Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 55

Bank dominance causing a misallocation of capital

The macro and micro economic reforms of successive Australian governments over the past 30 years are widely acknowledged as having provided the foundations of our continuous economic growth. The structural changes occurring across the Australian economy and throughout the developed world driven by outsourcing and offshoring, technological improvements, the internet and emergence of China, India, etc. give a great imperative to the Financial Services Industry Inquiry (Inquiry) to make recommendations that will support Australia’s future economic growth.

The Inquiry’s terms include: “Recommendations will be made that foster an efficient, competitive and flexible financial system, consistent with financial stability, prudence, public confidence and capacity to meet the needs of users.”

What is the role of an ADI?

It is imperative that everyone has confidence in our financial institutions, particularly Approved Deposit-taking Institutions (ADIs/banks). ADIs are mobilisers and allocators of capital, and therefore enablers to sustainable economic growth. They provide a critical enabling function, just as other infrastructure companies do.

However, banks should not be producers of real economic growth in their own right.  Nevertheless of the top 30 companies listed on the ASX, ten are financial institutions. Combined they contribute approximately 27% to Earnings Before Income Tax (EBIT) of the index and CBA, Westpac, NAB and ANZ are ranked in the top 5 by market capitalisation. Arguably, in the long run the size of these metrics is not sustainable.

Comparatively, only 3 of the top 30 companies in a combined Dow/NASDAQ index in the United States are financial institutions (Bank of America, JP Morgan and American Express), ranking 14th, 19th and 30th respectively. They contribute 12% of EBIT.

In Australia, over the past 30 years, the Materials sector, including BHP and a wide range of commodity-related industries has declined, the Industrials sector has all but disappeared whilst the financial services sector has doubled its share of the economy.

The US economy shows a very different picture. In the 1980s, the largest American companies were in the Materials and Industrials sectors, and like Australia, these sectors are now significantly smaller. However, unlike Australia these sectors have not been replaced by financial services. The USA has produced global IT corporations, such as Microsoft, Apple, Oracle, Google, Yahoo, Amazon, Facebook, LinkedIn, Twitter and Cisco Systems and pharmaceutical and biotech companies like Merck, Gilead Sciences and Pfizer, that through innovation are helping to transform the US economy. Unfortunately, Australia has not followed suit as there is only one health technology company (CSL) and no information technology companies in our top 30.

Optimum size of financial services sector

In July 2012, the Bank for International Settlements (BIS) published a study on the banking systems of 22 countries over a 30 year period. Its findings were that if a financial services sector was either too small or too large in terms of share of Gross Domestic Product (GDP), then it was an inhibitor to economic growth.

More recently the US Bureau of Economic Analysis revised down the real output of the US financial services sector from 7% to 6.4%. A percentage of this figure reflects the fact that the USA is a global financial centre, so for Australia, which is at best a regional centre, the figure should be smaller.

These indicators point to Australia’s financial services sector being too large, and it must shrink or the economic pie must grow substantially to return it to equilibrium.

Prior to the GFC there was an implicit Federal government guarantee of the ADIs. With the GFC, the implicit guarantee became explicit. Even though the retail depositors’ guarantee has been reduced from $1,000,000 to $250,000 per depositor, in the mind of the public the Federal government will always step in to save an ADI. Moral hazard needs to be addressed by the Inquiry.

Misallocation of capital

Investment decisions are made for a variety of reasons using a range of quantitative tools and techniques.  A frequently used starting point when considering investments is to compare expected returns to the risk free rate of a Commonwealth Government Security (CGS).

However, if you had the choice between investing in bank shares compared to a CGS since the GFC on a risk/return basis, there has been a compelling case to choose shares:

  • both are effectively guaranteed which neutralises the equity risk premium
  • bank shares pay fully franked dividends that are tax-effective, but there is no equivalent tax relief on CGS income
  • there is a capital gains tax discount on equity investment price gains
  • the public has become accustomed to bank profits and return on risk adjusted capital increasing regardless of the economic environment while companies in other sectors produce mixed results.

So from a simple investment perspective, bank shares provide a substantially and arguably better ‘risk free’ return than government bonds. However, there are other factors that are significantly adding to the misallocation of capital:

  • a triangulation occurring as the largest fund management companies are owned by the major banks, and they are investing either directly in their own shares or other bank shares, or indirectly through ASX indices
  • compulsory superannuation is turbo charging the direct and indirect investment in bank shares as the major fund managers must invest the money
  • retail investors, including SMSFs, understand the returns they can achieve from owning bank stocks and are buying bank shares instead of bank term deposits.

This cycle is unhealthy and risky and the obsession with financial services is resulting in a misallocation of capital. The market can’t self-correct for this, hence a circuit breaker is required.

Current framework needs changing

The current financial framework needs changing. In formulating its recommendations, the Financial System Inquiry should consider outcomes that would further reduce systemic risk without creating unnecessary impediments to Australia’s economic growth.

Michael McAlary is Founder and Managing Director of WealthMaker Financial Services.


Leave a Comment:



Growth and the size of the financial sector


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates


The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.


RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.


4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.


Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.


Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.


Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.