OECD: Banks ‘Sucking’ Growth Out Of Economies

A new OECD report has found a link between bank lending and economic growth. The report claims that the expansion of credit has contributed to lower GDP growth among developed economies.

The analysis documents a link from financial deregulation to credit expansion and slower growth.

‘ [Lending has developed] to the point where further expansion is at the margin associated with slower long-term economic growth’.

Bank lending does boost economies up to a certain point. But once the value of bank loans exceeds 60% of GDP, the effect reverses. After that, lending only serves to hurt long term growth according to the OECD.

They provide compelling evidence to support these claims. Take, for instance, what happens when lending increases from 100% of GDP to 110%. Their findings show this change resulted in a 0.25% reduction in GDP growth.

The problem for Aussie banks is that they’ve exceeded that margin by some length. Australia’s credit to GDP ratio, to put all this in context, is at a staggering 140%. That comes according to the Reserve Bank’s own internal figures. And it shows the extent to which lending is stunting economic growth in Australia.

As the report highlights, it could be costing the nation up to a third of a percentage point of economic growth.

If banks were lending more money to businesses, this might not be such a big problem. Instead, the banking sector remains reliant on credit expansion resulting from home loans. ‘The data shows that households’ borrowing has a negative marginal link with growth that is twice as large as firms’, the report said.

That’s why the OECD wants to see new regulations limiting home loan lending. In that respect, they’re no different to what prudential regulator APRA has tried to do already. They’ve also been warning banks to curb their lending, particularly to investors. The early signs are mixed. Investor lending is slowing, but it’s still growing.

The OECD’s recommendations to fix the banking sector

The OECD made several suggestions to limit the impact lenders have on economic growth across developed economies.

The first of these is to exempt lending institutions from government subsidies or assurances. This would remove the so called ‘too big to fail’ guarantee. And it would force banks with unfixable balance sheets to go bust.

This perhaps isn’t as relevant to Australia. None of our major banks are at risk of this in the near future. At the same time, it’s something that should apply to Aussie banks given the circumstances. Right now it’s hard to imagine a major bank being allowed to fail in a similar manner to Lehmann Brothers.

How does the OECD propose this could play out? ‘One way of ending too-big-to-fail would be to break up financial institutions into sufficiently smaller entities’, the report said.

This would reduce some of the risks associated with big banks. Breaking them up into smaller operations would diversify lending practices. But it may prove difficult to realise as it would be met with resistance by the banks.

Secondly, the OECD would like to discourage any policies which lead banks to prefer lending to households over businesses. This makes sense considering business spending is key to driving new economic growth. This particular recommendation is relevant to Australia’s current circumstances.

Lending to owner-occupiers and investors has kept rising, despite APRA’s warnings. Banks are, rightly or wrongly, taking advantage of pent up demand for housing loans. But it’s easy to see why the OECD has every right to raise concerns with this.

Australian banks use their own models and stress tests to gauge borrowers’ potential risk of default. That means that banks can set aside what money they’ll need to cover any potential home loan defaults. In doing this, banks have given themselves free license to sell attractive loans to borrowers. As a result, their self-imposed discounts have drastically boosted profitability on home loans compared to other types of loans.

Finally, the OECD wants the goods and service tax extended to deposits and loans. That would probably restrain excessive lending to home loan borrowers. The OECD hopes this could spur banks to increase lending to businesses over households.

But it may all end up in vain, as Australia’s housing demand shows no signs of slowing. What deters banks from expanding credit lending to home loan borrowers? Right now, there’s very little. Businesses are giving banks no reason to divert capital their way.

We should remember that business spending is set to tank over the next year. It could plummet by as much as $100 billion in the 2015–16 financial year. Even if banks wanted to supply capital to businesses, actual demand will be weak.

So where does all this leave us?

If recent history is anything to go by, their pleas will fall on deaf ears. The banking sector plays by its own unique set of rules. Nothing changed after 2008, so why would anyone expect it to be any different now?

Markets and Money’s Greg Canavan would say OECD’s findings are another sign of the coming recession. As one of Australia’s leading analysts, Greg worries about our economic future. He believes Australia’s already weak GDP growth will drop further over the next three quarters.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why we face a recession in 2015. He’ll show you why our debt levels are so out of control. And he’ll prove to you why the RBA realise the recession is coming.

Download your copy today and Greg will show you what you can do to protect your wealth from the fallout of the recession. To find out how to download his free report right now, click here.

Mat Spasic,

Contributor, Markets and Money

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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