Breaking the Banks: What went wrong with Australian banking? by Joseph Healy

1
THE BANKING SYSTEM
THIS chapter is intended to give the reader a general overview of the
nature of the banking market in Australia (which mirrors what is
largely true of New Zealand). It is not a detailed commentary, but it is a
broadly accurate picture on the shape of the market and its key drivers. In
painting the picture, the reader is reminded that a core role of a well-

functioning banking system is the efficient allocation of capital across the
economy. It is a legitimate public policy matter as different categories of
capital (e.g. lending to real estate versus SMEs) can perform different
economic functions. It is not simply a question of how much lending banks
do but what type of lending and what sectors that lending is allocated to.
Unlike the banking system in the UK or the US, the Australian banks are
largely domestic in nature, if you include New Zealand in that definition.
Equally, unlike the UK and the US, the Australian financial system is bank
dominated, with a surprising shallow fixed income market given the size of
the $2 trillion superannuation industry – Australia’s pension fund allocation
to fixed income is at 10 per cent, which is low compared to other
Organisation for Economic Co-operation and Development (OECD)
countries and the OECD average of 40 per cent. So, in Australia and in
New Zealand banks matter more in the financial system than they do in the
UK and the US. Therefore, they should play a true leadership role in
ensuring the financial system supports the real, or nonfinancial, economy.
This is a reasonable societal expectation given the privileges bestowed on
banks.
I am defining the Australian banking market in terms of customers, with
a simple split into retail or personal banking (private banking, personal
customers and very small businesses, such as the butcher, the baker and the
candlestick maker) and business banking. Retail banking can then be most
conveniently segmented by product and covers household mortgages,
current and term deposit accounts and unsecured personal lending, most
notably credit cards. Business banking on the other hand, is typically
segmented by size into SME (businesses with a turnover of up to $50
million per annum), Corporate (businesses with a turnover of up to $250
million per annum) and Institutional (the rest). Of course, businesses of all
sizes can also then be segmented by industry such as property, retail,
agriculture and financial institutions.
The emphasis in this chapter is on the lending role of banks and not on
deposits and other important services. Before getting into the chapter a
warning and an apology is warranted regarding the use of some jargon,
which may at times feel overly technical and occasionally theoretical. Some
readers may appreciate this, while others may not. For completeness, some
of the technical commentary is necessary and will help those who wish to
understand cause and effect. Those who prefer to skip the technical
commentary will not be disadvantaged.
FOUR STRUCTURAL DEVELOPMENTS
In understanding the dynamics of the Australian banking industry, there
have been four structural developments, which became apparent early in the
twenty-first century and which both define the industry and have had
material economic consequences. The first development, driven by Basel II
and the favourable risk weightings on mortgage lending (which is explained
below), resulted in a significant shift to household mortgage lending, away
from business lending. The second development was the diminution in
competition caused by a consolidation of the banks through M&A resulting
in the four major banks – the so-called four pillars – controlling
approximately 80 per cent of the market (with market share varying by
product but broadly in this range, see Table 3).
TABLE 3: BANK MARKET SHARE

Breaking the Banks: What went wrong with Australian banking? by Joseph Healy