Australian banks must be careful not to cause a new crisis: Gottliebsen

Directors of Australian banks will need to make some hard decisions given what is happening to their counterparts in Europe. If our banks make the correct decisions, the events in Europe will not cause an Australian banking crisis although they will still cause some pain.

If the Australian bankers make the wrong decisions, then we will have a credit squeeze and dangerous asset price fall. Or putting it another way, Australian bank chief executives are about to really earn their money and if they fail, they will be put on the scrapheap.

First let’s look at what is happening in Europe.

I wonder how the directors of the big European banks sleep at night. They know that they are concealing from their shareholders and the community the fact that they have lost their capital (and much more) punting on high interest rate government debt. They know that the European recession will hit their loans around Europe, although in that case they were prudent and spread their risk.

It seems the European bankers have put the whole thing in the too hard basket and hope governments will bail them out. But bailout or no bailout, the bankers will have to raise huge amounts of capital to cover their losses or fail. Many will simply fail but local depositors may be protected.

The European situation is a reminder that bankers are capable of making very bad decisions and this was underlined this week when the chief executive and co-chief investment officer of Pimco, Mohamed El-Erian, writing in the FT, pointed out, “a growing number of European banks are now either materially or wholly dependent on the European Central Bank and related facilities to survive. The situation is particularly acute for those banks that previously relied on wholesale funding, (my emphasis) which has essentially disappeared, and those suffering deposit outflows, which are accelerating in very troubled countries such as Greece.”

It is clear the European banks not only desperately need much more capital, but will need extra help as well.

Until yesterday, Australian banks could still access the same wholesale funding markets although the lenders wanted much higher interest rates. But outgoing Commonwealth Bank chief executive Ralph Norris told Fairfax media that as of today, those wholesale markets had been frozen for all banks, including Australian banks. This may change, but it is very dangerous.

The problem our banks face is that they will be tempted to respond by making the criteria for making loans to Australian customers much tougher and so adjusting bank balance sheets to reflect the conditions.

If they do that, then Australian banks will reduce asset prices and lift their bad debts. If Australian bank bad debts rise then wholesale money will be even harder to obtain and even more expensive. It will be a vicious circle.

In home lending consumers have borrowed too much and are very sensitive to cost. Reserve Bank official interest rates must fall. In the business arena the cost is usually less important than the availability. It is very important at this time that Australian banks keep funding the business community. If they turn down the money tap at a time when some European banks are taking action to close down their Australian loan book, we will have a major problem.

This article first appeared on Business Spectator.