Bank “Junk Food” credit, macroprudential and the Australian Banking Royal Commission

With all the excitement surrounding the announcement of a Royal Commission into Australian banks, a few have asked whether there are less drastic options than those recommended by the Glass Pyramid in the article “Real reform starts with a Banking Royal Commission”

One option that is often raised is that the Australian Prudential Regulatory Authority “APRA” could make more use of a regulatory tool that is commonly referred to as “macroprudential”. The argument goes that macroprudential action by APRA would ease the worst of the problems and allow the ‘hard’ issues about banking to be avoided or put off for another decade /generation – though most likely only until the next time the banking system explodes after too much greed and gouging.


Certainly in many economic department tea rooms and “think tanks” macroprudential is the new black. A quick Google search will reveal a bunch of articles on the subject.  Here is one by our very own Reserve Bank of Australia.

Macroprudential is recommended as a clever solution to the problem of private banks recklessly creating too much credit, earning fat bonuses and aiding and abetting asset price speculators who drive up particular asset prices as they chase tax effective capital gains.

The “theory” is that if only APRA would do some more  “macroprudential” we could avoid talking about our systemic “banking” problems.

The problem is that macroprudential is a #fakesolution that offers no real answer to the problems created by the current role of private banks in our monetary system.

What is Macroprudential?

Macroprudential as the name suggests must have some ‘prudential’ element to it.

But it is not ‘prudential’ in the sense that people usually associate with APRA. When people talk about ‘prudential’ and APRA they generally mean that APRA monitors the banks to make sure they are at low risk of going broke.

In their mission statement APRA puts it this way

“….Our mission: to establish and enforce prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions we supervise are met within a stable, efficient and competitive financial system….”

So what is meant by the word ‘prudential’ in macroprudential is a bit obscure, the RBA discussion of macroprudential does not exactly illuminate but it helps….. a bit 

“.While there is no universally accepted definition, most refer to macroprudential policy as the use of prudential actions to contain risks that, if realised, could have widespread implications for the financial system as a whole as well as the real economy; these risks are often referred to as systemic risks…”

It follows that the most likely meaning of ‘macroprudential’  is that if APRA uses macroprudential tools to regulate specifically how private banks create credit APRA might be able to reduce the risks that they will blow up themselves and the financial system along with them.    In doing so this will provide some ‘prudential’ benefit to the system as a whole.

In other words APRA should start directing how the banks make the decision to lend.

While it may sound like macroprudential is similar to what APRA currently does when it monitors ‘prudential’ standards and practices, it is actually very different.

Monitoring prudential standards and practices generally does NOT involve telling the private banks who, when and for what purposes they can create credit.   In theory it simply means telling banks they need more capital / funding source, different sources of funding and terms of various flavours, stress testing them and leaving the banks to ‘divine’ what that means for their credit creation operations.

Regulating how much credit the private banks create, who they create it for and for what purposes is very different.

Macroprudential is not just a tweak to the current regulatory model and this explains why APRA and the RBA have been very reluctant to embrace the concept that they should regulate how private banks create credit.

This should be self evident in the context of country where a highly concentrated banking system has managed to deliver, using hundreds of billions of external liabilities, nose-bleed residential asset prices in a continent sized country with only 23 million people.

Macroprudential – telling private banks how to create credit.

While macroprudential does involve regulating how the banks create credit it generally does not involve any fundamental change in the role of bank credit in the economy.

This is why the idea of macroprudential has become popular with those who recognise there is something profoundly wrong with our banking and monetary model but don’t really want to propose that we do anything substantial about it.

They acknowledge that a “deregulated free market” in private bank credit creation does not work and has a long record of failure but they hope that a bit of ‘regulatory’ intervention will be enough to keep the model from imploding or causing too much harm.

In other words they hope to fix the problems of “free market” private bank credit creation failure by having the regulator pick a few winners and ban the picking of a few duds. A bit of regulatory sticking tape and brown paper.

Macroprudential fans generally have few objections to private banks continuing to make fat profits from pumping asset prices.  All they want is for the banks to do so in a way that is less likely to result in an asset bubble popping.

For example there is nothing inherent in the ‘macroprudential’ approach that requires that credit creation by private banks should be productive and expand the productive capacity of the economy.

Simply stopping private bank credit from becoming bad debt and preventing the sagging of asset prices is the stunted objective of macroprudential theory.

Macroprudential:    Junk food is not the problem.

Using food as an analogy what this means is, that if private bank credit creation is considered food creation macroprudential would not object to the creation of junk food but it would object to banks producing “Junk” food and feeding it to fat people who might suffer a heart attack. It would just recommend that the banks find healthier customers for the junk credit.

Macroprudential generally sticks to the philosophy that private bank credit creation should remain central to our monetary system. It does not really seek to do more than make some minor ‘tweaks’.

What the macroprudential fan wants is for APRA to direct the banks to restrict the production and sale of junk food to fat people and instead direct as much as new credit as possible to healthy people who are not yet fat or at risk of sudden health failure (i.e. defaulting on their debts).

The macroprudential policy fan does not demand that the private banks henceforth produce, as far as possible, only healthy food (credit that expands the productive capacity of the economy).

Productive v Unproductive credit creation

The macroprudential approach does NOT demand that private bank credit creation be ‘productive’ and that is consistent with the way fans of macroprudential policy usually talk about what they consider are desirable macroprudential policies.

Many of those who argue for more “macroprudential” argue that credit be restricted by reference to particular classes of borrowers rather than the object or purpose of the credit.

They generally don’t argue that private bank credit creation be regulated with regard to whether the object of the credit creation is productive investment.

