Christopher Joye had an op-ed in the AFR today talking about the recent IMF Financial System Stability Assessment for Australia. This bit caught my attention:
The IMF’s anxieties derive from the fact that Australia’s banking system has become “one of the most concentrated in the world”. The four majors “hold 80 per cent of banking assets and 88 per cent of residential mortgages”. They are “highly interconnected, as they are among each other’s largest counterparties”. This means that “their expected default frequencies are [also] highly correlated”.
The IMF’s findings contradict the Martin Place meme that there is an adverse trade-off between financial stability and banking competition. Indeed, it suggests, as I have, that Australia’s financial system would be safer with a larger number of smaller institutions.
So I hunted down the actual document – which is somewhat more muted that Chris Joye’s account. The IMF says:
The major banks are highly interconnected, as they are among each other’s largest counterparties, and their expected default frequencies (EDFs) from Moody’s KMV are highly correlated.
I’m not sure what the Moody KMV method is, but my interpretation of what the IMF are saying is that if one of the Big Four experienced a significant enough negative shock so as to cause financial distress some or all of the other Big Four would also experience financial distress. Yes – that doesn’t surprise me. Now the probability of such a large negative shock is not zero, nor should it be, but I can’t imagine it is large either.
I am not convinced that the IMF suggests “Australia’s financial system would be safer with a larger number of smaller institutions” or if they did that they are correct. In a 2006 analysis of sixty-nine economies over the period 1980 – 1997 (including Australia) Thorsten Beck, Asli Demirguc-Kunt and Ross Levine find that greater bank concentration is associated with a lower probability of a banking crisis. While James Barth, Gerard Caprio, and Ross Levine report restrictions on banking activities are associated with higher probabilities of banking crises and lower levels of efficiency.