Posts Tagged ‘deleveraging’

Deleveraging in the Australian economy bites

Sunday, March 6th, 2011

If you read the newspaper headlines and billboard advertisements recently, you may notice something interesting (if not, strange) happening. National Australia Bank (NAB) announced that it is ‘breaking up’ with the rest of the banks in a new campaign. That immediately provoked reactions from the other banks, including Suncorp with its “breaking up” theme in a recent billboard advertisement.

Soon, bank investors are fretting about a price war among the banks, which means the race is on to the bottom for profits. As this news article reported,

Investors are becoming nervous about the prospect of a price war breaking out between the banks, with one major brokerage labelling the attacks a ?negative sum game?.

What on earth is happening?

Only as recently as four months, politicians were aiming their gun sights on the banks for ‘lack’ of competition, when Commonwealth Bank (CBA) initiated a rise in their mortgage rates that was almost twice the rate rise of the Reserve Bank (RBA). There were talk about building a “fifth pillar” in the banking system. Today, the banks seem to be starting a price war among themselves, in a race to the bottom.

Well, the reason is dead simple. To put it simply, banks are in the business of lending money. That’s their core business. As we wrote before in The dark side of rising bank profits,

One way to make more money is to increase lending.

Banks, as publicly listed companies in the stock exchange, are always under pressure to increase their profits year after year (i.e. seek growth). Heavens forbid that their profits ever fall! All hell breaks lose if that ever happens!

But there’s one big problem for them today- the savings rate of Australians have shot up to 10%, which is the highest since the early 1990s! That means that Australians are saving more money and repaying their debts. In other words, the Australian economy is now undergoing a deleveraging process. Consequently, it is becoming harder for the banks to make more money by lending more money. A very crude (and thus, inaccurate) analogy would be to compare the banks to dogs fighting among each other for a shrinking pie. As that article reported,

The infighting is an indirect result of the sluggish credit market, with banks under pressure to find growth, the report said.

What does this mean for the Australian economy?

As we explained in detail in Significant slowdown for Australia ahead?, deleveraging sucks away the aggregate demand from the economy. The first to get hit will be the retail sector that is related to discreditionary spending. The structural shift of Australian consumers from shopping in retail stores to shopping in the Internet is a symptom of deleveraging.

Given that the retail sector accounts for approximately 60% of the economy, continuation of this structural shift in consumer behaviour imply that more pain is in store for the retail sector.