Debunking the myth of our ‘well-regulated’ banks

Is a full enquiry into Australia’s banking industry overdue? source: shutterstock. Image sourced from

A Senate Economics Committee has been reflecting on life after the global financial crisis for Australian banks.

The general consensus has been to date that Australian banks escaped the worst of the fall-out due to strong oversight.

But it would be worth the Senate Committee’s time to go back to 2009 to re-consider a significant but under-reported tax avoidance case involving our largest banks, that prompts questions about tax avoidance and the role of our regulators.

In December of that year, the Big Four of Australian banking settled with the New Zealand Inland Revenue Department (IRD) after being found guilty of creating “tax avoidance arrangements entered into for a purpose of avoiding tax”.

The settlement was an eye-watering NZ$ 2.2 billion (A$1.7 billion), the largest legal settlement in Australian banking history to date.

Yet at the time it generated little interest in the Australian financial community. Perhaps this was due to the timing of the announcement - after the close of business, two days before Christmas.

The four banks issued almost identical one page media statements announcing the bare bones of their share of the “industry settlement”.

The New Zealand IRD also issued a press release, with NZ Revenue Minister, Peter Dunne, noting a lot of badly needed money (it was after all in the middle of the GFC) would flow into the local tax coffers.

Attention turned instead to the latest economic troubles affecting countries not lucky enough to be Australia.

But it is now a good time to revisit this issue: not as a cause of the GFC, but to put a lie to the claims that Australian bankers were somehow isolated from the dubious practices that sank banks around the world.

In fact they were not; as the judge in the tax case found, the local banks were just not very good at those practices and they were lucky to have a very accommodating banking regulator.

First, some history: when, in January 2004, National Australia Bank announced that the bank had lost $360 million in the now infamous “rogue trader” scandal, the Australian Prudential Regulation Authority (APRA) snapped into action, kicking off two independent inquiries.

By the time that the inquiries had reported their findings of risk management deficiencies throughout the bank, the CEO and chairman had resigned, the board had been reorganised, senior staff had retired or been sacked and proceedings were begun against the rogue traders.

It was APRA’s finest hour but, unfortunately, it may have proved a false, rather than a new, dawn for banking regulation in Australia.

Roll forward five years. As part of the IRD settlement, NAB announced a $500 million loss, much larger than the rogue trader loss. But where were the resignations, the apologies, the taking of responsibility for the fiasco?

And where were the independent inquiries initiated by the regulator? In fact, APRA has not, to this day issued a media release on the subject of the New Zealand Tax losses.

APRA could not have been caught off guard, as the proceedings in the New Zealand courts had been dragging on for several years and, sensing the game was up, the banks had already made provisions in their annual accounts.

Could it be that APRA is prepared to accept tax avoidance as a valid business strategy for the banks that it is tasked with supervising?

At this point, tax experts become very defensive about the difference between “tax avoidance”, which is “legal”, and “tax evasion”, which is not.

No one is suggesting that boards of the big four Australian banks have done anything illegal - but should they be engaged in activities that are so morally dubious?

Though legal, tax avoidance is reprehensible, especially in the case of banks that have been generously supported by taxpayers during bad times. Earlier this year, the UK Tax Authorities ordered Barclays and other UK banks to return 500 million pounds of tax avoided in “aggressive tax avoidance schemes”.

At the time, Barclays CEO, the now departed Bob Diamond, grudgingly accepted the censure and promised that the bank would become a “better citizen” in future. It is disheartening to see the cream of Australian directors being outshone on ethics by the Gordon Gecko of UK banking.

Most of the directors and executives of the Big Four banks were in place throughout the tax scandal, receiving remuneration in the early 2000s that was based on profits inflated by a much reduced Effective Tax Rates (ETR), but failing to resign, return bonuses or even apologise.

But if not shame, what about fear of regulators? APRA’s reputation is currently sky-high. Alan Kohler recently repeated what many believe: “basically, and to cut out the jargon, APRA is all over them [the banks] like a cheap suit, constantly issuing speeding tickets and forcing changed behaviour”.

But do the facts bear out this prevailing sentiment? A quick analysis of APRA’s media releases shows that of the 160 press statements since the beginning of 2008, only 16 relate to regulatory censure, or in regulator-speak “enforceable undertakings”.

The bulk of these slaps on the wrists relate to suspension or disqualification of directors in cases, such as the collapse of Trio Capital. Only one case resulted in criminal proceedings against an individual who was pretending to be a bank.

There were no fines, actions, threats of action or investigations against banks, small or large. This is despite the fact that, over the period, the largest banks were being publicly castigated for involvement in scandals such as Storm Financial and Opes Prime, and recurring failures of their IT systems. Recent revelations concerning APRA’s inability to sway banks over write-downs during the GFC cast some doubt on the real influence of the regulator.

Compare and contrast this low-key approach with the billions of dollars of fines being meted out by the US Securities and Exchange Commission (SEC) to banks, such as Citigroup, Barclays and Goldman Sachs.

The NZ Tax scandal would be worthy of not much more than a footnote in obscure textbooks and a few theses for doctoral candidates were it not for the fact that its resolution has wide and longer lasting implications.

Having been assured that the Australian and NZ governments will step in to bail them out in any future crisis, the failure of the regulator to act in this case shows that regulators will be loath to punish even blatant transgressions by the major banks, provided they act as a “herd”.

In banking, there is safety in numbers, if not for taxpayers and shareholders but, at least, for bankers. This is a form of moral hazard where the risks of wrongdoing are borne by the taxpayer and the rewards by the bankers. Furthermore, it is a form of moral hazard that is promoted by the actions and inaction of the banking regulator. Such moral hazard breeds hubris.

Immune from even a slight slap across the wrist, the leaders of the Australian banking industry have become impervious to criticism of their actions. For example, they have thumbed their collective noses at Treasurer Wayne Swan over the long-standing convention for keeping rises in home loan interest rates in line with RBA announcements.

Australian banks have similar “universal banking” models and similar balance sheets, with a number quite heavily exposed to housing sector debt.

In his inquiry into the collapse of the Irish banking system, the new head of the Central Bank of Ireland, Professor Patrick Honohan, bemoaned the fact that, in the run up to the GFC, there was a belief, held in common by banks and regulators, that the largest Irish banks were well regulated.

This collective myopia/groupthink constituted a form of “regulatory capture”, where the interests of the regulated and the regulators become, disastrously, aligned. A similar Pollyanna tendency is apparent in Australian banking circles.

Faced with the day-to-day consequences of the GFC, governments around the world are retooling their banking systems and changing the architecture of financial supervision.

The days when all banks were treated equally is long gone and recognising the dangers that some banks are Too Big To Fail (TBTF) new regulators and regulations have being created to focus specifically on the so-called Systemically Important Financial Institutions (SIFIs).

So far Australia has resisted even thinking about such changes to the local system.

Are Australian banks somehow more ethical than others? Maybe, but then again, as the NZ Tax scandal shows, maybe not. Are Australian regulators more effective than others? Again maybe, but they are remarkably low-key, with little evidence that they are improving banks’ behaviours.

The lack of action relies on two key assumptions: first that Australian banks will always behave themselves and secondly that regulators will punish them if they don’t.

In the light of evidence given to the Senate Committee and the events described here both of these assumptions are debatable. A full inquiry into banking in Australia is overdue and even if it only produced the conclusion that we do after all “live in the best of all possible worlds”, taxpayers, investors, governments, regulators, rating agencies and not least banks themselves would sleep much easier at night.