In other words the macroprudential approach argues that “Junk Food” credit creation for the purchase of existing property is fine provided the borrower is in an approved class of borrowers (healthy and less likely to keel over and default on their loans)

For example:

Macroprudential fans will generally argue that APRA should direct the banks to restrict credit to investors who have been gorging on “Junk” credit and instead now direct plenty of junk credit to first home buyers or owner occupiers who currently have lower levels of debt.

From the perspective of the “prudential” in Macroprudential this makes sense, as keeping the asset prices, that secure the private banking system, well pumped up with fresh credit is a fundamental ‘prudential’ objective and as First Home Buyers and owner occupiers are a lower risk of abandoning their credit obligations they are “healthier” or more ‘prudential’ targets for asset price pumping “Junk” credit.

Debt engorged investors are pragmatic and skittish people who will not hesitate to abandon their obligations if the need arises, so the macroprudential fan argues the banks just need to find debtors who can be ‘relied’ on to swallow a nice chunk of negative equity if the need arises.

Seen this way the philosophy of Macroprudential is fundamentally flawed as a real solution for reform of the current Australian banking and monetary system.

Macroprudential is simply seeking to keep a diseased and defective model working by having the regulator direct the banks to feed its “Junk Products” to healthier victims that are more likely to tolerate their ill effects.

Private bank credit creation must be clearly and demonstrably productive.

While the Glass Pyramid is of the view that the private banks should completely lose their privileges with regard to credit creation, if those privileges are to be maintained in any form at all it should only be on the explicit condition that they are used for productive purposes.

In other words credit creation regulation must require that private bank credit creation is restricted to expanding new productive economic capacity in infrastructure, goods and services.

This must be the core criterion of credit creation regulation.

This is not the macruprudential way.

While “new” housing is productive as new housing expands the productive capacity of the evonomy, credit creation to pump up or maintain the price of existing assets to reap capital gains tax benefits fails the criterion completely.

Credit creation to create new productive economic capacity in goods and services production and infrastructure is best of all.

See this article for the Glass Pyramid’s  discussion of the difference productive investment and unproductive #fakeinvestment.

How does credit creation regulation differ from Macroprudential?

The difference is that unlike the ‘macroprudential” approach which is concerned simply with maintaining the profitability and sustainability of the private banks,  credit creation regulation would be explicitly directed to ensuring that whatever private bank credit creation is allowed is restricted to the creation of NEW productive economic capacity.

The class (health) of the borrower is not the key issue though capacity to meet thecobligations of the loan are still important.

What matters is the purpose of the credit creation and that must be productive.

If people want to borrow money to have a speculative punt on asset prices they can still do that but they cannot borrow the money from a bank.

Banks are special and have a special privilege and ensuring it is not abused – i.e. By producing Junk Food credit – should be the central job of the regulators.

The fundamental flaw in the Macroprudential concept

The worst aspect of the “macroprudential” approach is that it is not even coherent or consistent with the overall philosophy of the current monetary model where in theory ALL credit creation decisions can be left “to the market”.   This ideology holds that monetary policy should be king and the banks can be left to “allocate capital / created money” to the most valuable purpose.

The role of a regulator like APRA in this ‘model’ is limited to a ‘prudential’ role. Just to keep an eye on things and make sure the banks don’t go mad and go broke.  But even that is not supposed to happen because ‘in theory’ it is not in the banks interests to destroy shareholder capital.

In simple terms the current banking and monetary model which was hatched in the 1980s and given its full set of wings by John Howard and Costello is supposed to operate perfectly fine WITHOUT an active regulator.

Which is why APRAs act/charter does not explicitly provide for any regulation of credit creation or even macroprudential – lite or otherwise.   It is also why the RBA and APRA denied for years that there is any role for “macroprudential” regulation and have been dragged kicking and screaming to an acceptance that they might have a macroprudential role to direct the banks to sell more “junk” credit to healthier folk rather than manic speculators chasing tax freebies.

This is not an accident or oversight.

The whole premise of monetary policy / private bank credit creation at the core of the economy is that  ‘the market’ is the best way of determining credit creation and it should be independent from government regulators like APRA and RBA. Apart from some ‘prudential’ supervision.

When you keep in mind that bank credit is effectively public money the connection between the monetary policy as king and tight fiscal policy / small government / balanced budget mania is clear.  It is all just neoliberal wealth concentrating asset price pumping mumbo jumbo as public policy.

Unfortunately the theory proved to be wrong.

As 30 years of asset price bubbles has demonstrated.

So even if the macroprudential fans are right and it might be possible to ‘fix’ some of our banking problems by just making some tweaks, the current regulatory regime is not designed for even that level of regulation and will resist the ‘tweaking’.

In any event at the very least APRA should be announcing any and all of its tweaks to credit creation regulation in the same way as the RBA announces changes to the target interest rate each month.

No more APRA “secret business”.

Fixing the flaw

While abolishing the private bank credit creation privilege is the best option, if some people prefer to retain some private bank credit creation the following points are important.

  • The governing objective for private bank credit creation should be that the credit is created for productive purposes only
  • Macroprudential policy is not true credit creation regulation as it does not imply a criterion of only productive credit creation. Macroprudential only aims to keep private banks operational by making sure they sell their “Junk Food” credit products to people less likely to default.
  • The existing regulators APRA and the RBA are simply not designed to regulate private bank credit creation.
  • To change the role of the existing regulators APRA and RBA is not just a ‘tweak’ it involves a fundamental change to their philosophy and the legislation and regulations governing their operations.
  • Such a change requires public debate and a Royal Commission is a good way to start that debate.

Categories: Macrobusiness

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