approved by banks. The other forty-nine are either taken to private lenders or told immediately that they will not qualify for finance of any kind.
Most have already done the rounds of the banks and been rejected more than once so they’re quite prepared for the message that we deliver. These days we can easily identify what is a bank deal and what is a private deal. The problem as we see it is that banks are beginning to lose the ability to assess a transaction based solely on cash flow. Whilst all banks say they do not rely on security, the lack of security (usually in the form of real estate or cash) will typically mean that the transaction is rejected. Regardless of how good the company’s cash flow is.
Back to my conversation with friends – we discussed new foreign players and fintechs as well as private lenders. The area of most interest though was an idea from over 80 years ago. That of State Banks. I can hear the moans and groans of former colleagues already. Didn’t we already try this? Didn’t they all end badly? The answers are yes and yes but let’s chase this elusive rabbit down the warren a little further.
For those of you too young to remember, we once had several banks owned by State Governments around the country. In no particular order they were/are: State Bank of NSW State Bank of Victoria State Bank of SA BankWest All but one of the above institutions is now owned by the Commonwealth Bank, itself once owned by the Federal Government. The other is owned by Westpac. Only a single brand, Bankwest (which operates on the same banking licence as CBA), has survived.
In this article, I’ll focus on the State Bank of NSW or as it was previously known, The Rural Bank. It’s important – for the sake of argument – to understand why these banks came about. The Rural Bank was formed in 1933 in the height of the Great Depression. Australia had mindlessly followed the UK and had all its eggs in the one British basket. We borrowed from the UK banks almost exclusively. That tap was switched off in 1931 as the UK banks became increasingly nervous about Australian banks’ ability to repay outstanding debts.
To add insult to injury the former head of the Bank of England (Sir Otto Niemeyer) had come to Australia to lecture us about needing to tighten our already asphyxiating belts. So State and Federal Governments (on the advice of Sir Otto) came up with the Premier’s Plan. The Plan stipulated that Australian Federal and State governments cut spending by 20%. Obviously, the bulk of this saving came from cuts to wages and pensions.
The plan also included tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans. Greece anyone? Overlay this with Australia’s dogged adherence to the gold standard and it meant we pretty much had a fixed currency (pegged to the British Pound) and thus no room to move. That meant we had to borrow (when no one was lending) to maintain our currency’s peg with the Pound. Again, Greece…?
The economic result was disastrous for Australia. Our economy was rural focused and the crash in agricultural commodity prices meant that we weren’t able to sell our wool – our main source of revenue at the time. Due to their inability to get funding, Australian banks were tightening their belts and not lending at the same time that state and federal governments were slavishly adhering to the advice of the aforementioned Sir Otto and cutting expenditure. It was an economic disaster. By the time Governments realised they were adding to the economic malaise, the damage had been done.
Enter the State Governments. The NSW Government quickly established – and more importantly guaranteed – a funding vehicle for farmers who had been locked out of traditional bank borrowing as banks had stopped lending (due to their inability to access funding). They called it the Rural Bank. After World War II, the Rural Bank’s scope was expanded to financing the needs of a wider market which included returned war veterans and after a while mortgages became the Bank’s main profit source.
This will sound familiar to those of you that remember the more recent GFC and banks reactions to it. As has been stated above, large swathes of the economy are excluded from borrowing via traditional means and have turned to privateers. Sadly, our governments today (of any political persuasion) are so driven by ideology it’s as if they would be struck down if they even explored what had previously worked so well. In short, the banking system of the 1930’s was not doing what it was meant to do and so required government intervention. We are at that point again now and probably have been for the past six years.
Now overlay the above with what is forecast to take place in employment markets. Most of you will have read that – due to technological advances and cheaper labour elsewhere – a very large proportion of you will probably not have a job in the near or distant future – a phenomenon that is probably already underway. If that’s the case, most will turn to self-employment.
Now, some of you may have read previous articles about the local banks switching off the tap to small business. That situation will not change because of the current global regulatory framework that penalises banks for lending unsecured to borrowers. Again, what is required is Government intervention that seeks to fill the void left by the banks (as was the case in 1933). It doesn’t have to be run by Governments. In-fact it can be partly funded or seeded by Government. As long as it has the right criteria to lend to those segments abandoned by traditional banks and carries a Government guarantee, then I would consider it mission accomplished.
It may even manifest itself as tax incentives to large super funds with Government capital and using superannuation funds as the institutions liabilities (this is already being done in a limited capacity at institutional levels but not in the SME and commercial sector). It doesn’t even have to be called a bank. Put another way, the job of banks is to ensure the lifeblood of business (capital) is made available. When banks stop providing said capital, surely governments need to step in and replace what is not being provided by private enterprise.
This has been the cornerstone of modern economic theory since Keynes rubbished Sir Otto’s approach on austerity during the Depression. With regards to regulatory oversight, it would need to be regulated by APRA but with the view that this institution would be established to lend to segments that APRA’s own regulatory framework is designed to exclude. Obviously, some careful thought needs to go into how this compliance would work. As this once cottage industry (compliance) now dominates global banking I’m sure people far more qualified than I in this field will have a view.
Yes, it will run higher losses but it will also be able to access cheaper funding and charge more for riskier lending. More importantly it will provide adequate capital for those that are being denied it. It may just be what is required to move our economy forward and start growing it at a decent clip. It will generate employment as small businesses would be able to access funds to enable growth. Lastly, as the current regulatory regime catches up with the needs of the population and traditional banks start to compete, the institution can be sold off. Its job would have been done by then.
Many will bemoan the fact that Governments involvement in this sector ended disastrously. Yes, it did (very high bad debts and lending of dubious quality) but it provided six decades of funding to a sector that needed it before it was sold off. Further, there was a major bank that also required bailing out in the early 1990’s. So, it wasn’t just the state banks that made bad decisions.