Poor pricing and high costs at centre of banking problem
The inability of banks to turn housing finance into a genuine commodity product offered at a progressively lower cost is a key theme of a new analysis of the Australian banking industry by the Whitlam Institute.
Banks' reluctance to properly price their loans for credit risk is a related theme of the analysis - and one intended to chime with Treasury's and financial regulators' keen interest in policy options for banking.
Nick Gruen, a former adviser to a Labor treasurer and also once a member of the Productivity Commission, wrote the policy paper for the institute, published this week. Gruen is also principal of loan broker Peach Financial as well as the consultancy Lateral Economics.
The policy proposals in Gruen's paper are summarised in the following two articles.
What's of interest first up, though, is the paper's focus on aspects of the debate that are too little discussed, such as the stubbornly high cost structures in banking.
The reform approach is also outlined. This calls for a series of microeconomic reforms that "holds out the promise of simultaneously delivering greater financial security and substantially increased competition" to quote the introduction by the director of the Whitlam Institute, Eric Sidoti.
The paper's core object is to frame the discussion about banking in Australia in the context of its productivity.
"It does not propose a new regulatory regime arising from a comprehensive view of finance," Gruen writes.
"Instead we go looking for hundred dollar bills on the pavement: that is, areas of inefficiency whose source can be easily seen in both theory and empirically, and which can be improved by the application of simple principles and procedures of microeconomic reform."
Gruen concedes that in the home loan sector in Australia - a credit market of A$1.1 trillion and comprising 58 per cent of all loans produced by the financial system - there is no doubt that the product is "commoditised".
In housing finance, Gruen writes, "the essential financial aspects of the vast bulk of activity do not differ between competitors … notwithstanding attempts at product differentiation between competitors.
"Often commoditisation is reinforced by regulation which itself reinforces existing industry practices and makes it difficult if not impossible for competitors to vary basic routines."
However, home loans lack an essential feature of many commoditised products: a trend to lower prices.
"In contrast to an industry like IT, where a service being 'commoditised' leads to dramatic price falls, in finance this has not happened," Gruen writes.
The pricing practices of banks on home lending interest Gruen, including the lack of risk margins in the interest rate for different categories of borrower and different degrees of buffer in the loan to valuation ratio.
"Surprisingly, and presumably inefficiently, credit risk on prime loans both below and above the 80 per cent loan to valuation ratio is not priced by the banks, though such pricing occurs above 80 per cent by virtue of [mortgage insurance] premiums rising with LVR."