Earlier this week, Westpac publicised some estimates of the costs to shareholders before implying that the estimate was probably a worst case scenario as it might also pass the levy through to its customers. The AFR reported Westpac’s announcement as follows –
Westpac is the first of those banks to release figures on how the levy will affect its profit.
According to the bank’s preliminary estimates, the levy would affect around $615 billion of its liabilities, and will negatively impact its 2017 full year results (for the year ended 30 September 2017).
The bank forecast that it would incur a “new cost” of $65 million after tax for its second half results.
That represents a cost of approximately $370 million (or $260 million after tax) per year.
Westpac stated this equates to around 8 cents per share in the first full year of the levy, and 4.3 per cent of dividends paid – based on its full-year dividends of 188 cents per share in 2016.
“The exact cost will depend on the final form of the new legislation passed and the composition of Westpac’s liabilities,” the bank noted in its statement to the ASX.
Westpac also affirmed it may pass on the levy to its customers, shareholders, suppliers, staff “or some combination of all four”.
The problem with the Westpac analysis ($260 million after tax) is that it assumed that it would fully be passed on to shareholders. Clearly it will not be and Westpac stated this explicitly.
In its response to the levy, NAB was a little blunter as it confirmed that the levy will be levied on everyone –
“The levy is not just on banks, it is a tax on every Australian who benefits from, and is part of, the banking industry. This includes NAB’s 10 million customers, 570,000 direct NAB shareholders, those who own NAB shares through their superannuation, our 1,700 suppliers and NAB’s 34,000 employees. The levy cannot be absorbed; it will be borne by these people.”
So despite the collective claims by the banks that upwards of $1 billion will be cut from their after tax profits (per annum), it is clear that this will not be case. If shareholders or investors are confused, or customers are worried, then the Government has a solution. The ACCC will be directed to undertake an inquiry into residential mortgage pricing. While the ACCC can require banks to explain changes to mortgage pricing and fees, they are not empowered to do anything about it. Does that sound like unenforceable red tape?
Arguably, statements to the market regarding profit adjustments or forecasts fall under the jurisdiction of ASIC. The government has directed the wrong authority to review the banks’ profit forecasts, which is clearly affected by who ultimately pays the levy.

AAA Budget Repair Levy

The day before Standard & Poor’s downgraded Australia’s second tier banks, the Prime Minister stated that the levy was necessary to bring the budget back in to balance and maintain the nation’s triple-A credit rating.
The irony is that in maintaining the Government’s credit rating via a levy (budget repair) on the major banks, the Government has indirectly caused a downgrade of the smaller second tier banks. The reason is that the levy is also partly justified by the Commonwealth Government’s implicit guarantee of the major banks that pay the levy. Therefore, the second tier banks (who aren’t levied) don’t have the implicit guarantee and are not sheltered by the AAA rating.
Thus last week’s claim that the levy on the banks evens up the playing field between large and smaller banks falls over this week as S&P pushes up the cost of funds for second tier banks!
It is our view that the desired outcomes of the bank levy have been lost in the political rhetoric. The levy can be justified as a plank to ensure the financial security of Australia’s future. However, the policy appears to have been haphazardly created and was rushed through without clear analysis of either its consequences or benefits.
The bank levy presents as a rerun of the mining tax debacle that was introduced by Kevin Rudd, mangled by Julia Gillard and left to die by subsequent governments. Back in 2012, the noble intention to claim a rent tax on the profitable utilisation of Australian land for resource extraction was lost in the murky swamp of Machiavellian politics.
The bank levy clearly should be designed to support the sustainability of Australia’s financial system. Profitable and well-capitalised banks are highly desirable, and they should pay for the implicit support of government and therefore of the taxpayers of Australia. If this levy is excessive and stabilises the budget, then we have a future choice: abandon it or put it into a sovereign wealth fund.
The sustainability of Australia’s finances and the funding of our liabilities (including unfunded pensions) should be compared to the responses and policies of a range of countries presented below. Many resource-rich countries have built large sovereign wealth funds that ensure the government is funded and financial systems are well underwritten and controlled.
Australia’s sovereign wealth fund (the Future Fund) was solely designed to service public servant pensions to be funded from consolidated revenue and accumulated for 20 years. Our Future Fund is not a sovereign wealth fund and it is so under-funded that it has no scope to support Australia’s financial system. The proposed bank levy is a result of decades of poor taxation policy.

In the following section, we review bank funding and the concerns by S&P for Australia’s excessive household debt and inflated residential property market. However, our closing thoughts on the bank levy are captured in this question – Why is it structured in such a complicated fashion?
Australian banks (including second tier banks) currently pay about $17 billion in income tax per annum. The Government proposes or seeks a further $1.6 billion per annum in taxation payments by the banks. Therefore it need only have put a 33% tax rate on bank pre-tax earnings. The surcharge of 3% on the taxation rate is no different to a Medicare tax levy or a budget repair levy imposed on PAYG taxpayers. Such a tax, on all banks, to secure a government guarantee on deposits seems a reasonable tax that does not hit depositors or borrowers. In our view, all banks should be levied to ensure that all are viable and competition is strong.
While many may claim such a tax is excessive or unfair, the truth of the matter is that the Australian banking sector is an excessively large part of the Australian economy. This size is both a benefit and a risk for Australians. And as S&P noted – so too is the level of household debt and the growing foreign debt (created by our banks).
We should never have allowed household debt levels to balloon, but now it is too late to do anything other than ensure that we can withstand the next economic downturn. Unfortunately, a bank tax or levy is one of the few options we are left with.
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Some charts to contemplate

Australia has four large commercial banks and each is independently too big to fail. These banks represent four of the ten largest ASX-listed companies and they are intricately imbedded in the investments and assets of superannuation funds  across the economy. This position includes exposures through direct equity, term deposits, loans and hybrid securities. The large banks are the backbone of the economy but they have grown faster than the economy since the GFC.
The first chart shows their massive loan growth which has compounded relentlessly since the recession of 1992/93. The banks are the financial intermediaries that raise funds and on-lend these funds to borrowers. As the chart discloses, the bank loan books have exploded and driven indebtedness in the household sector – most notably through investment loans against property.

After the shock of the GFC, the banks refocused their funding back towards retail deposits. Readers will recall that the biggest threat to Australia’s financial stability during the GFC was the liquidity crisis in international wholesale funding markets.
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A requirement of bank regulators across the world has been to direct banks to bolster their Tier 1 capital. Australian banks have responded, but in doing so they have drawn more capital from the major superannuation funds and magnified their weightings in the Australian share market index.
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Our final chart gets to the nub of the problem: the growth in Australia’s net foreign debt (today over $1 trillion) is approximately 80% drawn by Australian banks.
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While the slowing in bank foreign funding since 2014 is clear, it is evident that Australian banks have pushed foreign indebtedness too high. In doing so, the banks have directed their foreign-sourced funding into speculative property bubbles in parts of Sydney and Melbourne. This foreign debt has exposed Australia to severe consequences if there is a world-wide recession. That is exactly what S&P have focused upon in downgrading our second tier banks. The bank levy is a painful reminder of the consequences of sustained poor economic management.
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